There are several reasons why it is preferable sometimes to make advances against notes as collateral instead of discounting them. The borrower may need, perhaps, only part of the face value of the notes, and that only for a short time. The quality of the paper may not warrant an advance of more than a certain percentage, or the notes may be of a longer currency than three or four months, beyond which time a bank is loath to make an advance. Its assets must be kept liquid and not locked up in long time loans.
The merits of a note tendered as collateral should be gauged with no less care than if offered for discount; a large nominal margin may be delusive and by no means an adequate security. Such notes should be scrutinized as critically as discounted bills, and rejected if defective in any vital part. If notes offered by agricultural implement dealers and others are encumbered with conditions which render them nontransferable, they should be refused. Lien notes, or notes secured by lien on implements, machinery and other movable equipment, sold, should only be taken for collection, as it must be borne in mind that the maker has the right of set-off for any legitimate claim against the vendor, and third parties must always be prepared for something of this kind.
The bank in making advances of any nature has the right to expect the note taken to be free from any irregularity, and in accord with the requirements of the Bills of Exchange Act. It is not sufficient that a bank could probably overcome any irregularity by proving its case; even successful litigation is objectionable, and invariably means considerable worry and some loss in costs and time.
All notes taken as collateral security should be hypothecated to the bank on a form duly signed by the borrower (Figure 47 or 28). The form Figure 47 can also be used to pledge stocks and other securities, permissible under the Bank Act. The attorney for a customer cannot hypothecate collateral notes unless specially empowered to do so. All collateral hypothecations should be consecutively numbered as received from the customers, and filed in proper order in the vault.
The full margin of good collateral stipulated as the basis for any credit must always be maintained. A liberal margin will generally be found to be insufficient in case of trouble. The margin agreed upon in all cases should be calculated on the amount of collateral offered, and not based on the amount of the advance. For instance, on a margin of 25 per cent, advance $75 on each $100 worth of collateral deposited. Do not base the margin on 25 per cent of the advance, which in the above would only give $93.75 collateral for every $75 advanced.
Overdue paper should not be accepted as collateral.
In the case of wholesale accounts obtaining advances against trade paper deposited as collateral, it will be necessary to follow the account as closely as if the paper were discounted. For this purpose the blue book used in the discount department should be used (see Figure 25), and an account opened up for each obligant.
Hypothecation Of Bills And Securities
__________________Bills, Notes and / or other Securities in connection with the account of _____________, customer of The_______________________Bank.
If security is a bill or note enter its date in this column
Eater in this column:
Name of principal obligant, if the security is a bill. Description, if any other form of security.
The above mentioned securities and any renewals thereof and substitutions therefor and proceeds thereof are to be held by ThE....................Bank as a general and continuing collateral security for payment of the present and future indebtedness and liability of the above-named customer, and any ultimate unpaid balance thereof, and the same may be realized by the Bank in such manner as may seem to it advisable, and without notice to the undersigned, in the event of any default in such payment. The said proceeds may be held in lieu of what is realized, and may as and when the Bank sees fit, be appropriated on account of such parts of said indebtedness and liability as to the Bank seems best. The undersigned agree that the Bank may grant extensions, take and give up securities, accept compositions, grant releases and discharges, and otherwise deal with the customer and with other parties and securities as the Bank may see fit, without prejudice to the liability of the undersigned. The claims of the undersigned against any party on whom any of the foregoing unaccepted bills are drawn are hereby assigned to the Bank in the event of non-acceptance.
N.B. - If any bill or note lodged has been given for the accommodation of the customer, the accommodation maker or indorser must sign this document, and if any bill or note payable on demand is included, on which there is an indorser other than the customer, such indorser must sign also.
If the securities lodged are owned by some one other than the customer, this document is to be signed by such owner as well as by the customer.
In all cases of advances against this class of security it is necessary to see that drafts and notes which are returned unaccepted or unpaid are settled for, eventually, by the maker or drawee. The wholesale surrendering of these returned items to the pledger in exchange for fresh collateral drafts should not be permitted. Under no circumstances should unaccepted drafts which are lodged as collateral be held without presentation at the request of the pledger, or for any other reason.