By collateral security is meant stocks, bonds, and other evidences of property deposited by the borrower to secure a loan made to him by the bank. Such securities are deposited as a pledge or guarantee that the loan will be repaid at maturity; if not paid the securities may be sold to reimburse the lender. Collateral loans though made generally to brokers on such security as stocks are made also to merchants and commercial houses, and all kinds of collateral are offered. They may be made on "time," running for thirty days to several months, or on "call," that is, subject to payment on demand. The various forms of collateral offered to secure bank loans may be roughly grouped into three divisions: stocks and bonds, merchandise, and real estate. Some of the more important types of collateral loans may now be briefly considered.

Sometimes a merchant, instead of discounting the notes he receives in the course of business, may prefer to offer his own note to the bank for discount, pledging the "bills receivable" as collateral. If any of the bills thus pledged fall due during the term of the loan they must be "taken up" and replaced with other security or a corresponding part of the loan must be paid.

Assigned accounts are sometimes used as collateral to loans when business houses cannot secure their customers' notes for goods sold. The practice is to select some of the larger and better accounts receivable and assign them to the bank from which the loan is sought, with the understanding that the bank is to receive all payments on account and apply all receipts to the reduction of the loan, returning any surplus thus received above the amount of the loan to the borrower. This kind of collateral security is not held in high esteem generally among banks. It involves a rigid investigation of the financial standing of every account assigned to the bank, as well as considerable work in the handling of the loan and the collection of the payments. Furthermore, borrowers who resort to loans on this kind of security have in many cases exhausted every other kind of borrowing asset, and, therefore, need watching.

Collateral Note   Front

Collateral Note - Front.

Another form of collateral security which is extensively used, especially by traders on boards of trade and produce exchanges, is the warehouse receipt. These are receipts for goods such as grain, cotton or tobacco, stored in a warehouse under the regulation of a produce exchange or of the state authorities. They certify to the quantity and grade or kind of produce which will be delivered to the holder of the receipts when properly indorsed. The receipts are negotiable and when pledged for a loan at the bank are indorsed over to it, giving it a lien upon the goods. If the loan is not paid at maturity, the bank can take possession of the goods and sell them to satisfy the debt. If the borrower wishes to sell some of his cotton or wheat during the period of the loan he will generally be required to reduce his loan by a corresponding amount or to substitute other receipts.

Collateral Note   Back

Collateral Note - Back.

There has been a marked decline in recent years in the amount of trade paper offered for discount. The banks have therefore been compelled to look to other bases of security for their loans. The collateral loan based upon such security as stocks and bonds has come into wide use, but loaning upon merchandise has been regarded in some quarters as a kind of pawnbroking. Merchandise stored under adequate warehousing systems may, however, offer a perfectly safe form of collateral and this type of collateral is likely to have considerable development in the future. Already in the larger cities some of the banks in the wholesale districts carry large lines of loans on merchandise.

A bill of lading is a written acknowledgment by a railroad or other carrier of the receipt of goods for transportation. Since it is negotiable, and represents actual property, the bill of lading is a very safe kind of security. These bills are used extensively in connection with bills of exchange or drafts which they serve to secure. For instance, A, of New York, sells a bill of goods to B, of Chicago, subject to draft at thirty days. A attaches the bill of lading given to him by the railroad when he ships the goods, to the draft drawn either in his own favor or in favor of his bank and takes them to the bank. The bank forwards the draft with the bill of lading to its agent or correspondent in Chicago, who presents the draft to B for acceptance. Upon being notified by the Chicago correspondent that B has accepted the draft, the New York bank advances the money to A. Possibly, A may get immediate use of the proceeds of the draft upon depositing it. Ordinarily the bank is safe in advancing the money to A, since it retains title to the bill of lading until its Chicago correspondent secures B's acceptance of the draft, which is his promise to pay in thirty days. B cannot, at least he should not, get possession of the goods without the bill of lading which the Chicago correspondent surrenders to him only after he has accepted the draft. The "acceptance" is in effect double-name paper, secured by actual merchandise the evidence of which, the bill of lading, has passed through the hands of the bank. At maturity the acceptance will be collected by the Chicago correspondent of the New York bank and forwarded probably in the form of a bank draft. If B fails to meet the acceptance at maturity, the bank can recover from A.

The bulk of the cotton crop and a considerable part of the grain crop and other products are financed in this way. A few years ago a New York bank reported the handling of bills of lading representing over one hundred different products. Recognizing the importance of this branch of the banking business, and the abuses and frauds attending the use of bills of lading, the American Bankers' Association has for years tried to secure national legislation to protect banks against losses in handling this class of security. Several states have enacted a uniform hill of lading law suggested by the Association.

Another form of collateral which is coming largely into use is the life insurance policy. The older policies in the straight life or endowment form were not desirable as collateral to a loan because the lender might have to keep up the premium payments and wait for years to get his money back. The modern policy with a cash surrender value is better suited for use as collateral. A bank can safely loan on such a policy up to its cash surrender value at the time, for it practically amounts to a demand certificate upon the insurance company. Moreover, as additional premiums are paid the margin of security constantly improves.