Prior to the enactment of the Federal Reserve Act in 1913, national banks were prohibited from loaning on real estate, though state banks in most of the states are permitted to do so under certain limitations. National banks may, however, take real estate mortgaged or sold to it to secure debts previously contracted or due to them. Even then they are required to dispose of such real estate within five years.
The reason for this prohibition upon national banks, and the restrictions found in most of the state laws upon the proportion of a state bank's assets which may be loaned upon real estate, may be found in the disastrous experiences of banks prior to 1863 when real estate security was fluctuating and uncertain and heavy losses were incurred in lending on this seemingly solid basis.1 It is a sound principle and policy of commercial banking that the assets shall be kept "fluid." Since most of a bank's obligations are payable on demand it is necessary that the securities it holds shall be readily convertible into money. Commercial paper arising from actual business transactions and having from thirty days to four months to run is of this nature. Such paper, maturing constantly from day to day and being paid or renewed for similar short periods at the option of the bank, gives to the bank close control over its funds. Real estate, on the other hand, is not a "quick' asset, but often a very "slow" asset. A mortgage upon real estate may be perfectly good security, but it cannot be turned into money immediately in case of an emergency. Personal securities and most of the forms of collateral security previously described can be quickly assigned and realized upon, but the transfer of real estate is usually attended with some delay. In the case of savings banks, trust companies and insurance companies there is not the same need for keeping the assets in a convertible form; indeed it is rather desirable that a considerable part of their investments shall be more or less permanent; real estate loans, therefore, are well suited to their purpose.
In the past, conservative bankers have regarded the restrictions placed by law upon real-estate loans as wise and salutary. In recent years, however, there has been a persistent demand, mainly in the agricultural sections of the West and the South, where land and its products constitute the chief wealth, for more liberal laws regarding loans on farm lands. It is urged that a farm mortgage, if carefully selected, is the best kind of security; that state hanks, savings banks and trust companies are authorized to make such loans, and that national banks should be given the same privilege. More and more, however, commercial banks are tending to accumulate savings or time deposits. With proper restrictions a portion of such funds may safely and advantageously be loaned upon the security of farm property. This has been recognized by the Federal Reserve Act which provides that a national bank not situated in a central reserve city may make loans, limited to five years, on improved and unincumbered farm lands within its Federal reserve district up to 50 per cent of the value of the land. But no bank may loan more than 25 per cent of its capital and surplus or more than one-third of its time deposits in this way. The Act also provides for the rediscount of notes, bills and drafts drawn or issued for agricultural purposes or based on live stock and having a maturity not exceeding six months.
1Bolles: Money, Banking, And Finance, p. 118.