As stated in a previous chapter the chief business of the commercial bank is making loans through the purchase or discount of commercial paper. In exercising this function banks perform their most useful service to the business community and make the most profits for their stockholders. Attention has been drawn, also, to the close relation existing between loans or discounts and deposits. The bank's loanable funds come mainly from deposits and deposits arise largely from loans. These two important functions of the commercial bank are commonly associated in the term "discount and deposit."
In describing how a bank lends money, or more exactly, lends credit based upon its resources in money, it may be well to note the theoretical difference between loans and discounts. Banks discount paper for their customers; they buy the paper of others, commonly through the medium of note brokers. When a bank discounts the note of a customer his account is credited with the amount of the note less the "discount," that is, the interest or charge for the use of the bank's credit; the amount of the note purchased from an outsider, on the other hand, is paid for by check or draft, and at maturity the sum repaid will include the face of the note and interest. Though the latter transaction does not usually create a deposit in the bank buying the note, a deposit is created in some bank in which the check or draft is denosited. This explains in part why "deposits" and "loans and discounts" so nearly keep pace in the statements of commercial banks.
Bank loans are of two kinds: (1) time loans and (2) demand or call loans. Call loans are subject to call at any time and are made mostly to brokers on collateral security such as stocks, bonds, warehouse receipts, and like evidences of property. Collateral is sometimes given with time loans also, especially when they are made on single-name paper. With respect to security or protection, loans may be divided into (1) those having only personal credit or security and (2) those with collateral security.