Limitation of Acceptance Credit In addition to the interests of the drawer, drawee, acceptor, purchaser, and the party to whom the letter of credit is issued and his guarantor, the general public has an interest in the actual and contingent liabilities undertaken by the banks. These obliga tions, if recklessly assumed, may seriously affect the banking situation. In old banks experienced in the acceptance business, and in banking communities which exercise a mutual guardian ship and restrain excessive accepting by any bank, the danger is small; but when experience in this field of banking is lacking and where banking policy is conservative and sound in other respects primarily because of a severe system of bank supervision, the state may find it necessary to put restraints on the free exercise of the acceptance power. By limiting a bank's power to accept only such bills as arise out of the importation and exportation of merchandise or other such commercial transactions, a very definite limit is put to the extension of this sort of credit. Also if the total amount of acceptances outstanding at any one time is limited to some percentage of the capital and surplus of the bank, the liability can be kept within safe bounds. A third method is to limit the aggregate amount of acceptances bearing one drawer's name, thus distributing the risk. The United States government restricts the acceptance powers of national banks in these ways.
Difference Between Accepting and Lending A common misconception exists as to the difference between the processes of accepting and lending. The misconception, as commonly stated, is that in accepting, the bank does not part with money as it does in lending. In preceding chapters an effort has been made to show that when a bank lends it hardly ever does more than extend its demand liabilities in the form of bank notes and deposits. If it lends bank notes, it lends money; but the proportion of bank notes to deposits is small and the number of banks that issue notes is also small. To say that a bank lends money when it extends deposits is not exactly true; what is done is to extend its credit in the form of rights to draw money; to only a small degree, however, is money actually withdrawn, for in the first place many checks on the bank are redeposited with it, and in the second ,place the balancing of checks at the clearing house leaves only small settlements to be made and even these are not usually made in money.
Now when a bank accepts a time draft or bill of exchange it lends its credit to the drawer. Instead of the drawer exchanging his 6o-day promissory note for the bank's demand deposit credit, which will more readily circulate in the community, he draws a 6o-day bill on the bank, which by accepting the instrument ex tends to the drawer the use of its time credit for 6o days. The
drawer then converts this time credit into demand credit by sell ing the bill in the discount market for bank notes or a check or for cash which he immediately deposits in his bank.
In the foregoing explanation the important point to grasp is that the difference between accepting and lending is not the paying as against the non-paying of money, but is the extension of time credit as against demand credit. In either case the bank incurs a direct liability, against payment of which provision must be made. The two facts: first, that it is a time liability, and second, that the drawer has contracted to put the bank with funds before the maturity of acceptance, relieve the bank from anxiety about meeting the acceptance. The bank does not ex pect to be obliged to pay from its own funds; it regards the lia bility rather as a contingent one and therefore does not concern itself so much about its reserve. In this there lurks a positive danger. If due caution is taken in selecting drawers, in protect ing the issue of letters of credit, and in watching the documentary securities, the need of a reserve is small. No banker, however, can trust in the naive idea that, since accepting does not require the immediate payment of money, he may extend his acceptance business to any amount and keep no reserve as a protection there to. A reserve should be kept, but it may be much smaller than against bank notes and deposits.
Protection of Bills Payable A fourth form of bank credit liability that requires protection is Bills Payable. When a bank needs funds and does not fmd it expedient or possible to discount paper in its portfolio, it may borrow from other banks or financial institutions on its promis sory note. Where the practice of rediscounting, either with the central bank or on the open market, is the prevailing banking practice, borrowing by a bank on its note is unusual. In contrast with European practice, where a broad discount market has been developed, the practice of the American banking system has been quite provincial. The common method in the United States has been for a bank to borrow either on its own unsecured note or its note secured by pledge of commercial paper or—sometimes securities. By this method the paper need not be indorsed, and the creditor protects himself by insisting upon a liberal margin of safety. Loans of this kind are usually seasonal or arise in tight money periods. A bank which borrows in this way generally carries a good balance with the creditor bank during the rest of the year, and thus establishes friendly relations and a potential "line of accommodation." Interbank borrowings of this sort tend to the maximum utilization of the country's funds and the equalization of money rates both in place and time. The loans are more often time loans than call loans.