9. Industrial second class is made up of automatic or seasonal borrowers. By these terms it is intended to describe the operations of manufactur ers, merchants, farmers, drovers and other similar borrowers who require temporary accommodation during a period of production, transportation, distri bution or collection. These are the ordinary com mercial loans which have been described.
The rediscounts of other banks are a favorite form of this sort of loan, especially if the borrowing banks are located in sections where seasonal borrowing is the usual rule and are, therefore, themselves seasonal or temporary lenders. The risk is slight and the pro ceeds of rediscounts are likely to remain on credit with the lending bank in much larger proportion than the proceeds of ordinary loans. A bank usually borrows to increase its reserves; a firm usually borrows for spending purposes.
Until recently, rediscounts were looked upon with disfavor in the United States. Borrowers did not like to see their paper peddled about by the banks and thought that an attempt to rediscount was a sure sign of weakness on the part of the bank. Nevertheless, banks, especially those in the South and West, did a considerable amount of rediscounting in secret. In order that the rediscount operation might not be be trayed by the bank's indorsement, a paster bearing the indorsement was attached to the note and removed before it was returned to the original maker. This prejudice against rediscounting was unreasonable. The commercial paper which a bank holds should be one of its most liquid assets, and the sale of the paper is no evidence of weakness. As explained elsewhere, rediscounting forms one of the most valuable features of the great European banking systems.
The two classes just mentioned are considered the most desirable loans; the two following are less de sirable.
10. Capital loans.—A third class is composed of capital borrowers. This phrase is intended to de scribe the borrowing of permanent capital to be re paid from profits as they accumulate. This is a financial loan and it is likely to lead to continuous loans and over-trading. For instance, the president of a manufacturing corporation, constructing a new plant, finds that its cost exceeds the capital subscribed by the stockholders. He borrows the necessary money by making notes which are discounted by a friendly bank. This loan can be extinguished only
by borrowing elsewhere, by continuous operation at a profit, or by the sale of the plant.
The weakness of this position would quickly be made manifest should manufacturing operations cease. All capably managed banks discourage such loans in any substantial measure unless conditions are unusually favorable for continued high earnings which can be applied to reducing steadily such a loan within reasonable time. Capital for requirements of this character should be provided by the additional sub scriptions of stockholders or by bond issues. That is to say, the funds should be held in the form of a per manent or long-term borrowing at the option of the borrower thru bonds secured by mortgage.
This idea is expressed concisely by the advertise ment of a prominent Chicago bank: "Conservative banking consists in caring for many interests, while capitalizing none." The statement of a strongly or ganized manufacturing corporation or firm indicates convertible, quick assets sufficient to protect all quick liabilities. Of course, from the standpoint of the manufacturer engaged in a highly profitable line of work, there is an alluring temptation to endure for a period the sacrifices, buffetings and annoyances of carrying what is termed a plant debt, for the bor rower knows that he will be enabled thereby to main taM permanently a low capitalization and thus render the task of earning dividends lighter for all time to come when the plant debt shall have been finally ex tinguished out of earnings.
Not all financial loans are necessarily bad, but they should be made by a bank only after the most pains taking investigation. As a rule, they run for a con siderable length of time and thus are not a suitable form of loan for commercial banks.
11. Mortgage or permanent borrowers on mortgage constitute the final group in Mr. Law's classification. To this class belong the holders of improved and central real es tate in the larger cities. Because of the length of the loan and the difficulty of finding a ready market for mortgages in times of emergency, this class of loans has not been considered suitable for commercial banks. They are generally placed with corporations control ling trust or permanent funds, such as insurance com panies, savings banks, trust companies and mortgage, loan and investment corporations.