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W. P. G. HARDING, GOVERNOR
PAUL M. WARBURG, VICIGOVIRNOR
FREDERIC A. DELANO
,..,..
ADOLPH C. MILLER
CHARLES s. HAMLIN
!!:X·OP'F'JCIO MEMBERS
WILLIAM ..l..WcADOO
y• ...,
SECR-Y OF THE TREASUBY
CHAIRMAN
.
JOHN SKELTON WILLIAMS
H. PARKER WILLIS, S!CRITARY
SHERMAN P. ALLEN, ASST. SECRETARY
FEDERAL RESERVE BOARD
COMPTROLLER OF THE CURRENCY
AND FISCAL AGENT
WASHINGTON
ADDRESS REPLY TO
FEDERAL RESERVE BOARD
August 12, 1918•
. X:-1120
Dear Sir:
1
There is
by
inc~osed
for your
Counsel ae to the treatment as a
inforuati~
l~bility
copy of an opinion
of the
~aker
to the bank
for borrowed money 4 of_ a note Which has been rediscounted by a member
bank.
'the Boaf(l does not mean to suggest that n:ember 'banks should
...
avail' themselves generallY by rediscount.ing, of their authority to
trant lines of crecU.t in excess· of 10 per cen,t of their capital and
surplus as
~rescribed
by Section 5200 of the aavised.Statutes1 as
com~tible
is the belief of the Board tha.t wherever
i~
with the public.
interest, ¥red~t shi:u14 be ouriailecl rather than ekpanded.
Banks
shOUld kee~ in ~d thei~ contingent l~ability on rediscounted paper
which, if not paid by th~ uaker.. nust be taken up by the endorsing
~nlf,
and
i~ unable to reciiscount a. renewal, the bank. would find
itself enaumberecl with an excess line.
wish to grant
l~rger
Jn . cases,
however,
where
banks
.
.
.
'
credits with Govenm:ent obligations as security,
the power Cl.ltline4 in the Counsel's letter rray be a.va.ile.4 of to
advantage.
Very truly
you~a,
Governor.
The Governor,
Faderal
'•
.
Inclosure.
Rese~e
Bank,
~C)
& r<::d
t
x-n2oa
FBDBRA.L RESERVE BOARD
WASHINGTON
M.
August 7, 1918.
C. Elliott
Counsel
My dear Governor:
In an op1n1on approved by the Boa~d and published
on page 638 of the July, 1918, Bulletin, the question was
considered whether a note rediscounted by a member bank
should thereafter be treated as a liability of the maker to
the bank for borrowed money. In that opinion the following
statement appears:
nThis question was considered by the Board and
by the office of the COmptroller in connection with
the limitations prescribed by Section 5200 Revised
Statutes on liabilities to a national bank of any
one person, firm or corporation.
The conclusion was reached in that case that
notes which have been rGdiacountud by a national
bani.;: and which are no longer ormo<i or held by the
baru{, should not be included as a liability of the
maker to the banl-l: for borrmved money Yli thin the
meaning of Section 5200. 11
Exception has been taken to this conclusion by
some of the officers of the Federal reserve banks, and by
certain national bank examiners, and there seems to be some
apprehension on their part that this ruling of the Board
may be used by member ban.lrs for the purpose of evading the
limitations prescribed by Section 5200.
Yo~ have aslced this office to give further consideration to the question involved and to suggest \-.rhat, if any,
action the Board or the Comptroller should take to prevent
excessive loans from being made urAer authority of this ruling.
THis question is one which involves the application of the law of negotiable instruments.
Under Section 5136 Revised Statutes, ·;;hich prescribes the corporate powers of national ban~r:s, such banks
are authorized, a.-nong other things, to discount and"negotiate"
promissory notes •
..,
.
...
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X 1120a.
Under the Negotiable Instruments Law (Sec.30)
11 An 'instrument is negotiated
when it is transferred from
one person to another in such manner as to constitute the
transferee the holder the reof 11 •
Under S.action 5200 Revised Statutes the liabilities
to a national bank of any one person for borrowed money are
limited to an amount which mu~t not exceed ten per cent of
the capital and surplus of the lending bank.
Under authority of these two sections it is clear
that a national bank may discount the note of a customer
Ylhich does not exceed in amounf ten per cent of its capital
and surplus and may subsequently negotiate or sell this note
to a bona fide purchaser for value without notice ..
...
The question involved is whether the maker of the
note continues liable to the bank after the note has been
negotiated and is o>vned by a bona fide holder in due course •
•
Section 51 of the Negotiable Instruments Law provides that "The holder of a negotiable instrument may sue
thereon in h~e-own. name and payment to him in due
cotirse discharges the debt 11 •
,;
_j
!t is clear, therefore, that when such a note is
rediscounted by a bank its rights are transferred to the
holder in due course and the maker becomes liable to the
holder. It necessarily follows that the maker's iiability
to the bank ceases. If this were not true the mak:er might
obtain a dischar3e of his liability on the note by paying
the banlt even after it had transferred its rights by endorsement of the note to a bona fide holder.
To hold that the maker of a note continues liable
to a national bank for money borro..,-md,after the bank has
rediscounted the note, would be equivalent to holding that
a negotiable promissory note loses its negotiability when
discounted for the maker by a national bank. There is
clearly no legal justification for such a conclusion.
..
It h~s been suggested that the position taken in
the opinion .under consideration constitutes a radical departure froo previous rulings of the Car.1ptrollcrs office •
It is true that for m~ years it was custooary
for mtional b1.nks to continue to carry as assets notes
which had been rediscounted. This practice, which necessarily
resulted in a duplication of the assets of n~tional banks,
has, however, been discontinued and while the reports ot condition now show the Ol':lount of bills or notes rediscounted
those amounts are not included in tho total assets of the bank.
74.
t
-3-
X 1120a.
It necessarily follows that unless a note remains an asset
of a bank after it has been rediscounted it does not constitute
a liability of the maker to the bank but becomes a liability
of the maker to.the bona fide holder.
..
I
This principle has been consistently recognized by the
Comptroller's office in the administration of the estates
of failed banks. The maker of a note held by a failed
bank is ordinarily entitled to offset his deposit balance
with the bank against the note but in the administration
of receiverships the Comptroller has consistently declined
to allow the maker of a note to offset his deposit balance
if the note is not in the hands of the receiver but is held
by some other bank under rediscount on the ground that he
may thereby obtain preference over other creditors to the
extent of the offset if the estate of the bank is 'nsufficient
to pay the depositors in fUll. This question was involved in the
case of United States P4P! v. Mq~ir.,ll6 N• C. 550;21 s. E.
~In tl1a.t case the maker of the note ''"a.s endeavoring to
~ve,his liabi~ity treated as a liability to the. bank in
order to obtain the benefit ot an offset but the court
dis alloo.-.,ed his claim.
With all due deference to the opinion of those nho
have taken exception to this ruling of the .Board, the fear
that it may be successfUlly used by banics to evade the
limitations of Section 5200 seems to be very much exaggerated.
·,
So long as the customer's paper is well secured or
is of such intrinsic value as to find ~ ready ~~rket with
other banks the contingent liability incurred by the endorsing
bank is not of serious consequence. On the other h~, if
the p~per offered for rediscount is not intrinsically valqable
and the offering bank is merely seeking to evade the limitations
of Section 5200,it is not likely that other banks would feel
disposed to rediscount such paper. They would in such case
be muCh more likely to require the borrowing bank to execute
its note secured by its customer's note with a proper margin,
in which case the customer's paper would remain the property
of the borrcw1ing bank and would have to be included in the
liabilities of the ~rs to the borrowing bank. If the
borrm7ing bank, in order to evade the limitations of Section
5200, should enter into an a~eement with its correspondent to
repurchase rediscJunted paper before maturity, or to leave
the proceeds of the rediscount on deposit with it, the transaction would not have been entered into in good faith and an
examiner or officers of a Federal reserve bank would be
justified in treating such paper as subject to the limitations of Section 5200.
·~
.
75
'
.
X ll20a ~
As stated by Daniel on Negotiable Instruments
(Section 779-b, Volume l, Sixth Edit ion)"U:rdR' several provisions of the statute (Negotiable Instruments Law),it is held that merely giving the transtetrer credit does not constitute the
transferee a holder in due course. Thus when a bank
simply discounts a note ani credits the amount thereof
on the endorser•s account, without paying to him any
value for it,such bank is not a purchaser for value
or a holder in due course as defined by the statute".
(AlbaRv County Bank v. People's Co-operative Ice Co.,
~6 N. Y. S.772, 92).
If, however, a bank negotiates a note of its
customer in good faith in order to obtain additional fUnds
to take care of the needs ot other eustaners, there would
seem to be ~o justification far ~ting the liability of
its customer to the bona fide holder of the note as a liability to the bank itself. The tact that the bank is
contingently liable as end.ars~r and may be called upon to
pay the hate if the maker defaults should very properly be
taken into eonside:ratiob in dete:n'nining liabi-lities that
may be i~urred by the bank under Section 5202 but should
not be taken into consideration in determining the li:!bili ...
ties that may be incurred to the bank under Section 5200.
The Board ha.s heretofore ruled that a national
bank may lenl to one customer an amount equal to ten per
cent of its capital and surplus and may the rea:fter accept
drafts of the same customer under authority of the Federal
Reserve Act.. In this case the bank assumes a direct and
not a contingent lia. bili ty on the drafts accepted and is
the primary ob:Ugor. This fact. however, does not justify
the Board in requiring banl~ to treat this liability assumed by the bank as a. liability of its customer to the
bank f'or borrowed money within the rmaning of Section
5200.
If the Board feels that it is necessary to take
fr~~ being used
by member banks as a means of evading the limitations of
Section 5200, it is suggested that it might amend Section
lll of Regulation "A", series of 1917, to read substantially
as follows:
any affirmative action to prevent its ruling
111.
Applications for Rediscount.
"All applications for the rediscount of
notes, drafts or bills of excl1ange, must contain
76
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a certificate of the member bank in form to be
prescribed by the Federal reserve bank, that to
the best of the knowledge and belief of the officers of the applicant bank, such notes, drafts
or bills of exchange have been issued for one or
more of the purposes mentioned in 2 (a); such
certificate shall also show whether the notes,
drafts or bills discounted for any one borrower
whose paper is offered for rediscount, exceeds
ten per cent of the capital am surplus of the
applicant bank,including notes, drafts or hills
held in its ovn1 portfolio or under rediscount
with other banks.
If the aggregate of such notes, drafts or
bills does exceed tert per cent of the Capital
and surplus of the applicant bank, such certificate shall shcm (a) the amount held in itS own
portfolio, (b) the amount rediscounted with other
banks,(c) the amount and character of security
held;(d) whether or not the member bank is under
agreement to repurchase at or before maturity
notes, drafts and bills rediscounted. (o)whether
or not it has received the actual proceeds of
notes, drafts and bills rediscounted or mere~
a book credit therefor."
With this regulation in force,the Federal
reserve bank i.-.rould be able to determine the amount of
secured am unsecured paper diScounted by the applicant
bank for any one borr~ver and rediscounted with other
banks. If properly secured, the contingent liability
of the member bank on the paper rediscounted in good
faith would constitute merely a nominal liability. On
the other hand. if the intrinsic value of the paper rediscounted appeared to be such as to make it more than
probable that the endorsing member bank would be called
upon to pay it, the Federal reserve bank could in its
discretion determine whether such paper thlnlgh technically eligible should be accepted for rediscount by the
Federal reserve bank.
The Comptroller of the Our rency might in like
manner require national banks to show in their reports of
condition information called for in the Regulation of the
Board as amended in aocordq:nae with the foregoing suggest.ion.
-6-
X 112Ga
!"..
The National Bank Examiner might likewise require the officers of the national bank to certify on oath
whether the bank is under agreement to repurchase rediscounted paper and whether it has received the proceeds of such
paper or merely a book credit and, for reasons hereinbefore
stated,mi8ht treat all paper rediscounted under an agreement to repurchase or for· which merely book credits have been
received, as subject to the limitations of Section 5200.
Respecttu.lly,
M. C. Elliott,
Counsel.
Hon. W. P. G. Harding,
Governor,
Federal Reserve Board.
~.
78
@FedFRASER