XIII Overdrafts

CHAPTER XIII OVERDRAFTS The overdraft, much less common in American banking than in England and Scotland,1 represents a loan. The overdraft is, therefore, one form of bank credit. Now an overdraft is frequently the result of error. If, however, errors are large and frequent, they are probably not merely inadvertent. Overdrafts are also the result of chronic indifference on the part of the depositor. They are also to be expected in connection with the accounts of depositors that are hard pressed for capital. Business firms newly established, whose trade is less brisk than was expected, are likely to over1 The system of cash credits, most fully developed by the banks of Scotland, in accordance with which borrowers are enabled to secure the privilege of drawing on the bank up to an amount arranged for, paying interest on only what is actually drawn from the bank, is often referred to as having been a most powerful force in the development of the resources of Scotland and the advancement of its agriculture, commerce, and manufactures. A cash credit may be defined as permission to run an overdraft secured by good bondsmen, limited in amount and to be reduced to small proportions, if not entirely repaid, at certain times. Permission to overdraw may stand for a long period of years unless the bank becomes dissatisfied with the bondsmen or they withdraw from the obligation. Cƒ. John Johnston, Scottish Banking System, Proceedings, Twenty-Eighth Annual Convention, American Bankers' Association, New Orleans, 1902, p. 78.

235 236 BANK CREDIT draw their accounts. Farmers, eager to "get out of debt" and having an almost insatiable appetite for more land, as a rule maintain either no bank accounts or only small balances. The farmer may leave a standing order at the bank to call him up if he overdraws.1 Banks, as well as business concerns, overdraw their accounts occasionally. Many country banks in the South have had annoyances arising out of delay in the mails or telegraph delivery remittances. Frequently, when such delays have occurred Northern banks have protested the checks without notice to the banks that drew them, to the deterioration of the credit of the drawing bank.2 In general, however, bankers in the past, particularly before 1915 when the Comptroller of the Currency issued a ruling to national banks against the practice, have taken the position that there is no use of making an enemy for the bank because of an overdraft of one hundred dollars or less, which might influence unfavorably that many depositors.

Where overdrafts are very large the condition can sometimes be explained by reference to competition, and particularly among banks that are not subject to strict supervision. A big hearted private banker is more likely to be imposed upon by his depositors than the national banker of similar temperamental makeup. But a national bank may be in keen competition 1W. H. Smith, Balances as a Basis of Credit, Proceedings, Fifteenth Annual Convention, South Carolina Bankers' Association, 1915, p. 10. 2 T. J. Byerly, Troubles of a Banker Arising from the Overdraft, Proceedings, Thirteenth Annual Convention, North Carolina Bankers' Association, 1909, p. 148.

OVERDRAFTS 237 with a private or state bank operated under less strict examination and supervision and find it difficult to keep its ledger free from overdrafts on account of that competition. Such a national bank in Ohio (Mt. Sterling) at one time had total resources of approximately $400,000 and overdrafts of about $50,000. At that time it was not uncommon for the two banks in Mt. Sterling, a town of 1,200 inhabitants, to have overdrafts in excess of the total overdrafts of all the banks in any city in the state.1 Objectionable Features The overdraft is highly objectionable on several grounds. It is the result of somebody's miscalculation or carelessness and without definite agreement as to its terms.2 Overdrafts are unavailable in case of need. They cannot be rediscounted. Furthermore it is maintained that in the liquidation of the affairs of defunct banks the percentage of loss from overdrafts is much larger than where the loan is secured by note.3 In many instances large loans that have endangered the safety of banks began as overdrafts. In these cases the banks tried to protect themselves by converting the overdraft into a loan when it was so late that the note 1R. H. Schryver, How the Rural Batiks May be Benefited by the Federal Reserve Bank, Proceedings, Twenty-Fifth Annual Convention, Ohio Bankers' Association, 1915, p. 68.

'Thornton Cooke, The Passing oƒ the Overdraft, Proceedings, Twenty-Eighth Annual Convention, Kansas Bankers' Association, 1915, p. 85. 1J. H. Cranford, TriaL· of a Country Banker, Proceedings, Alabama Bankers' Association, 1904, p. 51.

238 BANK CREDIT at best represented only a hope.1 It is probably true that a banker able to say no when he feels a loan is unsafe often permits an overdraft rather than protest a check. In State and National Banks State banks, as well as national, have been gross offenders in respect to overdrafts. The state instituI.2O .60 ,eo -rt> •20 1V InA / \Á ¯ i \ \ \ l t-OO] •60) •¿a< raro >ers >eao taas /aao teas raoo rsor r?m ttta· /e»o, Diagram 7 tions have, however, in some instances, offered the excuse to examiners that they allowed overdrafts because competing national banks allowed them.2 How extensive a place the overdraft has occupied in the assets of our national banks is shown by diagram 7,—based on reports of the Comptroller of the 1R. N. Sims, Banks and Their Obligations, Proceedings, Louisiana Bankers' Association, 1917, p. 49. 2 Idem, op cit., p. 48.

OVERDRAFTS 239 Currency,—in which is shown the ratio of overdrafts to loans. It is clear from the diagram that the troublesome item is passing. State banks and trust companies have shown the same tendency, only less strong, to reduce this red ink item. From 1910 to 1916 the ratio of overdrafts to loans in all non-national banks fell from .52 to .31 per cent. Rules for Controlling Overdrafts Where overdrafts are allowed at all, the banker may be governed advantageously by the following considerations: 1. Let it be fully understood that an overdraft is an exceptional privilege, granted only for the time being and in emergency. 2. When overdrafts occur, as by mistake, notify the customer at once, requesting him to settle. 3. Grant the privilege to no one about whose ability or willingness to pay there is any doubt. 4. Charge interest as on any other advance of funds. 5. Suggest in a friendly manner to the customer who asks to be allowed to overdraw that it is contrary to the policy of the bank and that an advance on note would be a favor to the banker.1 6. Rather than permit an overdraft, particularly in connection with the operation of buying grain and stock, hold a demand note for a sufficient sum to prevent it, even if interest is charged only on the sum used.

1W. G. Dillon, Overdrafts, Excessive Loans, Past-Due Paper, Proceedings, Seventeenth Annual Convention, Tennessse Bankers' Association, 1907, p. 72.

240 BANK CREDIT 7. Educate the merchant and others to purchase drafts, rather than send personal checks. 8. There is a type of depositor that insists on making use of the overdraft in order to avoid paying interest on funds he might not use. He may be going out of town and is not sure he will need additional funds. The banker ought to interrogate such customers politely and closely as to who is under greater obligation to hold funds in readiness to meet the emergencies of the customer's business, the banker or the customer himself.1 9. A customer, let the banker bear in mind, is naturally afraid to attempt to overdraw the first time, but after doing it successfully once the precedent is established. A customer is not likely to take offense if his first attempt to overdraw is frustrated. It is challenging the second or third offense that creates enmity. Depend upon Bank Supervision Whether in the case of a customer attempting to overdraw for the first time or in the case of one hardened to the practice, it is a very present help to the banker to have his hands upheld by bank supervising authorities. Overdrafts are, in fact, a function of the thoroughness of bank supervision. Strict supervision militates against robust advances in this form. By way of illustration it may be mentioned that overdrafts in the state banks of Nevada were reduced from $485,000 in January, 1911, when a new law providing for effective supervision went into effect, to $46,012, 1J. H. Cranford, <rp. cü., p. 52.

OVERDRAFTS 241 less than two and a half years later.1 Bankers themselves, supervision apart, are able to keep this fractious item within narrow bounds only through the execution of a firm and tactfuï policy. An Index of the Soundness of the Bank Overdrafts are, it follows, an index of the character of the bank. A large overdraft item on the financial statement is an almost certain indication that the "note pouch is bulging with rotten, mouldy notes that long since should have been charged off." 2 Large overdrafts signify an easy-going management and an inferior clientele. 'Eugene Howell, State Banks of Nevada, Proceedings, Fifth Annual Convention, Nevada Bankers' Association, 1913, p. 52. 2 A. L. Mills, Doubtful Banking, Proceedings, Oregon State Bankers' Association, 1907, pp. 43, 44.