The term commercial paper, as we are using it, applies to such promissory notes and bills of exchange as belong to this credit system. It does not apply to such notes and bills when they owe their existence to credit operations of a different kind, such for example as accommodation loans or investment operations. Indeed, the essential characteristic of commercial paper is not revealed in the form of the credit document but in the fact that it is a link in this chain of exchange operations by which modern commerce is carried on.
This use of the term should also be distinguished from the one common among bankers and others. In this popular usage these documents are called commercial paper because they are themselves objects of commerce. In our use of the term the adjective "commercial" applies to them only when they play the rôle of intermediary in a process of exchange through credit. In this sense it is a matter of indifference whether they pass through the hands of brokers or not, and the fact of their being objects of purchase and sale does not confer the quality of commercial paper upon documents having an origin and character other than that above described.
2. The Operation of Discount
Every person in this chain of credit is confronted with the problem of paying his debts as they mature by the use of the amounts due him from other people. Since it is rarely possible to arrange maturities on both sides in such a way that the amounts due to be paid him at a given date shall at least equal those he is due to pay on that date, some means of transforming claims against other people due in the future into present means of payment must be found. The one universally employed is the discount of commercial paper. By this is meant the exchange at a bank of his own promissory notes due at times when debts of equal or greater amount due him mature, or of bills of exchange drawn against his debtors, for cash or credits on a checking account. These latter are available as means of payment at any time.
As a consideration for this accommodation, the bank charges interest for the period intervening before the maturity of the paper discounted. Sometimes this charge is paid at the time the paper is purchased and sometimes at the date of its maturity. The term "discount" technically means taking interest in advance by making available as means of present payment in any of the above mentioned forms a sum less than the amount the bank expects to collect at the date of the maturity of the discounted paper. If the interest is paid when the discounted paper matures, the process is technically called a loan. However, since the time of collecting interest makes no essential difference in the nature of the transaction, the process is commonly described as the discount of commercial paper, regardless of whether the interest is collected in advance or not.
3. The Conduct of Checking Accounts
A checking account is an ordinary book account on which are credited the cash deposited by a customer and the proceeds of collections, loans, and discounts made on his behalf, and on which are debited payments made to him in cash or on his behalf to other people or to the bank itself. These payments are made on orders signed by the customer and known as checks.
The ordinary customer of a commercial bank every day brings to the bank the cash he receives as the result of the day's business, and the checks received, drawn on his own and other banks, and is credited with the amount on the books of the bank as well as on a passbook which he himself retains. If he needs cash during the day, he presents to the bank a check payable to himself for the amount needed, and receives the kinds and denominations wanted; and if he wants to make payments to his creditors in other forms than cash, he sends them checks on his bank payable to their order, or a check drawn by his bank on some bank in another place, usually called a draft, which he has obtained by exchanging for it a check drawn to the order of his bank. To the amount of these payments his account at the bank is debited, and from time to time his passbook is left at the bank for the entry therein of the debits made to date and its subsequent return to him.
The customer must take care that his account is not overdrawn, that is, that the debits on his account do not exceed the credits, since overdrafts, except by accident or for very short periods and small amounts, are not allowed in this country, and in other countries, where they are allowed, they must be provided for in advance by a special agreement between the bank and the customer, which usually involves the deposit with the bank of ample security. In order to avoid overdrafts, the customer in this country agrees with his banker on what is known as a "line," that is, a maximum amount of loans or discounts to be allowed. Whenever his credit balance falls to a certain minimum, also established by agreement with the bank, the latter discounts for him the paper of his customers, that is, bills of exchange drawn on them or their promissory notes in his favor, or his own promissory notes. The proceeds of these discounts are credited on his account like deposits of cash or of checks for collection.
So long as the discounts are confined to commercial paper the bank's part in these transactions consists almost exclusively of bookkeeping between its customers and between itself and other banks. Ordinarily, what is debited on one man's account is credited on another's, the cash received nearly balancing that paid out. To the extent that the cash receipts and payments do not balance, the bank either has a surplus or is obliged to provide for the meeting of a deficit. The means available for this latter purpose will be explained in subsequent sections, as well as some of the details of this bookkeeping process. For the present it is important to note precisely how the discount of commercial paper is related to this bookkeeping process.