Banking A system of trading in money which involved safeguarding deposits and making funds available for borrowers, banking developed in the Middle Ages in response to the growing need for credit in commerce. The lending functions of banks were undertaken in England by money- lenders. Until their expulsion by Edward I in 1291, the most important money-lenders were Jews. They were replaced by Italian merchants who had papal dispensations to lend money at interest. In the 13th cent. credit was essential to finance commerce and major projects. The most important was the wool trade but other examples included large buildings such as Edward's castles in north Wales. When Italians had their activities in England curtailed in the early 14th cent., they were replaced by English merchants and goldsmiths, whose rates of interest were sufficiently low to avoid the usury laws. Monarchs had borrowed from merchants and landowners for centuries. By the late 17th cent., the growth of parliamentary power over government expenditures required more regulation. The Bank of England, founded in 1694, gave the government and other users of credit access to English funds. Similar developments occurred in Scotland and Ireland. These banks remained without serious competition until the later 18th cent., when expanding commercial activities gave scope to merchants, brewers, and landowners to establish banks based on their own cash reserves. Errors of judgement sometimes occurred and ‘runs on the bank’ took place when depositors, fearing for the security of their money, demanded its return. Fluctuations in the value of money because of the return to a gold-based currency after the end of the Napoleonic wars (1815) precipitated a series of crises. To stabilize the currency the government eventually introduced the 1844 Bank Charter Act, which gave the Bank of England the functions of supervising the note issue and of monitoring the activities of the banking system. Regulatory powers were put in place in 1845 to control banking in Scotland and Ireland. In the 19th cent., overseas trade and the expanding British empire reinforced the place of London as a centre of merchant banking. The skills of these specialist bankers attracted business from foreign firms and governments Seeking loans. These arrangements made possible the rapid development of railways, heavy engineering, mines, and large commercial developments. Many of these merchant banks survive, including Rothschilds, Lazard Brothers, Kleinwort Benson, and Schroders. Internal trade was funded mainly by a larger number of local banks which, after the middle of the 19th cent., became consolidated into a much smaller number of banks. Numbers continued to diminish so that by 1980 banking was dominated by four companies: Barclays, Lloyds, Midland, and National Westminster. Banking has been characterized, largely because of technological innovation, by anincreasingly sophisticated provision ofbanking services and an expansion of consumer credit. The business of safeguarding and lending money is often arranged through machine-readable cards and continuous access by telephone. Overview The fundamental functions of a commercial bank during the past two centuries have been making loans, receiving deposits, and lending credit either in the form of bank notes or of "created" deposits. The banks in which people keep their checking accounts are commercial banks. There were no commercial banks in colonial times, although there were loan offices or land banks that made loans on real estate security with limited issues of legal tender notes. In 1781 Robert Morris founded the first commercial bank in the United States—the Bank of North America. It greatly assisted the financing of the closing stages of the American Revolution. By 1800, there were twenty-eight state-chartered banks, and by 1811 there were eighty-eight. Alexander Hamilton's financial program included a central bank to serve as a financial agent of the treasury, provide a depository for public money, and act as a regulator of the currency. Accordingly, the first Bank of the United States was founded 25 February 1791. Its $10 million capital and favored relationship with the government aroused much anxiety, especially among Jeffersonians. The bank's sound but unpopular policy of promptly returning bank notes for redemption in specie (money in coin) and refusing those of non-specie-paying banks—together with a political feud—was largely responsible for the narrow defeat of a bill to recharter it in 1811. Between 1811 and 1816, both people and government were dependent on state banks. Nearly all but the New England banks suspended specie payments in September 1814 because of the War of 1812 and their own unregulated credit expansion. The country soon recognized the need for a new central bank, and Congress established the second Bank of the United States on 10 April 1816. Its $35 million capitalization and favored relationship with the Treasury likewise aroused anxiety. Instead of repairing the overexpanded credit situation that it inherited, it aggravated it by generous lending policies, which precipitated the panic of 1819, in which it barely saved itself and generated wide-spread ill will. Thereafter, under Nicholas Biddle, the central bank was well run. As had its predecessor, it required other banks to redeem their notes in specie, but most of the banks had come to accept that policy, for they appreciated the services and the stability provided by the second bank. The bank's downfall grew out of President Andrew Jack-son's prejudice against banks and monopolies, the memory of the bank's role in the 1819 panic, and most of all, Biddle's decision to let rechartering be a main issue in the 1832 presidential election. Many persons otherwise friendly to the bank, faced with a choice of Jackson or the bank, chose Jackson. He vetoed the recharter. After 26 September 1833, the government placed all its deposits with politically selected state banks until it set up the Independent Treasury System in the 1840s. Between 1830 and 1837, the number of banks, bank note circulation, and bank loans all about tripled. Without the second bank to regulate them, the banks overextended themselves in lending to speculators in land. The panic of 1837 resulted in a suspension of specie payments, many failures, and a depression that lasted until 1844. Between 1833 and 1863, the country was without an adequate regulator of bank currency. In some states, the laws were very strict or forbade banking, whereas in others the rules were lax. Banks made many long-term loans and resorted to many subterfuges to avoid redeeming their notes in specie. Almost everywhere, bank tellers and merchants had to consult weekly publications known as Bank Note Reporters for the current discount on bank notes, and turn to the latest Bank Note Detectors to distinguish the hundreds of counterfeits and notes of failed banks. This situation constituted an added business risk and necessitated somewhat higher markups on merchandise. In this bleak era of banking, however, there were some bright spots. These were the Suffolk Banking System of Massachusetts (1819–1863); the moderately successful Safety Fund System (1829–1866) and Free Banking (1838–1866) systems of New York; the Indiana (1834–1865), Ohio (1845– 1866), and Iowa (1858–1865) systems; and the Louisiana Banking System (1842–1862). Inefficient and corrupt as some of the banking was before the Civil War, the nation's expanding economy found it an improvement over the system on which the eighteenth-century economy had depended. Secretary of the Treasury Salmon P. Chase began agitating for an improved banking system in 1861. On 25 February 1863, Congress passed the National Banking Act, which created the National Banking System. Its head officer was the comptroller of currency. It was based on several recent reforms, especially the Free Banking System's principle of bond-backed notes. Nonetheless, the reserve requirements for bank notes were high, and the law forbade real estate loans and branch banking, had stiff organization requirements, and imposed burdensome taxes. State banks at first saw little reason to join, but, in 1865, Congress levied a prohibitive 10 percent tax on their bank notes, which drove most of these banks into the new system. The use of checks had been increasing in popularity in the more settled regions long before the Civil War, and, by 1853, the total of bank deposits exceeded that of bank notes. After 1865 the desire of both state and national banks to avoid the various new restrictions on bank notes doubtless speeded up the shift to this more convenient form of bank credit. Since state banks were less restricted, their number increased again until it passed that of national banks in 1894. Most large banks were national, however. The National Banking System constituted a substantial improvement over the pre–Civil War hodgepodge of banking systems. Still, it had three major faults. The first was the perverse elasticity of the bond-secured bank notes, the supply of which did not vary in accordance with the needs of business. The second was the decentralization of bank deposit reserves. There were three classes of national banks: the lesser ones kept part of their reserves in their own vaults and deposited the rest at interest with the larger national banks. These national banks in turn lent a considerable part of the funds on the call money market to finance stock speculation. In times of uncertainty, the lesser banks demanded their outside reserves, call money rates soared, security prices tobogganed, and runs on deposits ruined many banks. The third major fault was that there was no central bank to take measures to forestall such crises or to lend to deserving banks in times of distress. In 1873, 1884, 1893, and 1907, panics highlighted the faults of the National Banking System. Improvised use of clearinghouse certificates in interbank settlements some-what relieved money shortages in the first three cases, whereas "voluntary" bank assessments collected and lent by a committee headed by J. P. Morgan gave relief in 1907. In 1908 Congress passed the Aldrich-Vreeland Act to investigate foreign central banking systems and suggest reforms, and to permit emergency bank note issues. The Owen- Glass Act of 1913 superimposed a central banking system on the existing national banking system. It required all national banks to "join" the new system, which meant to buy stock in it immediately equal to 3 percent of their capital and surplus, thus providing the funds with which to set up the Federal Reserve System. State banks might also join by meeting specified requirements, but, by the end of 1916, only thirty-four had done so. A majority of the nation's banks have always remained outside the Federal Reserve System, although the larger banks have usually been members. The Federal Reserve System largely corrected the faults to which the National Banking System had fallen prey. Admittedly, the Federal Reserve had its faults and did not live up to expectations. Nevertheless, the nation's commercial banks had a policy-directing head and a refuge in distress to a greater degree than they had ever had before. Thus ended the need for the Independent Treasury System, which finally wound up its affairs in 1921. Only a few national banks gave up their charters for state ones in order to avoid joining the Federal Reserve System. However, during World War I, many state banks became members of the system. All banks helped sell Liberty bonds and bought short-term Treasuries between bond drives, which was one reason for a more than doubling of the money supply and also of the price level from 1914 to 1920. A major contributing factor for these doublings was the sharp reduction in reserves required under the new Federal Reserve System as compared with the pre-1914 National Banking System. By 1921 there were 31,076 banks, the all-time peak. Every year, local crop failures, other disasters, or simply bad management wiped out several hundred banks. By 1929 the number of banks had declined to 25,568. Admittedly, mergers eliminated a few names, and the growth of branch, group, or chain banking provided stability in some areas. Nevertheless, the 1920s are most notable for stock market speculation. Several large banks had a part in this speculation, chiefly through their investment affiliates. The role of investment adviser gave banks great prestige until the panic of 1929, when widespread disillusionment from losses and scandals brought them discredit. The 1930s witnessed many reforms growing out of the more than 9,000 bank failures between 1930 and 1933 and capped by the nationwide bank moratorium of 6–9 March 1933. To reform the commercial and central banking systems, as well as to restore confidence in them, Congress passed two major banking laws between 1933 and 1935. These laws gave the Federal Reserve System firmer control over the banking system. They also set up the Federal Deposit Insurance Corporation to insure bank deposits, and soon all but a few hundred small banks belonged to it. That move greatly reduced the number of bank failures. Other changes included banning investment affiliates, prohibiting banks from paying interest on demand deposits, loosening restrictions against national banks' having branches and making real estate loans, and giving the Federal Reserve Board the authority to raise member bank legal reserve requirements against deposits. As a result of the Depression, the supply of commercial loans dwindled, and interest rates fell sharply. Consequently, banks invested more in federal government obligations, built up excess reserves, and imposed service charges on checking accounts. The 1933–1934 devaluation of the dollar, which stimulated large imports of gold, was another cause of those excess reserves. During World War II, the banks again helped sell war bonds. They also converted their excess reserves into government obligations and dramatically increased their own holdings of these. Demand deposits more than doubled. Owing to bank holdings of government obligations and to Federal Reserve commitments to the treasury, the Federal Reserve had lost its power to curb bank-credit expansion. Price levels nearly doubled during the 1940s. In the Federal Reserve-treasury "accord" of March 1951, the Federal Reserve System regained its freedom to curb credit expansion, and thereafter interest rates crept upward. That development improved bank profits and led banks to reduce somewhat their holdings of federal government obligations. Term loans to industry and real estate loans increased. Banks also encountered stiff competition from rapidly growing rivals, such as savings and loan associations and personal finance companies. On 28 July 1959, Congress eliminated the difference between reserve city banks and central reserve city banks for member banks. The new law kept the same reserve requirements against demand deposits, but it permitted banks to count cash in their vaults as part of their legal reserves. Interest rates rose spectacularly all during the 1960s and then dropped sharply in 1971, only to rise once more to 12 percent in mid-1974. Whereas consumer prices had gone up 23 percent during the 1950s, they rose 31 percent during the 1960s—especially toward the end of the decade as budget deficits mounted—and climbed another 24 percent by mid-1974. Money supply figures played a major role in determining Federal Reserve credit policy from 1960 on. Money once consisted largely of hard coin. With the coming of commercial banks, it came also to include bank notes and demand deposits. The difference, however, between these and various forms of "near money"— time deposits, savings and loan association deposits, and federal government E and H bonds—is slight. Credit cards carry the confusion a step further. How does one add up the buying power of money, near money, and credit cards? As new forms of credit became more like money, it was increasingly difficult for the Federal Reserve to regulate the supply of credit and prevent booms. Since 1970 banking and finance have undergone nothing less than a revolution. The structure of the industry in the mid-1990s bore little resemblance to that established in the 1930s in the aftermath of the bank failures of the Great Depression. In the 1970s and 1980s, what had been a fractured system by design became a single market, domestically and internationally. New Deal banking legislation of the Depression era stemmed from the belief that integration of the banking system had allowed problems in one geographical area or part of the financial system to spread to the entire system. Regulators sought, therefore, to prevent money from flowing between different geographical areas and between different functional segments. These measures ruled out many of the traditional techniques of risk management through diversification and pooling. As a substitute, the government guaranteed bank deposits through the Federal Deposit Insurance Corporation and the Federal Savings and Loan Insurance Corporation. In retrospect, it is easy to see why the segmented system broke down. It was inevitable that the price of money would vary across different segments of the system. It was also inevitable that borrowers in a high-interest area would seek access to a neighboring low-interest area—and vice versa for lenders. The only question is why it took so long for the pursuit of self- interest to break down regulatory barriers. Price divergence by itself perhaps was not a strong enough incentive. Rationing of credit during tight credit periods probably was the cause of most innovation. Necessity, not profit alone, seems to have been the cause of financial innovation. Once communication between segments of the system opened, mere price divergence was sufficient to cause flows of funds. The microelectronics revolution enhanced flows, as it became easier to identify and exploit profit opportunities. Technological advances sped up the process of market unification by lowering transaction costs and widening opportunities. The most important consequence of the unification of segmented credit markets was a diminished role for banks. Premium borrowers found they could tap the national money market directly by issuing commercial paper, thus obtaining funds more cheaply than banks could provide. In 1972 money- market mutual funds began offering shares in a pool of money-market assets as a substitute for bank deposits. Thus, banks faced competition in both lending and deposit-taking—competition generally not subject to the myriad regulatory controls facing banks. Consolidation of banking became inevitable as its functions eroded. The crisis of the savings and loan industry was the most visible symptom of this erosion. Savings and loans associations (S&Ls) had emerged to funnel household savings to residential mortgages, which they did until the high interest rates of the inflationary 1970s caused massive capital losses on long- term mortgages and rendered many S&Ls insolvent by 1980. Attempts to re- gain solvency by lending cash from the sale of existing mortgages to borrowers willing to pay high interest only worsened the crisis, because high-yield loans turned out to be high risk. The mechanisms invented to facilitate mortgage sales undermined S&Ls in the longer term as it became possible for specialized mortgage bankers to make mortgage loans and sell them without any need for the expensive deposit side of the traditional S&L business. Throughout the 1970s and 1980s, regulators met each evasion of a regulatory obstacle with further relaxation of the rules. The Depository Institutions Deregulation and Monetary Control Act (1980) recognized the array of competitors for bank business by expanding the authority of the Federal Reserve System over the new entrants and relaxing regulation of banks. Pressed by a borrowers' lobby seeking access to low-cost funds and a depositors' lobby seeking access to high money-market returns, regulators saw little choice but capitulation. Mistakes occurred, notably the provision in the 1980 act that extended deposit insurance coverage to $100,000, a provision that greatly increased the cost of the eventual S&L bailout. The provision found its justification in the need to attract money to banks. The mistake was in not recognizing that the world had changed and that the entire raison d'être of the industry was disappearing. Long-term corporate finance underwent a revolution comparable to that in banking. During the prosperous 1950s and 1960s, corporations shied away from debt and preferred to keep debt-equity ratios low and to rely on ample internal funds for investment. The high cost of issuing bonds—a consequence of the uncompetitive system of investment banking— reinforced this preference. Usually, financial intermediaries held the bonds that corporations did issue. Individual owners, not institutions, mainly held corporate equities. In the 1970s and 1980s, corporations came to rely on external funds, so that debt-equity ratios rose substantially and interest payments absorbed a much greater part of earnings. The increased importance of external finance was itself a source of innovation as corporations sought ways to reduce the cost of debt service. Equally important was increased reliance on institutional investors as purchasers of securities. When private individuals were the main holders of equities, the brokerage business was uncompetitive and fees were high, but institutional investors used their clout to reduce the costs of buying and selling. Market forces became much more important in finance, just as in banking. Institutional investors shifted portfolio strategies toward equities, in part to enhance returns to meet pension liabilities after the Employment Retirement Income Security Act (1974) required full funding of future liabilities. Giving new attention to maximizing investment returns, the institutional investors became students of the new theories of rational investment decision championed by academic economists. The capital asset pricing model developed in the 1960s became the framework that institutional investors most used to make asset allocations. The microelectronics revolution was even more important for finance than for banking. Indeed, it would have been impossible to implement the pricing model without high-speed, inexpensive computation to calculate optimal portfolio weightings across the thousands of traded equities. One may argue that computational technology did not really cause the transformation of finance and that increased attention of institutional investors was bound to cause a transformation in any event. Both the speed and extent of transformation would have been impossible, however, without advances in computational and communications technologies. Bank Failures American financial history to 1934 was characterized by numerous bank failures, because the majority of banks were local enterprises, not regional or national institutions with numerous branches. Lax state government regulations and inadequate examinations permitted many banks to pursue unsound practices. With most financial eggs in local economic baskets, it took only a serious crop failure or a business recession to precipitate dozens or even hundreds of bank failures. On the whole, state-chartered banks had a particularly poor record. Early Bank Failures Early-nineteenth-century banks were troubled by a currency shortage and the resulting inability to redeem their notes in specie. States later imposed penalties in those circumstances, but such an inability did not automatically signify failure. The first bank to fail was the Farmers' Exchange Bank of Glocester, R.I., in 1809. The statistics of bank failures between 1789 and 1863 are inadequate, but the losses were unquestionably large. John Jay Knox estimated that the losses to noteholders were 5 percent per annum, and bank notes were the chief money used by the general public. Not until after 1853 did banks' deposit liabilities exceed their note liabilities. Between 1830 and 1860, weekly news sheets called bank note reporters gave the latest discount quoted on the notes of weak and closed banks. All businesses had to allow for worthless bank notes. Although some states—such as New York in 1829 and 1838, Louisiana in 1842, and Indiana in 1834—established sound banking systems, banking as a whole was characterized by frequent failures. The establishment of the National Banking System in 1863 introduced needed regulations for national (i.e., nationally chartered) banks. These were larger and more numerous than state banks until 1894, but even their record left much to be desired. Between 1864 and 1913—a period that saw the number of banks rise from 1,532 to 26,664—515 national banks were suspended, and only two years passed without at least one suspension. State banks suffered 2,491 collapses during the same period. The worst year was the panic year of 1893, with almost five hundred bank failures. The establishment of the Federal Reserve System in 1913 did little to improve the record of national banks. Although all banks were required to join the new system, 825 banks failed between 1914 and 1929, and an additional 1,947 failed by the end of 1933. During the same twenty years there were 12,714 state bank failures. By 1933 there were 14,771 banks in the United States, half as many as in 1920, and most of that half had disappeared by the failure route. During the 1920s, Canada, employing a branch banking system, had only one failure. Half a dozen states had experimented with deposit insurance plans without success. Apparently the situation needed the attention of the federal government. Fdic Established The bank holocaust of the early 1930s—9,106 bank failures in four years, 1,947 of them national banks—culminating in President Franklin D. Roosevelt's executive order declaring a nationwide bank moratorium in March 1933, at last produced the needed drastic reforms. In 1933 Congress passed the Glass-Steagall Act, which forbade Federal Reserve member banks to pay interest on demand deposits, and founded the Federal Deposit Insurance Corporation (FDIC). In an effort to protect bank deposits from rapid swings in the market, the Glass-Steagall Banking Act of 1933 forced banks to decide between deposit safeholding and investment. Executives of security firms, for example, were prohibited from sitting as trustees of commercial banks. The FDIC raised its initial capital by selling two kinds of stock. Class A stock (paying dividends) came from assessing every insured bank 0.5 percent of its total deposits—half paid in full, half subject to call. All member banks of the Federal Reserve System had to be insured. Federal Reserve Banks had to buy Class B stock (paying no dividends) with 0.5 percent of their surplus—half payable immediately, half subject to call. In addition, any bank desiring to be insured paid .083 percent of its average deposits annually. The FDIC first insured each depositor in a bank up to $2,500; in mid-1934 Congress put the figure at $5,000; on 21 September 1950, the maximum became $10,000; on 16 October 1966, the limit went to $15,000; on 23 December 1969, to $20,000; and on 27 November 1974, to $40,000. At the end of 1971 the FDIC was insuring 98.6 percent of all commercial banks and fully protecting 99 percent of all depositors. However, it was protecting only about 64 percent of all deposits, with savings deposits protected at a high percentage but business deposits at only about 55 percent. By the mid-1970s the FDIC was examining more than 50 percent of the banks in the nation, which accounted for about 20 percent of banking assets. It did not usually examine member banks of the Federal Reserve System, which were the larger banks. There was a degree of rivalry between the large and small banks, and the FDIC was viewed as the friend of the smaller banks. Whereas in the 1920s banks failed at an average rate of about six hundred a year, during the first nine years of the FDIC (1934–1942) there were 487 bank closings because of financial difficulties, mostly of insured banks; 387 of these received disbursements from the FDIC. During the years from 1943 to 1972, the average number of closings dropped to five per year. From 1934 to 1971 the corporation made disbursements in 496 cases involving 1.8 million accounts, representing $1.215 billion in total deposits. The FDIC in 1973 had $5.4 billion in assets. Through this protection, people were spared that traumatic experience of past generations, a "run on the bank" and the loss of a large part of their savings. For example, in 1974 the $5 billion Franklin National Bank of New York, twentieth in size in the nation, failed. It was the largest failure in American banking history. The FDIC, the Federal Reserve, and the comptroller of the currency arranged the sale of most of the bank's holdings, and no depositor lost a cent. The 1980s and the Savings and Loan Debacle The widespread bank failures of the 1980s—more than sixteen hundred FDIC-insured banks were closed or received financial assistance between 1980 and 1994—revealed major weaknesses in the federal deposit insurance system. In the 1970s, mounting defense and social welfare costs, rising oil prices, and the collapse of American manufacturing vitality in certain key industries (especially steel and electronics) produced spiraling inflation and a depressed securities market. Securities investments proved central to the economic recovery of the 1980s, as corporations cut costs through mergers, takeovers, and leveraged buyouts. The shifting corporate terrain created new opportunities for high-risk, high-yield investments known as "junk bonds." The managers of the newly deregulated savings and loan (S&L) institutions, eager for better returns, invested heavily in these and other investments—in particular, a booming commercial real estate market. When the real estate bubble burst, followed by a series of insider-trading indictments of Wall Street financiers and revelations of corruption at the highest levels of the S&L industry, hundreds of the S&Ls collapsed. In 1988 the Federal Home Loan Bank Board began the process of selling off the defunct remains of 222 saving and loans. Congress passed sweeping legislation the following year that authorized a massive government bailout and imposed strict new regulatory laws on the S&L industry. The cost of the cleanup to U.S. taxpayers was $132 billion. In addition to the S&L crisis, the overall trend within the banking industry during the 1980s was toward weaker performance ratios, declining profitability, and a quick increase in loan charge-offs, all of which placed an unusual strain on banks. Seeking stability in increased size, the banking industry responded with a wave of consolidations and mergers. This was possible in large part because Congress relaxed restrictions on branch banking in an effort to give the industry flexibility in its attempts to adjust to the changing economy. Deregulation also made it easier for banks to engage in risky behavior, however, contributing to a steep increase in bank failures when loans and investments went bad in the volatile economic climate. Legislators found themselves torn among the need to deregulate banks, the need to prevent failures, and the need to recapitalize deposit insurance funds, which had suffered a huge loss during the decade. In general, they responded by giving stronger tools to regulators but narrowly circumscribing the discretion of regulators to use those tools. During the 1990s, the globalization of the banking industry meant that instability abroad would have rapid repercussions in American financial markets; this, along with banks' growing reliance on computer systems, presented uncertain challenges to the stability of domestic banks in the final years of the twentieth century. As the economy boomed in the second half of the decade, however, the performance of the banking industry improved remarkably, and the number of bank failures rapidly declined. Although it was unclear whether the industry had entered a new period of stability or was merely benefiting from the improved economic context, the unsettling rise in bank failures of the 1980s seemed to have been contained. Private Banks The term "private banks" is misleading in American financial history. Virtually all of the banks in the United States were privately owned—even the First and Second Banks of the United States, the nation's "national" banks, sold 80 percent of their stock to private individuals. Apart from a few state-chartered banks owned exclusively by the state governments (the Bank of the State of Alabama and the Bank of the State of Arkansas, for example), all of the financial institutions in the United States were privately held. The confusion arose in the chartering process. If states chartered the banks, they were usually referred to as "state banks," even though they were not owned by the states. Alongside these chartered banks, however, existed another set of privately owned banks called "private banks." The chief difference between the two lay not in ownership, but in the authority to issue bank notes, which was a prerogative strictly reserved for those banks receiving state charters. Private bankers ranged from large-scale semibanks to individual lenders. The numbers of known private bankers only scratch the surface of the large number of businesses engaging in the banking trade. Some of the larger nonchartered banks even established early branches, called "agencies," across state lines. They provided an important contribution to the chartered banks by lending on personal character and by possessing information about local borrowers that would not be available to more formal businesses. Private bankers also escaped regulation imposed on traditional banks, largely because they did not deal with note issue—the issue that most greatly concerned the public about banks until, perhaps, the 1850s. "Private banking" continued well into the early twentieth century. Savings Banks The broad category of savings institutions is made up of several types of legal structures, including savings banks, building and loan associations, and savings and loan associations. Two of the most distinctive features of savings institutions are their mutual ownership structures and operation as cooperative credit institutions, which exempt them from income taxes paid by commercial banks and other for-profit financial intermediaries. Savings banks originated in Europe. The first ones in the Western Hemisphere were the Philadelphia Saving Fund Society (opened 1816, chartered 1819) and the Provident Institution for Savings in Boston (chartered 1816). The concept of savings banks originated in the philanthropic motives of the wealthy, who wished to loan funds to creditworthy poor who exhibited the discipline of thrift through their savings behavior. Although savings banks provided a safe haven for small accounts, it is doubtful that these banks made many loans to the poor. Rapid Expansion in the Nineteenth Century Early savings banks were immediately popular. During their first twenty years of development in the United States, savings bank deposits grew to some $11 million. The popularity of savings banks resulted in part from their reputation for safety. They avoided runs by enforcing by laws that restricted payments to depositors for up to sixty days. As a result of these provis ions, no savings banks failed in the panic of 1819. Around nine hundred commercial banks failed in the panic of 1837, but only a handful of savings banks met that fate. Most savings banks also survived the subsequent panics of the nineteenth century. In the panic of 1873, some eighteen out of more than five hundred savings banks in existence suspended operations nationwide. Losses to savings bank depositors are thought to have been relatively insignificant across most of the nineteenth century. Between 1819 and 1854 no savings banks failed in the state of New York. Between 1816 and 1874, a period that includes the panic of 1873, total losses to savings bank customers in Massachusetts totaled only $75,000 on a savings bank deposit base of $750 million. As a result of their safety, savings banks' popularity surged and by 1890, 4.3 million depositors held $1.5 billion in savings banks across the nation. The panic of 1893, however, slowed savings bank growth. Through the latter half of the nineteenth century, the class of acceptable investments for savings banks was broadened. By 1890, savings banks were invested in a wide array of assets, including government and state securities and corporate equities and bonds. Moreover, some savings banks began establishing themselves as joint-stock rather than mutual institutions. The combination of these two developments began to blur the distinction between investments of savings banks and commercial banks. Again, in 1893 most savings banks avoided failure by enforcing by laws that restricted payments to depositors. But consumer and business confidence was low and the economic disruption long. As a result, savings bank growth fell off considerably during and after the 1893 panic, although they soon recovered. Competition, Federal Regulation, and the Democratization of Credit In 1903 the comptroller of the currency ruled that national banks could hold savings balances. Hence, following the panic of 1907 concern for depositor safety grew in all sectors of the financial services industry. This concern, along with substantial heterogeneity in savings institutions in general and savings bank investments and operations in particular, led to the establishment of the postal savings system in 1910 as a direct competitor to existing savings institutions. The postal savings system provided a safe haven for commercial bank depositors during the Great Depression. However, savings bank depositors experienced far fewer losses than commercial bank depositors during this period because of their diversification and their by laws allowing the restriction of payments. New Deal legislation contained many provisions for depositor safety, including an expansion of federal authority over savings banks and building and loan associations. Prior to the 1930s, all savings banks were chartered and regulated by the states in which they operated. The New Deal established federal authority under the Federal Home Loan Bank Board for chartering and regulating savings banks and savings and loans. The creation of the Federal Deposit Insurance Corporation (FDIC) in 1933 and the expansion of the network of savings institutions are undoubtedly related to the demise of the postal savings system in the 1950s. Savings banks and related institutions are thought to have contributed substantially to the democratization of credit in the United States during the twentieth century. Mortgage lending by these institutions led to widespread home and property ownership. Moreover, nonmortgage savings bank lending was the basis for the development of Morris Plan lending, an early form of consumer finance. Pioneered by Morris Plan Company in 1914, small, short-term (less than one year) loans were made to individuals who repaid them in fifty weekly installments. The loans became extremely popular, and by 1917 Morris Plan loans totaled more than $14.5 million to over 115,000 borrowers. Although savings banks and savings and loans (and their predecessors, building and loan associations) were cooperative credit institutions, historically the institutions differed in some important ways. Savings and loans (and building and loan associations) concentrated primarily on residential mortgages, while savings banks operated as more diversified institutions. In the twenty years following World War II mortgages were favorable investments, so the difference between savings bank and savings and loan operations was insignificant. However, during late 1966 and 1967 savings banks were able to invest in corporate securities in the absence of mortgage loan demand, while savings and loans were not. Decline and Resurgence Many savings banks converted from mutual to joint-stock ownership during the 1980s. Facing new profit pressures from shareholders, the newly converted savings banks adopted portfolios similar to those of savings and loans. When sharply increased interest rates and the fundamental maturity mismatch between short-term deposits and long-term mortgages led to protracted difficulties in the savings and loan industry, many of these newly converted savings banks failed. Although lax supervision led to the replacement of the regulator of both savings and loans and savings banks (the Federal Home Loan Bank Board) with a completely new regulator (the Office of Thrift Supervision), savings bank deposits were insured by the FDIC and thus were not affected by the failure of the Federal Savings and Loan Insurance Corporation. Although the popularity of savings institutions (including savings banks) waned in comparison with commercial banks following the crisis of the 1980s, savings institutions experienced a resurgence during the 1990s because of competitive loan and deposit rates, their mutual ownership structure and resulting tax advantages, and the broad array of financial services they may offer under contemporary banking law.
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