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					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.