The History of American Banks
The Bank of North America, established in 1781, was the first bank chartered by the United States government. Although it was privately owned, it operated as the government’s bank and issued paper banknotes. These were promises to pay the bearer on demand. Banks had to maintain adequate reserves of gold to meet demands for repayment of the notes. Individual North American states chartered other large banks to issue banknotes. These banks focused on making short-term loans. Many were forced into bankruptcy. This was because they had over-extended their lending.
The First Bank of the United States was chartered by the federal government in 1791. It was established to serve both the government and the public. It ran into conflict with the state-chartered banks. They objected to the domination of the popular First Bank of the United States notes, which were seen to be safer than other banknotes. The government failed to renew its charter and the bank ceased trading in 1811. A second Bank of the United States was chartered in 1816. It ceased trading in 1836, due to opposition from local bankers and lack of federal government support. The years from 1837 to 1863 are referred to as the “Tree Banking Era”. In this era, American banking was represented by state-chartered banks. There was no federal regulation, and no consistency in the laws controlling the operation of the banks. This lack of regulation resulted in bank fraud, and many banks failed.
In the early 1800s, New York State created a fund to which each member bank contributed. The fund operated like a fractional reserve system, as this was money that the banks could not lend out. It was held as security for the banknote holders, in the event that the bank failed. New York became the world’s financial centre after the completion of the Erie Canal in 1825. Its local banks had provided the capital for the construction of the canal.
American Civil War (1861-1865) resulted in a change in the monetary system and new legislation. The war needed funding. The need to use metals for war meant coins were scarce. The 1863 National Bank Act led to the establishment of the Office of the Comptroller of the Currency. This office had the power to issue national bank charters. This created a dual banking system. Banks could operate under either a national or federal charter. The act also led to the production of national banknotes as a unified national currency. Only banks operating under the national charter were allowed to issue a national banknote. All national banknotes were backed by US government bonds, or US Treasury securities. National banks were required to keep a significant volume of bonds on deposit with the Comptroller of the Currency. In exchange, the banks received banknotes worth 90 per cent of the value of the bond held.
The state banks encouraged their customers to open demand deposit accounts. Withdrawals from these accounts were made by writing a cheque. Cheques, as a substitute for paper or coin currency, became well established. Between 1873 and 1907 they outnumbered banknote circulation. Some banks experienced liquidity problems. At times, the banks did not have enough cash, or liquid assets that could be changed quickly into cash. These banks could not honour their depositors’ cheques and went out of business.
In 1907, a large number of depositors in New York City attempted to withdraw their money at the same time. The result was the Wall Street Panic. This spread across the United States as banks suspended withdrawals.