State Banks in the United States

State Banks and the State Laws

The banking laws of the states varied considerably. Some states authorized the issue of notes upon state bonds, many of which, especially at the outbreak of the Civil War, proved valueless. In New England, however, a system prevailed which required the prompt redemption of the banks’ notes at par. The New England Bank was the pioneer of this movement in 1814. (…)

What was called the “free-banking system” was inaugurated in New York by the act of 1838. This system permitted any body of persons, complying with the requirements of the law, to form a bank and issue circulation secured by the deposit of various classes of public bonds. This system was in operation at the outbreak of the Civil War, was imitated in several other states, and became in a measure the model of the national banking system. The state banks of Indiana and Ohio were among the most successful of the state banks, being modelled somewhat on the European plan of a central bank. They held in their states an exclusive charter for issuing notes and had branches at important points throughout the state. Under the management of Hugh McCulloch, afterwards secretary of the treasury, the bank of Indiana weathered the crisis of 1857 without suspending specie payments, and retired its circulation when gold went to a premium in 1862.

One of the defects of the state system of note-issues was the inconvenience which it occasioned. Notes issued outside a state could not safely be received without careful scrutiny as to the responsibility of their issuers. The systems prevailing in New England, in Louisiana, in Ohio and in Indiana were eminently successful, and proved the soundness of the issue of bank-notes upon the assets of a well-conducted commercial bank. But the speculation fostered by loose banking laws in some other states, and the need for uniformity, cast a certain degree of discredit upon the state banks, and prepared the way for the acceptance of a uniform banking system in 1864. [1]

History of State Banking: the Michigan Act (1837)

In the early and mid nineteenth century the supply of gold and silver coins was insufficient to serve as the only form on money as is prescribed by a literal interpretation of the Constitution. For this reason and despite its inherent risks, state banking thrived as a means of augmenting the money supply. To further facilitate the growth of banking, the 1837 Michigan Act was adopted as the first of the nation’s free banking laws. Literally, a free banking system is one without any form of government restriction on banking activities, save the enforcement of legal contracts and prohibitions against fraud (Sechrest, 3). The Michigan Act did not achieve this pure definition, but it and the other free banking laws enacted in subsequent years constitute the closest the U.S. has come to literal free banking.

The Michigan Act granted a banking charter to any person or group that satisfied established criteria, rather than requiring an act of the Michigan legislature each time a new group petitioned to open a new bank. Specifically, the bank’s owners had to purchase at market value state bonds and then deposit those bonds with the state auditor as collateral. However, the bank could issue banknotes up to the marketvalue of the bonds, so the performance of the bond market directly affected the system’s ability to issue notes. Banks were also required to redeem their notes on demand in gold or silver coin. Failure to do so resulted in the bank being closed by the state, and the bank’s assets being liquidated. The state’s bank examiners were in charge of enforcing this specie reserve requirement, but the banks were always one step ahead. Consider this account given by Galbraith:

At the outer extreme of compliance, a group of Michigan banks joined to cooperate in the ownership of reserves. These were transferred from one institution to the next in advance of the examiner as he made his rounds. And on this or other occasions, there was further economy; the top layer of gold coins in the container was given a more impressive height by a larger layer of ten-penny nails below. But not all of the excesses of leverage were in the West. In the same years, in the more conservative precincts of New England, a bank was closed up with $500,000 in notes outstanding and a specie reserve of $86.48 in hand (Galbraith, 63-64).

In addition, depositors were granted a lien on the bank’s assets. Other than these conditions, there were no significant restrictions on a bank’s activities in the free banking system (Sechrest, 96-100) [2]

Resources

Notes

1. Source: Encyclopedia Britannica (1911)
2. Edward Flaherty, A Brief History of Central Banking in the United States.

Further Reading

• Monetary Decisions of the Supreme Court, New Brunswick, New Jersey: Rutgers University Press, 1960.
• Galbraith, John K., A Short History of Financial Euphoria, New York: Penguin Books, 1990.
• Galbraith, John K., Money: Whence it Came, Where it Went, Boston: Houghton Mifflin, 1995.
• Information about State Banks in the Gale Encyclopedia of American Law.
• Hammond, Bray, Banks and Politics in America, Princeton University Press, 1957.
• Hixson, William F., Triumph of the Bankers: Money and Banking in the Eighteenth
  and Nineteenth Centuries, London: Praeger, 1993.
• Kidwell, David S. and Richard Peterson, Financial Institutions, Markets, and Money,
  5th edition, 1993.
• Knox, John J., A History of Banking in the United States, New York: Bradford Rhodes, 1903.
• Sechrest, Larry J., Free Banking: Theory, History, and a Laissez-Faire Model,
  London: Quorum Books, 1993.
• Symons, Edward L., Jr. and James J. White, Banking Law, 2nd edition, 1984.

Articles:

• Money Bill Goes to Wilson To-Day, New York Times, pages 1-3, December 23, 1913.
• Wilson Signs the Currency Bill, New York Times, pages 1-2, December 24, 1913.