STATE SYSTEMS OF BANK-OBLIGATION INSURANCE The roots of Federal deposit insurance lie deep in America's banking history. At the time of its adoption in 1933, insurance of bank obligations had a legislative history in the Congress reaching back to 1886 and a record of State experiments extending back to 1829. An analysis of Congressional proposals was published two years ago.1 The objectives and character of State systems adopted prior to 1933 are described here. Studies of the operations of the various State systems are in progress. Particular attention is being paid to the quality of supervision of the insured banks, adequacy of the insurance funds, and the impact of changes in business conditions upon the operations of the systems. It is planned to make the results of these studies available when they are completed. Purpose of State insurance plans. Among the various motives which led States to make use of the insurance principle for the protection of bank depositors and noteholders, there were two which were of importance: to protect the community from severe fluctuations of the circulating medium occasioned by waves of bank failures; and to guard against loss to individual depositors and noteholders, particularly those of small means. The available evidence indicates that the first of these, concern with the circulating medium as such, predominated. Credit for the idea of insurance of bank obligations is given to Joshua Forman of New York. Writing in 1829, when bank-supplied circulating medium was largely in the form of banknotes rather than deposits, he argued as follows: ". . . they [the banks] enjoy in common the exclusive right of making a paper currency for the people of the State and by the same rule should in common be answerable for that paper." Nearly a century later, the Supreme Court of the United States, in upholding the constitutionality of deposit insurance laws in Oklahoma, Kansas, and Nebraska, defined the purpose of insurance of bank obligations by the States. In a unanimous opinion, rendered in 1911, both of the purposes described earlier were noted but protection of the circulating medium was clearly given major emphasis. Justice Holmes said: It may be said in a general way that the police power extends to all the great public needs. It may be put forth in aid of what is sanctioned by usage, or held by the prevailing morality or strong and preponderant opinion to be greatly and immediately necessary to the public welfare. Among matters of that sort probably few would doubt that both usage and preponderant opinion give their sanction to enforcing the primary conditions of successful commerce. One of 1 Annual Report of the Federal Deposit Insurance Corporation for 1950, pp. 68-101. 1 Assembly Journal, New York State, 1829, p. 179. those conditions at the present time is the possibility of payment by checks drawn against bank deposits, to such an extent do checks replace currency in daily business. . . the primary object of the required assessment is not a private benefit . . . but . . . is to make the currency of checks secure, and by the same stroke to make safe the almost compulsory resort of depositors to banks as the only available means for keeping money on hand.1 Adoption of insurance systems. The insurance of bank obligations among the States occurred during two periods, over forty years apart. The first began in 1829 with the adoption of an insurance plan by New York. During the next three decades another eastern State and four western States followed New York's lead. The last of these systems came to a close in 1866 when the great majority of State chartered banks became national banks. Insurance of bank obligations was not attempted again by the States until 1907 when Oklahoma provided for the establishment of a deposit guaranty fund. Similar funds were established in seven other States during the following decade. By 1930 all eight had become insolvent or inoperative, as a consequence of large numbers of bank failures or of relatively high incidence of failures among the larger insured banks. The fourteen States which adopted insurance systems between 1829 and 1917, and the length of time each system operated, are shown in Table 32. In the majority of cases the systems eventually proved unworkable. However, several enjoyed a moderate degree of success during their entire period of operation; and three, in Indiana, Ohio, and Iowa, were highly successful. INSURANCE OF BANK OBLIGATIONS IN SIX STATES, 1829-1866 The bank-obligation insurance plans operating prior to 1866 differed substantially from those of the later period. This was a consequence both of the characteristics of banking during this earlier period and the fact that the plans were experimental procedures in providing protection for bank creditors. Approximately one-half of the nation's bank-supplied circulating medium before 1860 was composed of the notes issued by individual banks. This was because banks commonly extended credit in the form of circulating notes rather than deposits, particularly in the less developed areas of the country. For example, in 1838 note circulation of safety-fund banks in Michigan was more than three times their deposits, whereas in New York City the banks' deposits exceeded their banknotes by about the same extent. Noble State Bank v. Haskell (1911), 219 U. S. 111. Table 32. STATE INSURANCE SYSTEMS FOR THE PROTECTION 1 In a number of cases the law was repealed subsequent to the terminal date shown above. In some of the first six States closing dates may have preceded date shown by one year. Indiana's insurance system was included in the act establishing the State Bank of Indiana, the charter of which expired January 1, 1857. The same insurance system was included in the March 3, 1855, act establishing the successor institution, the Bank of the State of Indiana. An insurance system was provided for in an act of March 7, 1842; however, no banks were organized under the law and it was repealed in 1845. A permanent injunction preventing the State banking board from putting the law into operation was not dissolved until January 3, 1911, when the United States Supreme Court ruled the Oklahoma. Kansas, and Nebraska laws constitutional. Another difference related to the function of bank capital. In addition to serving as ultimate security for the protection of bank creditors, bank capital was more extensively used as a tool for the limitation of bank operations than is the case today. In the early decades of the nineteenth century restrictions as to the amount of bank lending, or the creation of obligations, were often expressed in terms of multiples of capital rather than, as at present, in terms of required reserves against deposits. Table 33 summarizes the provisions of each of the six plans which operated prior to establishment of the national banking system. Obligations insured. In the first four plans adopted, all debts of the participating banks, i.e., circulating notes and deposits primarily, were covered by insurance. In New York insurance was later restricted to circulating notes and this same restriction was also provided for in the last two plans adopted. However, in none of the six State plans was there any limitation within the framework of obligations insured on the amount of insurance provided the individual bank creditor. Limitation of insurance to circulating notes in the three States reflected a then current, but by no means universal, belief that banks affected the circulating medium only through the issuance of banknotes. Also, there was the feeling that depositors could "choose" their banks, whereas noteholders, who were commonly persons of modest means, frequently had no choice but to receive the banknotes. |