Table 33. PRINCIPAL PROVISIONS OF BANK-OBLIGATION INSURANCE 1 Included circulating notes, deposits, and miscellaneous liabilities; excluded capital accounts. 2 Act of April 12, 1842. Free Banks, which were authorized in 1838, did not participate in insurance. Membership. Most of the insurance plans adopted during the early period were intended to include, immediately or eventually, all operating banks. In New York, Vermont, and Michigan the law applied to all banks to be formed subsequent to the act, with provision that existing banks must join at the time their charters were extended or renewed. Michigan went even further and specifically provided what may have been intended in the earlier plans: that existing banks could join at their option prior to a renewal or extension of their charter. In Indiana, Ohio, and Iowa all Branch Banks of State Bank systems were included in the insurance plans. These Branch Banks were not similar to modern institutions of the same designation but, instead, were independent banks supervised by an agency called the State Bank. Since the Indiana constitution originally restricted banking to Branch Banks there was full participation during the first eighteen years of the plan's operation in that State. Branch Banks in Ohio and Iowa were not given monopoly rights, although no competing banks were formed in Iowa during the period the insurance plan was in operation. Table 33. PRINCIPAL PROVISIONS OF BANK-OBLIGATION INSURANCE Free banks, which were authorized in 1851, did not participate in insurance. In 1842 participating banks were authorized under specified conditions to withdraw from insurance. Branch Banks were essentially independent banks which possessed their own officers, distributed earnings to their own stockholders, and which collectively constituted the "State Bank" in these States. With the appearance of "Free Banking", which provided bond security for circulating notes, the original intent of including all banks in the insurance systems was dropped. Free Banks authorized in New York in 1838, in Ohio and Vermont in 1851, in Indiana in 1852, and in Iowa in 1858, were not included in the respective insurance systems. Only Michigan, which adopted New York's free banking law in 1837, before it had passed the New York legislature and while inclusion of Free Banks in the insurance system was still being considered, specifically required that the new banks become part of the insurance system. Table 34 shows the maximum number of banks participating in insurance in each of the six States and the obligations insured at such times. It will be noted that the proportion of banks insured ranged from a little more than 50 percent in two States to 100 percent in one State. Percentagewise, participation was higher during earlier years in some States, since it was not until after the appearance of Free Banks that the number of insured banks reached a maximum. Table 34. MAXIMUM NUMBER OF BANKS PARTICIPATING IN 1 New York, Vermont, Michigan and Indiana, circulating notes plus deposits: Ohio and Iowa, circulating notes only. See note 7 for explanation of Michigan data. Excludes private banks. Data as of August 1847. Branch Banks of Bank of State of Indiana. Branch Banks of State Bank of Indiana, 1834-1856, numbered 13 at maximum, all of which were insured. Data for November 15, 1862. Deposits include individual and interbank deposits plus certificates of deposit. Estimated number in operation near end of year. "Circulating notes only (estimated). Deposit information not sufficiently complete for estimation. Types of insurance systems. Insurance of bank obligations during this period was provided by three methods: 1) establishment of an insurance fund, commonly referred to at the time as a "Safety Fund", 2) a requirement that insured banks mutually guarantee each other's obligations, and 3) a combination of the first and second. Reliance upon an insurance fund alone was the case in New York, Vermont, and Michigan. As indicated in Table 33, the fund was established through assessments levied on capital stock of participating banks, reflecting the relationship between capital and bank obligations previously noted. Expenses incurred in administering the insurance systems, including salaries and expenses of Bank Commissioners, were charged against the funds. While New York's insurance system was spreading to Vermont and Michigan, Indiana developed an alternative plan in 1834. It required that all participating banks mutually guarantee the liabilities of a failed insured bank. This obligation became effective when a failure occurred, and no provision was made for an insurance fund. Insurance systems adopted by Ohio in 1845 and Iowa in 1858 apparently reflected a conscious desire to incorporate the essential portions of the two types, with major reliance on the Indiana precedent. As shown in Table 33, protection for bank creditors in Ohio and Iowa rested essentially upon the mutual guaranty provision, with the insurance fund available for reimbursement of the contributing banks. This was probably due in part to the fact that Indiana's system had proved highly successful by 1845, while difficulties had been encountered in New York, and in Michigan the fund had been exhausted. The method of meeting expenses connected with administration of the Ohio and Iowa systems also followed that of Indiana, in that it was accomplished through special assessments on insured banks rather than through charges on the fund. In each of the five States having insurance funds, custody of the fund was given to the supervising authority, but ownership, directly or indirectly, remained with the banks. Method of paying creditors of failed banks. Immediate payment of insured obligations was effectively provided for in only two of the six States during this period. The systems of Ohio and Iowa provided that the necessary funds would be made immediately available through special assessments levied on the sound participating banks in proportion to their note circulation. This represented an improvement over systems adopted earlier. In New York, Vermont, and Michigan, creditors had to wait until liquidation of the failed bank had been completed, and the deficiency determined, before receiving payment from the insurance fund. Indiana required that its insurance plan become operative if liquidation of the assets of the failed bank proved insufficient to meet the claims of bank creditors within one year. Termination of the insurance funds. Five of the six State insurance systems in operation during this first period terminated in 1866 when most of the participating banks voluntarily converted to national banks. This action did not stem from dissatisfaction with the insurance systems, some of which had been highly successful, but rather from the fact that in 1865 a prohibitive tax upon State banknotes was levied by the Congress. In the sixth State, Michigan, the insurance system terminated about 1842 as a consequence of exhaustion of the fund. GUARANTY OF CIRCULATING BANKNOTES BY THE FEDERAL GOVERNMENT Although the majority of insurance systems adopted before 1860 had proved successful, almost a half century passed before insurance of bank obligations was again attempted by any State. This was not due to a decline in interest by the States in securing a stable and safe circulating medium, but rather to the fact that in 1863 the Federal Government acted to provide this protection through establishment of the national banking system. As noted previously, circulating notes issued by individual banks constituted an important portion of the circulating medium at that time. When, in 1865, Congress placed a prohibitive tax upon the notes of State banks, those of national banks remained the only circulating banknotes. These notes were guaranteed by the United States Treasury and their safety was unquestioned. Consequently, so long as they maintained their relative importance in the circulating medium there seemed to be no necessity for further development of insurance of bank obligations. The national banking system was essentially an extension on a nations! scale of the free banking systems established earlier in many States. That is, subject to certain restrictions, banking was open to all persons who qualified under the law and note issues were secured by the posting of collateral, in this case United States bonds. However, one important difference between the State systems and that adopted by the Federal Government was that the primary guaranty for the notes was the credit of the Government rather than the value of the posted collateral. Holders of notes of a failed national bank were to be paid immediately and in full by the United States Treasury regardless of the then existing value of the bonds posted and whether or not any difficulty was encountered in disposing of the bonds.1 As the Comptroller of the Currency stated in his first report to Congress: If the banks fail, and the bonds of the government are depressed in the market, the notes of the national banks must still be redeemed in full at the treasury of the United States. The holder has not only the public securities but the faith of the nation pledged for their redemption.2 INSURANCE OF BANK DEPOSITS IN EIGHT STATES, 1907-1930 It was apparently not foreseen early in the 1860's that deposits, rather than circulating notes, would come to constitute by far the largest portion of the nation's circulating medium. In 1860 the two items were about equal in amount. By 1870 deposits were about twice, and by the end of the century seven times, circulating notes. It was against this setting that efforts were renewed to guard against the disastrous effects of the destruction of circulating medium through bank failures and to provide a greater degree of protection for bank creditors. The adoption of State deposit insurance programs between 1907 and 1917 was also a consequence of difficulties many of the States were meeting in attempting to provide for stable banking systems. It will be noted in Table 32 that seven of the eight States involved were located west of the Mississippi River. Problems similar to those of New York, Vermont, and Ohio a half century earlier were current. Consequently it is not surprising that State legislators turned to insurance of bank obligations, although in this instance insurance related only to bank deposits. Table 35 summarizes the principal provisions of the plans adopted by the eight States. 1 12 Stat. 672. First Annual Report of the Comptroller of the Currency, November 28, 1863. |