VI THE REGULATION OF BANKING Introduction Banking was one of the first forms of business to be subjected to government regulation. Because of the almost universal demand for the accomodations which banking affords and because of the tremendous power that is inherent in the control of loanable funds, the business has long been regarded as quasi-public in its nature. Indeed, there are many who hold that all banking should actually be conducted by the government itself; that to permit private interests to control the supply of bank currency and credit is to foster one of the most vicious of monopolies. But while it has long been recognized that banking is a public-service calling, we have, not yet completely abolished private banking; for in many states it is still possible for individuals to engage in a general banking business subject to no regulation whatever. The numerous disastrous failures of such institutions in recent years, however, have fortunately developed an agitation against them which promises to result in their complete elimination from our banking system. Many of the large investment, banking institutions are also unchartered and largely unregulated; but since they are for the most part controlled by men of large financial experience, and since they deal chiefly with other large financial interests, these private institutions do not present the same problems as do those which are designed to serve the public by means of a general banking business. The problems that arise in connection with the private investment banks are related to the possible misuse of the great power they wield through the control of the resources of capital. A second reason for government supervision of banking is that it is necessary for the control of the system as a whole in its relation to the entire economic structure of society. As has been indicated in the preceding chapter, individual banks cannot escape relations with other banks, their own prosperity and safety being fundamentally linked with that of the system as a whole; and as a consequence the banks themselves have been forced, in the absence of adequate government regulation, to develop machinery for controlling themselves as a system. At certain points, however, and at certain times, as has been noted, these voluntary associations have proved inadequate to the requirements of the situation. The government has therefore been looked to for the direction and control of banking-in the interests of the banks themselves and through them of the entire economic system. Governmental supervision of banks has assumed various forms. In addition to requiring banks to incorporate, and thereby to conform with certain general provisions with reference to organization, the government has laid down numerous regulations pertaining to the character and extent of loans and the amount and nature of the reserve that must be held against deposits. Both national and state governments have developed regulations along these lines, and in the main they have based them on principles that have been developed out of many years of actual banking experience. The most important feature of government regulation of banking, however, has been in connection with the issue function. While deposits have gone largely unregulated, bank notes have from the very beginning of our banking history been subject to numerous regulations. This special attention to the issue function is due in part to the fact that it was long the primary form in which bank obligations were manifested, in part to the fact that bank notes pass from hand to hand without regard to the character of those who hold them and thereby form a part of the money supply of the country quite as much as do gold and silver or government paper, and in part to the fact that we must look to the notes to give flexibility to the currency system as a whole. The regulation of note issues has taken many forms, and the discussions of the principles underlying bank currency have been as vigorous and prolonged as the controversy over bimetallism. There are two fundamental problems in connection with the regulation of bank notes: that of making them safe and that of making them elastic, that is, responsive to the varying requirements of trade. Until the Civil War we had no national system of banking, and as a whole our bank currency was in a chaotic condition, lacking safety, uniformity, and elasticity. Here and there sound banking principles were being developed: in numerous instances bank notes were reasonably secure; in some sections of the country there was developed more or less uniformity; and now and then a measure of elasticity was found. But on the whole the situation could hardly have been worse. The national banking system made a great step in advance when it eliminated all state bank issues and gave us a safe and uniform national currency based on the deposit of government bonds in the federal Treasury. But this system of bond-secured notes did not provide for an elastic medium of exchange; and since we depend upon bank notes to furnish us virtually all the elasticity we have in our monetary system (aside from deposit currency), one of our most serious banking problems has remained for solution until the present day. It is believed, however, that the federal reserve system has solved the problem of an elastic currency. A. Governmental Supervision 96. INCORPORATION1 BY WILLIAM A. SCOTT It is generally admitted nowadays that no one ought to be permitted to engage in the banking business without special authority from the state. The reason for this is the need, in the interests of safety, of the public regulation and supervision of this business. Experience has shown that this can best be secured by the requirement of incorporation through special charter or in accordance with general laws, such charters or laws prescribing the conditions under which the business must be carried on. Without incorporation it is difficult, if not impossible, to separate banking from other lines, and consequently to know precisely who are engaged in it and how it is being conducted. Under such conditions certain persons are sure to escape the regulations prescribed by law and designed for the safeguarding of the public. As between incorporation by special charter or under general laws, practice in the past has varied widely, but general banking laws are fast becoming the rule the world over. They prevent favoritism and secure uniformity. Only in the cases of highly specialized institutions of peculiar character, like the great central banks of Europe, is the special-charter method of incorporation likely to survive. The differentiation of the banking from the general incorporation laws of a state, that is, those applicable to other kinds of industrial 'Adapted from Money and Banking, pp. 131-32. (Henry Holt & Co., 1910.) corporations, is also desirable on account of the peculiarities and public importance of this business. Such differentiation is rapidly becoming the rule in this country. The need of incorporation applies to savings banks and trust companies quite as much as to commercial banks. Incorporation may be either under state or national law. 97. ADOPTION OF THE SYSTEM OF FREE BANKING' BY HORACE WHITE The system of free banking, or incorporation under the provisions of a general law, had its origin in the State of New York in 1838, although the State of Michigan had something resembling it a year earlier. Prior to that time bank charters in New York were a part of the spoils system of politics. Accustomed as we are to the spoils system of today, it nevertheless sounds oddly to read that bank charters were granted by Whig and Democratic legislatures only to their own partisans. Not only was this the common practice, but the shares in banks, or the rights to subscribe to them, were parceled out by political "bosses" in the several counties. Of course, corruption flourished in such soil. The people became exasperated by the indecencies witnessed at Albany. A reaction in favor of equal rights was the natural consequence, and out of this came the FreeBanking Law of 1838. Under this law the Comptroller was authorized to issue circulating notes to any association organizing itself as a bank and depositing stocks of the United States, or any State, or bonds secured by mortgage on real estate of a certain specified grade. The system had a bad start. Within five years after the law was passed twenty-nine banks that had organized under it failed, and the deposited securities realized only seventy-four cents on the dollar of the outstanding notes. This led to changes in the law by which all State bonds were ruled out except those of New York, and the mortgage securities were keyed up to a high pitch, but still not high enough. The free-banking system made little headway in other eastern states, but it was quite generally adopted in the West during the decade just preceding the Civil War. While the early experience under free banking was generally disastrous, the fault lay, not in the general incorporation law, but in the inadequate regulation of the conditions under which banks thus organized were operated." • Adapted from "National and State Banks," Sound Currency (1894-95), II, 7-8. 2 For other features of the free-banking system, see selection No. 121.-EDITOR. |