Banking History & Overview

  A Brief Look at the History of the Banking System

Dual Banking System

Bank Regulatory Structure

A Closer Look at the State Banking Regulation

A Brief Look at the History of the Banking System

Banking in the United States has gradually evolved over two hundred years. A product of a succession of monetary crises, today's system is profitable and strong. Its strength and viability result from the fact that bankers and legislators have learned the lessons of history. It is a most interesting history, one closely tied to the history of the nation itself, for the evolution of banking reflects the philosophy and mood of the population at different times.

Many of the settlers during Colonial times came from countries where a central bank dominated the financial scene. Instead of following the pattern that had existed in European countries, the early settlers moved toward the opposite extreme. They believed anyone who wanted to establish a bank could. Each of the original 13 colonies strongly defended its right to regulate banking within its own borders. One primary weakness leading to many bank failures during this period was the practice of individual banks issuing their own notes which could presumably be redeemed in gold and silver. In theory these notes would be used as money in payment of debts. In actual practice this was not the case and there was a growing distrust by the public in this system. People were becoming aware that a sound monetary system was essential to the health of the nation's economy. A system had to be devised with some sort of circulating medium in which the people had confidence. Alexander Hamilton, Secretary of the Treasury, was instrumental in the creation of the First Bank of the United States in 1791. It was established under a strict set of provisions regarding capitalization; it could issue its own paper currency up to the amount of its capital. Its charter was granted for a 20-year period; however, due to strong opposition and the memory of central banks of other countries and the control they exerted, in 1811 Congress voted down renewal of the charter, and the bank went out of existence.

The period of 1811-1816 witnessed the same weaknesses that had existed prior to the formation of the First Bank, but on a much larger scale. The number of undercapitalized and poorly run state chartered banks continued to increase and public confidence in the banking system deteriorated. This led to the chartering of the second Bank of the United States in 1816. While the bank generated public confidence, it was bitterly resented by state banks and opposed by President Andrew Jackson. For these reasons, Congress failed to renew its charter in 1836.

The period from 1836-1863 has been described as the darkest in America's banking history. The rapid geographic expansion, population growth and economic prosperity combined to create an ideal climate for the growth of commercial banking. However, many of the banks that opened lacked both sufficient capital and prudent management and failed to serve their communities. Also, many banking abuses crept into the system. By 1858, counterfeiting had become widespread and merchants refused to accept bank notes. Public faith and trust in the banking system were at their lowest point.

A severe fiscal crisis in the federal government was brought about in 1863 by two years of Civil War conflict. During this period, President Lincoln was forced to look for new methods of obtaining funds. He appointed Salmon P. Chase, Secretary of the Treasury, the task of finding these sources of revenue and, at the same time, overhauling and reforming the banking system. Chase introduced dramatic legislation, passed by Congress in 1863 as the National Currency Act and amended a year later as the National Banking Act. These acts not only form the basis of today's banking structure, but they also provided a solution to the federal government's financial woes by opening up a new market for Treasury bonds. The 1863 and 1864 Acts provided for:

1. The creation of a new type of financial institution, to be called a national bank. Each national bank would be privately owned but chartered directly by the federal government. Rigorous qualifying standards for new charters were established. Stockholders whose contributions made up the required capital for the opening of a national bank were made personally liable in the event the bank failed. Existing state-chartered banks were invited to convert to this new charter if they wished and if they could meet the standards.
   
2. Established a new office in the Treasury Department called the Office of the Comptroller of Currency. This office would be responsible for chartering, regulating, and examining all national banks.
   
3. The creation of a new, uniform type of currency called the national bank note. Before issuing them to customers, each national bank was required to purchase a certain amount of government bonds and pledge them to the Treasury Department. This technique not only gave the public a measure of confidence in the soundness of the notes but also raised money for the government and kept the amount of each bank’s outstanding notes in relation to its capital.
   
4. Established a system of required reserves. Each national bank, as stipulated by the National Bank Act, had to maintain reserves against both its deposits and its notes.

Dual Banking System

The 1863-1864 legislation was responsible for much of what we see today on the American banking scene. National banks competitively exist side by side with far more numerous state-chartered banks offering, in general, the same services and operating in the same fundamental way. The fact that every commercial bank must be chartered by either the federal government or the banking authorities in its own state has created what is known as the dual banking system.

Creation of Federal Reserve System

Several weaknesses in the National Banking Act become evident through the passage of time, among these were:

 > Lack of a Check Collection System,

 > An Inflexible Currency,

 > Pyramiding Reserves.

Due to these weaknesses, in 1912 President Woodrow Wilson stated further reforms were necessary. This reform was the Federal Reserve Act, which was enacted in 1913. The Act was a fascinating example of compromise legislation. To those who feared excessive concentration of power in Washington, it provided a measure of local control. To those who opposed the idea of a strong central bank, it provided for private ownership. To those whose chief concern was the money supply, it offered a new type of currency, the Federal Reserve Note, which did not have to be backed by bonds but would be accepted as official tender.

Creation of the Federal Deposit Insurance Corporation

Just as the lawmakers who drafted the National Banking Act, the lawmakers who drew up the Federal Reserve Act could not have predicted the collapse of the stock market, the depression of the 1930s and the banking crisis that resulted. During the Roaring Twenties, states extended charters to thousands of new banks under the prevailing philosophy that the future was limitless and that the business boom would continue indefinitely. That philosophy was put to rest when the stock market crash of October 1929 caused a decrease of $14 billion in paper values in a single day.

During 1930, 1,300 commercial banks closed their doors, and by 1933 an additional 7,000 had failed. Some $7 billion in deposits disappeared through these bank failures. These banks became the hub of a vicious circle. Businesses went into bankruptcy, defaulted on their bank loans and reduced their expenses by firing workers. People often could not withdraw funds from their banks to meet everyday expenses because the banks simply did not have the cash.

This brought about the creation of a new federal agency, the Federal Deposit Insurance Corporation (FDIC). It was established to:

> Set standards of operation for its members,

 > Examine them to ensure compliance with standards,

 > Take any one of several actions designed to prevent a troubled bank from failing, and

 > Pay depositors if an insured bank should fail.

Bank Regulatory Structure

It is evident by now that regulation and supervision of banking has evolved over time, largely in reaction to historical events, with no grand structure or design.

The individual institution determines the regulatory agencies and the rules under which it operates by its charter selection, either state or federal.

 Principal Regulatory Agencies

Even though banks may be regulated by several regulatory agencies, it only has one primary regulator.

 State Banking Departments

Primary regulator of state-chartered banks. May also regulate bank holding companies which own state-chartered banks

 Federal Deposit Insurance Corporation

Primary federal regulator for state-chartered banks and savings banks that have deposit insurance but who are not members of the Federal Reserve.

 Federal Reserve Bank

Primary regulator of all bank holding companies and state-chartered banks that are members of the Federal Reserve System.

Office of the Comptroller of the Currency

Primary regulator of federally chartered (National) banks and may participate in exams of bank holding companies that own federally chartered banks.

Agencies generally cooperate with each other to reduce regulatory burden on banks by:

1. Conducting alternating exams,
2. Conducting concurrent or joint exams, and
3. Sharing information and examination reports.

Critics of the system of multiple regulators call it redundant and inefficient and suggest replacing it with one single regulatory czar. Others, however, argue the diversity actually strengthens the banking system by providing an environment that nurtures innovation and flexibility. Additionally, concentrating power would risk politicizing bank regulation.

A Closer Look at the State Banking Regulation

A primary responsibility of the Division is to supervise and regulate Ohio's state-chartered banks. As of December 31, 2000, there were 119 state-chartered banks with aggregate assets of $56.6 billion. In addition to state-chartered banks, the Division regulates money transmitters and organizations doing trust business in Ohio. Two principal regulatory functions are corporate application processing and bank examination/supervision.

Chartering Agent

The division is the sole chartering agent for new state banks. As mentioned previously, the OCC is the chartering agent for national banks. New state banks must submit an application and receive the Division’s written approval before they can commence business. Existing state-chartered banks must also submit applications and receive written approval before opening branches, merging with other institutions and engaging in many other activities such as selling additional capital stock.

A bank charter is a license to conduct business. To minimize the risk of failure and losses to the bank insurance fund, the bank chartering process is used to set minimum standards for:

1. Capital
2. Experienced Management
3. Business Plan, and
4. Policies and Procedures

The charter can be obtained from either the federal government or individual state governments. No other business enterprise in the United States operates under a dual chartering system. Whichever charter, state or federal, is chosen, that chartering agency becomes the primary regulator.

Factors in the Choice of Charter

• Supervisory fees,
• Regulatory structure,
• Business structure,
• Responsiveness of primary regulator, and
• Available banking powers.

All chartering agencies evaluate applications on these factors:

1. Financial history and condition,

2. Adequacy of capital structure,

3. Future earnings prospects,

4. General character of management,

5. Deposit insurance risk,

6. Convenience and needs of the community, and

7. Consistency of corporate powers with laws

Examination/Supervision

The Division’s examiners assess the overall safety and soundness of state-chartered banks and evaluate compliance with applicable regulations and laws. The examiners rate the banks based upon six characteristics together comprising the CAMELS ratings (so named for the acronym that identifies the six characteristics examined): 

• Capital Adequacy
• Asset Quality
• Management
• Earnings
• Liquidity
• Sensitivity

Following the assignment of individual "component" ratings, a composite rating is assigned as the overall rating of the institution. Ohio's state-chartered banks are generally rated high using this system. All 50 states, the Federal Reserve System, and the Federal Deposit Insurance Corporation use this rating system. The current examination ratings of all state-chartered banks indicate the following results:

In addition, division examiners examine bank holding companies that own Ohio-chartered banks as well as trust departments and data processing operations of state-chartered financial institutions. These specialty examinations also measure performance using standardized rating systems widely used by federal and state banking regulators.

Fees

The division's operations are fully funded through annual fee assessments to banks based on asset size and through various charges for application processing and other activities. On an average, state banks save approximately (depending on size) 20 to 70 percent on assessments compared to nationally chartered banks. Assessments and other fee amounts are set annually by the State Banking Board based upon recommendations of the Superintendent.

Regulatory Actions

By statute, the Superintendent has the power to place various regulatory actions (formal and informal) upon a bank. In the least severe situation, the Superintendent may request the board adopt a board resolution or action plan to address problems. In this situation the bank would monitor the resolution. An informal agreement between the board of directors and Superintendent (Memorandum of Understanding) is used for moderate problem situations. More serious cases involve formal action(s) in the form of Written Agreements and Cease and Desist Orders. Cease and Desist Orders are legally enforceable.

Trade Associations

Industry - The national trade association for banks is the American Bankers Association located in Washington, D.C. The trade associations for Ohio banks are the Ohio Bankers Association and the Community Banker Association of Ohio, both headquartered in Columbus, Ohio.

Regulatory - The Division is a member of the Conference of State Bank Supervisors (CSBS). This organization provides numerous benefits to the Division including technical and career development schools for examiners.  The Division’s banking regulatory function has been accredited by the Conference of State Bank Supervisors (CSBS) since 1989. That process includes undergoing a detailed on-site review by a qualified team of experienced bank regulators selected by CSBS. Accreditation sets a standard for recognizing the quality of a state agency’s supervisory and regulatory activities and provides a framework for fostering continued improvement.