Largest financial intermediary with historically important role in money supply process and transmission of monetary policy.
Commercial banks received state charters primarily between 1789 and 1863. Their liabilities (sources of funds) consisted mostly of banknotes but included some deposits. Their assets (uses of funds) consisted of specie (gold and silver) and short-term commercial loans intended for financing inventories or accounts receivable.
The federal government chartered the First Bank of the United States (1791-1811) and the Second Bank of the United States (1816-1836). These banks attempted to control the money supply and improve the soundness of commercial banks by redeeming banknotes of state banks. Particularly in western and southern states, bankers disliked these activities and successfully prevented an extension of the Second Bank’s federal charter.
Between 1837 and 1863, states exclusively regulated banks. Banking regulations and the extent of supervision differed substantially among states, resulting in a heterogeneous currency with numerous banknotes circulating at varying discounts. The federal government reestablished a regulatory role through passage of the National Banking Act of 1863 and its subsequent amendments. The act’s objectives included providing a uniform national currency and strengthening the government bond market. It established nationally chartered banks, the reserves of which included gold and United States government bonds. It imposed a 10 percent tax on state banknotes, thereby eliminating banknotes as a source of funds for state-chartered banks.
However, state-chartered banks survived by acquiring funds through deposits. They thrived after 1880 because many bankers saw profit opportunities in obtaining a state bank charter, which had lower capital requirements, lower reserve requirements, more flexibility regarding loans, and less supervision than national banks. A dual banking system developed in which a bank could have either a national charter or a state charter.
The dual banking system resulted in a complex structure of regulation as each state established its own set of rules for banks operating in that state. Many states became unit-bank-ing states, in which a bank could operate at only one location, because many people feared that large banks would engage in monopolistic practices if allowed to expand geographically. Restrictions on national banks reinforced these state banking laws. Because this legal environment limited where a bank could operate, the United States developed a system with many more commercial banks—and typically smaller banks—than banking systems of other industrialized nations.
The national banking system provided a uniform currency, which reduced transactions costs, but it remained subject to significant fluctuations in the money supply and frequent bank panics that resulted in many bankruptcies and business failures. In 1913, Congress established the Federal Reserve System to act as a lender of last resort when no other sources of funds are available to ensure the banking system’s stability.
Between 1930 and 1933, the Federal Reserve failed to prevent a financial collapse as approximately one-third of commercial banks went bankrupt. To rebuild the banking system and to prevent its future collapse, Congress passed the Glass-Steagall Act (1933) and the Banking Act of 1935. This New Deal economic legislation of President Franklin D. Roosevelt, reflecting the view that too much competition existed in the banking industry, separated commercial banking from the investment banking and securities industry, created the Federal Deposit Insurance Corporation (FDIC), restricted checkable deposits to commercial banks, and regulated interest rates paid on deposits.
The legislation established a restrictive legal environment in which commercial banks operated during the next five decades. Although commercial banks gradually lost market share among financial intermediaries, the banking system would not substantially change until the 1970s. Ultimately financial innovation resulted from improved technology that lowered costs of providing certain financial services/instruments, from banks seeking improved profit by avoiding existing regulations, and from rising and more variable inflation, which increased both interest rate risk and cost of regulations.
The problems caused by rising inflation throughout the 1970s forced major changes in the legal environment in which banks operated. Some savers withdrew funds from depository institutions to purchase direct claims by borrowers (for example, certificates of deposit or money market accounts) as market interest rates rose above legal interest rate ceilings placed on banks; the rapid growth of money market mutual funds intensified loss of deposits. As many banks faced dwindling profits and even bankruptcy, Congress passed the Depository Institutions Deregulation and Monetary Control Act (1980) and Garn-St. Germain Depository Institutions Act (1982). These acts allowed depository institutions to provide interest-bearing checkable deposits, to issue more competitive savings accounts, and to broaden permissible activities of thrifts (mutual savings banks/saving and loan associations).
The legislation was too late to prevent numerous bankruptcies among thrifts, which had losses from withdrawal of funds or bad loans. Bankruptcies became less common among commercial banks, which were concentrated in oil-producing states. These banks had poorly diversified loan portfolios and had to deal with fluctuating oil prices, but because oil was in short supply in the 1970s the banks did not experience a withdrawal of funds. Congress passed the Financial Institutions Reform, Recovery, and Enforcement Act (1989) to bail out thrifts and passed the Federal Deposit Insurance Corporation Improvement Act (1991) to improve soundness of commercial banks by establishing new categories of capital adequacy.
During the 1970s and 1980s, banks expanded across state lines as interstate compacts developed. During the 1990s, they obtained greater flexibility, expanding geographically and broadening their range of activities. The Riegle-Neal Interstate Banking and Efficiency Act (1994) established nationwide interstate banking. During the 1980s and 1990s, the Federal Reserve allowed specific bank holding companies to expand activities. Because restrictions on commercial banks’ securities and insurance activities placed U.S. banks at a competitive disadvantage to foreign banks, bills to repeal Glass-Steagall appeared regularly in Congress during the 1990s. The Gramm-Leach-Bliley Financial Services Modernization Act (1999) repealed Glass-Steagall to allow consolidation of financial services. Numerous mergers among banks from the mid-1990s to 2003 indicate that some banks believe their best strategy is to become large diversified financial service firms by growing geographically and increasing the range of products they offer. However, other banks stress local ownership and personal service as their strategy for survival.
The share of assets in financial intermediaries such as commercial banks and securities dealers has continued to fall, particularly since 1985, because of the rising importance of mutual funds and pension plans. However, banks remain
Berlin than closing the border between East and West Berlin on August 13,1961.
In 1984, Mikhail Gorbachev started to change the Soviet Union’s policies by instituting perestroika (a reorganization and movement toward an open economy) and glasnost (openness that included a movement toward free speech and a loosening of control by the USSR national police, the KGB). The Soviet reforms also influenced other communist countries, especially Poland and Hungary, which had established a nonphysical but effective Iron Curtain that prevented free travel out of those countries. On August 23, 1989, Hungary opened the Iron Curtain to Austria, allowing East German tourists to escape to Austria through Hungary, and in September 1989 more than 13,000 East German escaped via Hungary within three days. The event marked the first mass exodus of East Germans after the erection of the Berlin Wall in 1961. Mass demonstrations against the government and the economic system occurred in East Germany starting at the end of September and finally ending in November 1989. Erich Honecker, East Germany’s head of state, finally resigned on October 18, 1989, and the new government issued a new law that lifted travel restrictions for East German citizens.
At 6:53 P.M. on November 9, 1989, a member of the new East German government responded to a press conference question about when the new East German travel law would take effect. The official answered: “Well, as far as I can see,… straightaway, immediately.” That moment signaled the end of the Berlin Wall. That night East Germans opened the deadly border peacefully at 10:30 P.M. During the ensuing weeks, citizens helped tear down the wall. Official demolition began on June 13, 1990, and most work was completed by November 30,1990.
