The Revolution in Banking Theory

"The independent retail stores have given way to chain stores. ... Local industries have merged with larger corporations."

Three trends that have been developing in the banking field are now arresting public attention.

1. The failure during the past eight years of 4925 banks out of a total of 30,812 in operation on June 30, 1921, has called into question the soundness of the system. From the public standpoint the essential feature of a banking system is that the bank acts as a safe repository of the funds entrusted to it; that within limits these funds may be used by the bank for investments; but that eventually the funds must be returned to the depositors. This fundamental of a sound banking system is being called into-question by the appalling fact that within eight years almost one sixth of the United States banks have been suspended with losses to the depositors.

2. In spite of the prohibition of branch banking by national statute and by laws in most states, over six thousand banks in the United States are in no sense independent unit banks, but are grouped in chains by holding companies, corporations, partnerships, or individuals. In other words, the theory of the independent local unit bank has broken down in 25 per cent of the banks in the United States. The restriction of branch banking is bringing into existence chains of banks, some of them threatening to become systems, controlled outside of either the state or the federal system, and varying in financial resources from powerful, well-managed groups of influential city and central banks under publicly incorporated and capitalized holding companies to groups of banks precariously owned by individuals and susceptible of questionable management.

3. Finally, there is the movement toward bank mergers, presaging a new financial era. In the last eight years, the number of banks has been reduced by almost five thousand. In part this reduction is due to bank failures, and in part to the absorption of banks by mergers. Though the number declined, the total resources of all banks, and of the average bank, increased, indicating the trend to larger banking units. A recent series of mergers brought the resources of a new New York bank to two and a half billion dollars, a veritable financial empire and symptomatic of the merging movement.

Summarizing the three movements: we are faced with a banking weakness, as shown by the large number of failures; there is a tendency toward unification of the banking system by chain and group banking, thus circumventing the restrictions on branch banking; and the same tendency is working by means of mergers. These movements are related, and primarily have their inception in the integration that is taking place in business and industry and is creating a new economic era.

The theory of the national government, and of most states, on which the United States banking system is established is that each bank should be a local institution, locally financed and managed, drawing funds from local depositors and using its financial resources for the development of local business enterprises. Such lapses as have occurred in the history of the national banking development and those that have taken place in some states only serve to emphasize the tenacious adherence, in both legislative and banking circles, to the theory of the unit bank. Efforts to establish a national banking system have in the past been hampered by the fear that such banks will become dominant factors and will centralize the banking field.

The First Bank of the United States was chartered by Congress in 1791 as an outgrowth of the woeful failure of the Continental Congress to finance the War of the Revolution, but after establishing branches in some of the then larger towns Congress refused to renew the charter. In a sense, the War of 1812 repeated the banking history of the previous war; the government had no banking system through which to finance the war, and as a result of bitter experience during this period the Second Bank of the United States was chartered in 1816, the re-charter being vetoed by President Jackson fifteen years later. The years of the Civil War, and the reconstruction afterward, again emphasized the need of a national fiscal agency, and at that time a national banking system was established; but, in conformity with the principle of the unit bank, no banking head was given the system until 1913, when, after a long period of acrimonious debate, in which the sacredness of the local bank was the dominant issue, the Federal Reserve System was established. The new system, through its centralized agency, permitted certain cooperation, notably for reserves and discounts, with its member banks, but forbade branch banking—that is, ownership of one bank by another—thus maintaining the integrity of the unit-bank system.

A majority of the states have followed the lead of the Federal Government and have prohibited branch banking to the state-chartered banks, though in several instances this statement needs qualifications. Some states, like New York, permit branch banking within city limits, on the theory that branches established for the convenience of scattered customers within the city do not impeach the principle of the unit bank. Practice in other states varies. California, for example, permits branch banking to its state-chartered banks, limited only by state boundaries.

This liberality on the part of some states toward branch banking to affect the Reserve System. It became increasingly onerous in New York City for national banks to compete with state banks for deposits when the state banks had branches scattered in convenient neighborhoods, whereas the business of the national banks was confined to one headquarters, usually in the financial district. In other large cities, members of the Federal Reserve System were similarly placed disadvantages. In consequence bank after bank changed from national to state charter, and members of the Reserve System dropped out in increasing numbers in order to take advantage of the more liberal provisions of the state charters.

In 1919, the state banks’ resources comprised 55.41 per cent of the total, and in March 1929 they were 60.15 per cent. The resources of the national banks had declined from 44.59 per cent in 1919 to 39.85 in 1929. In order to enable the national banks to compete with the state banks, Congress passed the McFadden Act, permitting the establishment of branch banks to members of the Federal Reserve System in states where branch banks are permitted by state law, but in any event limiting such branch banks strictly to city limits.

The situation, then, that the banking community is facing to-day is that historically, legally, and in theory the unit bank is still entrenched in the national banking system and in that of most of the states. Branch banking is permitted under national charters only within city limits, and under most state laws there is the same restricted limit. Because of the legal adherence to this theory, there are now in the United States 25,961 supposedly local self-contained banks, which represent a decline from the peak of 30,812 banks in 1921.

It should be noted here, in passing, that neither in Canada nor in Europe has banking developed along any such theory. Thus, Canada has eleven banks with 4040 branches; the United Kingdom has seventeen banks operating through thousands of branches in England, Ireland, Scotland, and Wales, some of them being represented in the West Indies, Palestine, Egypt, India, and practically every part of Africa under the British flag, and even in parts of foreign Africa; banking in France, Germany, Denmark, Holland, and other commercial European countries is similarly centralized.

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