Commercial banking history

The term given to banking institutions that provide a full array of customer services to both retail and business customers. In the 19th and early 20th centuries, commercial banks served mostly business customers, and “commercial banking” was appropriate when describing them. Banks accept deposits from customers, and make loans at a higher rate of interest. Originally, most of the deposits accepted were from business customers, and the loans made were also to businesses for short to medium terms.

Commercial banks were organized in the late 18th century around the time of American Independence. The Bank of North America was chartered in Philadelphia by Robert MORRIS and was followed by the BANK OF NEW YORK, chartered by Alexander HAMILTON in 1784. Throughout the 19th century, banks remained partnerships and conducted business mainly with businesses and wealthy individuals. They were confined to their home states and often their home cities or counties. Interstate banking did not exist, being prevented by state banking laws that kept out-of-state banks from encroaching on local markets. In addition to the commercial banks, commercial banking on a limited scale was done by private banks—smaller banks that also conducted securities operations. Individual savers usually kept their savings at thrift institutions that were organized to grant them mortgage credit if they kept their deposits with the same thrift.

Banking was mostly a state-level affair until the Civil War. Most banks obtained a charter from and operated within their home states. In the absence of a central bank, especially after the closing of the Second BANK OF THE UNITED STATES, many state banks issued their own banknotes, backed by specie. While acceptable within the state, having different notes issued by the states sometimes slowed interstate commerce and often led to widespread forgery. Only when the Civil War broke out did Congress attempt to remedy the situation.

The first major banking law at the national level was passed by Congress in 1864, the NATIONAL BANK ACT. The law created the Office of the Comptroller of the Currency. Banks that registered with that office were allowed to carry the designation “national bank,” and the comptroller also was given regulatory powers over them. Banks were also discouraged from operating in the securities markets. But in the absence of a central bank, the comptroller had only limited powers since banks that did not register with the office were not within its limited regulatory orbit. The act effectively created a two-tier banking system in the United States, with one group of banks at the state level and another at the federal level.

In the 1890s, banks played a substantial role in the general consolidation, or trust, movement, helping to merge companies and often encouraging their directors to sit on corporate boards. After the turn of the 20th century, the powerful New York banks became known as the “money trust,” a name signifying that they controlled the reins of credit. They were investigated by the Pujo Committee in 1912 in an attempt to understand their effect upon the trusts and the creation of credit.

After the FEDERAL RESERVE was created in 1913, a new regulator was added, but the Fed had authority only to dictate reserve requirements and examine those banks that were registered with it. In the 1920s, the banks also began acquiring securities subsidiaries through their parent holding companies and played a major role in underwriting and selling bonds and (later) stocks, before the Crash of 1929. The period between 1921 and 1933 witnessed a large number of bank failures, with almost 15,000 banks failing or merging with others.

Bank activities were severely curtailed by the BANKING ACT OF 1933, and those with securities operations were forced to divest. The act defined the areas of finance that commercial banks were allowed to engage in. The act prohibited commercial banks from participating in corporate securities activities. The MCFADDEN ACT of 1927 had already prohibited banks from opening new branches across state lines, and it seemed that bank activities were now limited in terms of both activities and expansion. But some larger banks employed holding companies to their advantage by buying banks in other states, avoiding the restriction about opening new branches. One of the most aggressive was the BANK OF AMERICA, which organized as the Transamerica Corporation in order to expand in the western states and in New York City. After several challenges to this sort of expansion, Congress finally passed a new restrictive act limiting bank expansion across state lines.

During World War II, banks changed their habits to aid in the war effort as the Federal Reserve maintained a close control over interest rate levels. The Fed pegged the level of interest rates allowed in the marketplace and relaxed reserve requirements for banks that held Treasury securities as assets rather than loans. As a result, banks became major holders of Treasury securities and remained as such until the Korean War, when the interest rate peg was abolished, and banking returned to its peacetime business.

In 1956, the BANK HOLDING COMPANY ACT further defined the role of the Federal Reserve in regulating the activity of bank holding companies. Banks continued pressure on regulators to expand but now had to satisfy the Federal Reserve Board. Throughout the 1960s and 1970s, banks expanded into areas permitted by the Fed and also expanded substantially overseas.

High interest rates in the mid- and late 1970s had a negative effect as many savers withdrew their cash in favor of higher yields in money market mutual funds. Pressures caused by this phenomenon prompted Congress to pass the DEPOSITORY INSTITUTIONS DEREGULATION AND MONETARY CONTROL ACT, deregulating interest rates and expanding the power of the Federal Reserve. The perennial problem of who regulated the banks was closer to being solved since all banks now were subject to the Fed’s reserve requirements, regardless of location or charter. Usury laws began to crumble in many states as well, as high interest rates were now tolerated by state legislators, who feared losing banks in their states if they did not loosen the decades-old restrictions. CITIBANK began opening credit card facilities in states that did not have usury ceilings, and the door swung open for New York and other major banking centers to roll back their laws.

In the 1980s, commercial banks were beset with loan problems. Many had made loans to developing countries in South America and Asia that had to be rescheduled or written off, leaving the banks with record losses. Many loans had been made at variable rates of interest that soared to record levels between 1981 and 1984. As a result, many banks were forced to increase their base capital, following an increase in capital requirements made by the Bank for International Settlements in 1988 in conjunction with the Fed and the Bank of England. Those American banks that could not meet the requirements were forced to merge or close their doors. As a result of the loan and capital problems, many banks began to seek new avenues of business in fee banking, the sort usually reserved for investment banks. Many commercial banks also purchased smaller savings and loans, hard hit by the junk bond scandal in the later 1980s, giving them a stronger foothold in the residential mortgage market.

In the 1990s, commercial banks began to expand their activities into investment banking under liberal interpretations of the holding company act made by the Federal Reserve. This included underwriting of corporate securities, forbidden since the Banking Act of 1933. However, full integration of banking, INVESTMENT BANKING, and insurance did not occur until Congress passed the FINANCIAL SERVICES MODERNIZATION ACT in late 1999. The law liberalized and expanded the list of permissible activities for a bank; as a result, the industry began to offer “universal” banking services under one roof for the first time.

When banks entered the RECESSION following the stock market drop of 2001, they were exposed to the financial markets and the loan markets for the first time since the early 1930s. Several large banks suffered notable losses on both their loan portfolios and in the securities markets, leading critics to suggest that re-regulation was needed to prevent further erosion of the financial system.

See also CHASE MANHATTAN BANK; MORGAN, JOHN PIERPONT.

Further reading

• Bodenhorn, Howard. A History of Banking in Antebellum America. New York: Cambridge University Press, 2000. 
• Calomiris, Charles. U.S. Bank Deregulation in Historical Perspective. New York: Cambridge University Press, 2000. 
• Rothbard, Murray N. A History of Money and Banking in the United States: The Colonial Era to World War II.Washington, D.C.: Ludwig von Mises Institute, 2002. 
• Wright, Robert E. The Origins of Commercial Banking in America, 1750–1800, New York: Rowman & Littlefield, 2001.