History of Banking in the U.S.
June 1, 2023
The United States’ banking history can be traced back to the late 1700s. Prior to the first U.S. banks, individuals provided credit to each other or relied on credit from banks and merchants in Great Britain. The currency used at that time consisted of foreign coins and paper money issued by individual colonies.
The Bank of North America became the first financial institution chartered by Congress in 1781 and opened in Philadelphia in 1782. Shortly thereafter, Alexander Hamilton founded the Bank of New York in 1784, which operates today as BNY Mellon and is the oldest continuously operating bank in the U.S. The Bank of Massachusetts was also founded in 1784 and, through mergers, is part of Bank of America today. When George Washington became the first President in 1789, these were still the only three banks in the U.S. Washington chose Alexander Hamilton to serve as the first Secretary of the Treasury, who worked to provide the U.S. with a modern banking system.
The Bank of the United States, also known as First Bank of the United States, was chartered by Congress in 1791 to deal with war debt from the Revolutionary War and to create a firm financial footing for the government. The Bank’s headquarters was in Philadelphia and it had eight branches located in Boston, New York, Charleston, Baltimore, Norfolk, Savannah, Washington, D.C., and New Orleans. The First Bank of the United States was Hamilton’s vision of a central bank, one that could act as a source of capital to develop new businesses and to grow the economy. However, many argued that it was unconstitutional, as the Constitution granted Congress the ability to tax and print money, not a private corporation. Due to this reasoning and because the war debt had mostly been repaid, Congress decided not to renew the Bank’s charter in 1811.
Soon after, war debt built up again due to the War of 1812, and Congress chartered the Second Bank of the United States in 1816 to promote a uniform currency, to act as a clearinghouse that could hold large quantities of bank notes from other banks, and to discipline banks who over-issued notes by threatening to redeem the notes. The Second Bank was also located in Philadelphia. Andrew Jackson was an opponent of the Bank, as he believed it was susceptible to corruption and was difficult to control. Bank President Nicholas Biddle used the Bank’s resources against Jackson, and Jackson responded by pulling Federal deposits from the Bank. As a result, the Bank’s charter was ultimately not renewed by Congress in 1836.
State legislatures largely chartered banks in the late-1700s and early-1800s, but this soon became highly politicized, as parties who held control would show preference by granting charters to supporters. A few states implemented free banking laws in the 1830s to move away from such politicization. This made the granting of bank charters an administrative function rather than a legislative function of government. The number of banks increased as a result and provided access to banking for more Americans.
One of the biggest issues revealed during the early days of banking in the U.S. was that currency exchange was very complicated. Many banks had trouble converting bank notes into coin because they lacked the necessary reserves. Additionally, bank notes were issued by individual banks rather than a central bank, so it was much harder to detect counterfeit bills from banks in other states. The Union government under Abraham Lincoln helped offer a solution to this issue in 1863 when they began chartering national banks and started to print and issue a national currency backed by U.S. bonds. Congress took this a step further in 1865 when it passed a tax on state bank notes, effectively ending the use of state bank notes. However, state banks could still accept deposits without issuing notes, and by the late 1800s, a dual banking system developed between national and state banks.
After experiencing several banking crises, Congress decided to create a new central bank known as the Federal Reserve System (the Fed) in 1913. By the end of 1914, the Fed was organized into 12 regional Reserve Banks in cities across the country. The Fed helped make U.S. currency even more consistent with the introduction of Federal Reserve Notes, which completely replaced national bank notes by the 1930s.
Federal Deposit Insurance was introduced during the Great Depression by the Banking Act of June 1933, otherwise known as the Glass-Steagall Act. The Banking Act of June 1933 also provided Federal regulation of interest rates on deposits and separated investment banking and commercial banking.
Banking was largely stable from the 1930s to the 1980s, but it had also become less competitive and more regulated than it had been before that time. By the 1960s and 1970s, it became clear the commercial banking industry was losing significant market share to the investment banking industry, which was less regulated and could be more innovative as a result. Money market mutual funds are one example; depositors were able to receive higher interest rates on these funds than any deposit product a commercial bank could offer. This partially changed in the 1980s when ceilings on interest rates were repealed and commercial banks could start offering higher interest rates on deposit products.
Congress repealed the Glass-Steagall Act in 1999. This gave banks the opportunity to obtain additional funding to make loans and purchase securities. However, some banks and lenders mistakenly offered loans with looser credit terms and purchased mortgage-backed securities from investment banks with the belief that housing prices would continue to rise. This created a housing and commercial real estate boom that eventually turned into a bubble when housing prices fell. By the mid-2000s, many borrowers defaulted on mortgages, causing a sharp decrease in the value of mortgage-backed securities.
Banks who offered looser credit terms and invested too much in mortgage-backed securities found themselves in a difficult position, as market funding drastically decreased and the decline in value of their assets threatened to put them out of business. However, unlike the early 1930s, depositors did not rush on banks to withdraw their money because they were now largely protected by Federal Deposit Insurance. The Fed and the U.S. Treasury eventually stepped in to prevent a banking and financial crisis like the one that had taken place in the 1930s.
In response to the events that led to the Great Recession in 2007-2008, President Obama signed the Dodd-Frank Wall Street Reform and the Consumer Protection Act in 2010. The Consumer Financial Protection Bureau (CFPB) was formed at this time to educate consumers and enforce Federal consumer financial law to ensure financial products are fair, transparent, and competitive.