Academic journal article Economic Review - Federal Reserve Bank of Kansas City

Kansas Banking in the 1930s: The Deposit Insurance Choice and Implications for Public Policy

Academic journal article Economic Review - Federal Reserve Bank of Kansas City

Kansas Banking in the 1930s: The Deposit Insurance Choice and Implications for Public Policy

Article excerpt

The recent financial crisis is reopening the debate about how much public assistance to give to distressed financial institutions. Key elements of the public safety net-deposit insurance and Federal Reserve lending to depository institutions-were greatly expanded during this crisis. Additional aid provided by policymakers included public capital assistance to banks through the Troubled Asset Relief Program, FDIC guarantees of newly issued bank debt, arranged mergers and bailouts of certain large institutions, and Federal Reserve lending to selected nonbank entities. These efforts helped financial markets function during the crisis and prevented a broader economic collapse. However, such actions raise two concerns. The first is the cost to taxpayers, and the second is whether this expanded protection gives financial institutions a greater incentive to take on risk, thus making the financial system more vulnerable.

The effect on the financial system of this emergency assistance and related risk-taking incentives is difficult to assess and measure. However, a unique circumstance in the 1930s provides an insight into how a piece of the federal safety net-federal deposit insurance-has altered the financial landscape. The vast majority of U.S. banks quickly became insured after the Federal Deposit Insurance Corporation (FDIC) began offering deposit insurance in 1934. Many state-chartered banks in Kansas, however, chose to remain uninsured. Why did these Kansas banks think they could operate successfully without deposit insurance following the worst banking crisis in U.S. history? Also, how did these banks differ from the banks that quickly adopted deposit insurance, and what might these differences tell us about deposit insurance?

This article examines these uninsured state banks in Kansas and finds notable differences between them and state banks that offered FDIC-insured deposits. The uninsured banks, in fact, were generally stronger institutions that exhibited higher capital ratios, fewer real estate lending problems, and far less need for public assistance from the Reconstruction Finance Corp. In contrast, the FDIC-insured banks were typically weaker institutions and thus were likely to have a greater need for deposit insurance.

Section I of this article provides an overview of the state banks in Kansas and the choices they made about adopting deposit insurance. Section II analyzes the differences between the banks that remained uninsured after the FDIC was established and the banks that adopted deposit insurance. Section III reviews the incentives that deposit insurance may provide to banks and the implications for public safety nets.

I. KANSAS BANKS AND THE DEPOSIT INSURANCE CHOICE

When federal deposit insurance was introduced in 1934, participation was mandatory both for national banks and for state banks that were members of the Federal Reserve.1 State nonmember banks, however, could choose whether to participate. By June 1934, 326 Kansas banks-more than 58 percent of all state banks in Kansas-were still uninsured (Table 1). Also, more than 42 percent of the total deposits in state banks in Kansas were in uninsured banks.2

In this regard, the Kansas banking system differed from that of almost every other state. Only 14 percent of state banks in other states were uninsured compared to the 58 percent in Kansas. Also, only 1.4 percent of all commercial bank deposits and 3.1 percent of all state bank deposits in the United States were in uninsured banks in October 1934. In its 1934 Annual Report, the FDIC noted that many of the uninsured banks were "located in three states in which the insurance program has met with general opposition and disapproval."3 While the FDIC did not identify the three states, much of this opposition likely was centered in Kansas.

As late as 1950, more than one-third of the state banks in Kansas still were uninsured, thus indicating their commitment to operating without deposit insurance and their ability to survive without it. …

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