Were Banks Special Intermediaries in Late Nineteenth Century America? / Commentary
White, Eugene N., Lamoreaux, Naomi R., Review - Federal Reserve Bank of St. Louis
The financial crises and vastly increased competition of the last two decades have radically reshaped the American financial system. One key feature of this transformation has been the declining importance of banks' traditional activities. Weakened by crises and regulatory disadvantages, banks' share of intermediation has shrunk while the shares of other financial intermediaries and markets have expanded. The shrinking banking; sector has raised concerns because banks are important "special" lenders to small firms and other borrowers, they operate the payments system and provide liquidity, and monetary policy is carried out by altering their balance sheets. To put in historical perspective the issue of banks' declining role in lending, this article examines the nature of bank lending in the late nineteenth century and why banks remained the dominant intermediaries, ever. when disadvantaged by regulation and challenged by competitors.
In banking history, the late nineteenth century is termed the National Banking Era. Beginning in 1864 with the passage of the National Banking Act and ending with the founding of the 1 ederal Reserve System in 1913, the National Banking Era was a period of rapid economic growth and price stability. Growth was accompanied by the spread of financial intermediation and innovation. Given the virtual prohibition of branch banking and low capital requirements, the demand for banking services drove up the number of commercial banks that were chartered under the National Banking Act and state laws from 467 in 1864 to 21,478 in 1913. Commercial banks' portfolios were shaped by regulations that prohibited investment in equities, limited mortgages, and encouraged short-term loans. Their liabilities were predominantly demand deposits, and although there had been experiments with insurance of bank liabilities before the Civil War, there was no insurance until very late in the period, when seven states created deposit guarantee funds after the Panic of 1907 (White 1983; Calomiris 1993).
As they do today, commercial banks felt competitive pressures from other regulated financial markets and intermediaries, including trust companies, investment banks, insurance companies, and thrifts. Combining deposit and loan banking with other financial activities, trust companies competed vigorously in the Northeast and Midwest. Commercial banks could not easily meet the demand for longer-term finance by the newly emergent modern corporations. Instead, investment banks created the large bond and equity markets to finance big business. These new financial instruments were absorbed by life insurance companies, often allied with investment banks, which had a steadily rising flow of policy premiums to invest. Banks also faced competition from the money markets. Improvements in transportation and communications enabled commercial paper houses to intrude on banks' territory, offering access to a national market for short-term credit. Mutual savings banks catered to small depositors and the mortgage market, although mortgage companies and savings and loan associations became increasingly important competitors late in the century.
In spite of these fast-growing challengers, commercial banks retained their preeminent position in the National Banking Era. Table 1 reports the shares of all financial intermediaries' assets. Although it is difficult to reconstruct a complete picture of the financial system before 1900, the table demonstrates that commercial banks retained their dominant position among intermediaries well into the early twentieth century. There was little change between 1880 and 1922, when commercial banks steadily held approximately 63 percent of assets. The twentieth-century decline is evident in 1950; by 1990, commercial banks held only 27 percent of all financial intermediaries' assets.1 The sources of this recent decline have been studied intensively (Boyd and Gertler 1993; Wheelock 1993; and Berger, Kashyap, and Scalise 1995). …