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FEDERAL DEPOSIT INSURANCE CORPORATION WASHINGTON 25 ADDRESS OP H. EARL COOK, DIRECTOR FEDERAL DEPOSIT INSURANCE CORPORATION BEFORE THE STATE BANK DIVISION AMERICAN BANKERS ASSOCIATION ATLANTIC CITY, N. J. - SEPTEMBER 29, 19^7 CONTRIBUTION OP THE FEDERAL DEPOSIT INSURANCE CORPORATION TO THE DUAL BANKING SYSTEM I. Introductory Ccmments "The dual hanking system needs no Justification. It works*./* These words written "by the distinguished gentleman who was your president last year, Frank G. Rathje, epitomize the sentiments of Americans who apply the test of practicality to this important segment of their economic structure. Thus tested, the many elements of strength in our banking system are brought to sharp focus. For more than 80 years, this country has conducted its banking through the facilities of institutions free to choose between Federal and State law as the source of '¡charter powers and governmental supervision* The system Bince its inception in 1863 has played an important part in the successful financing of four wars as well as a continuing industrial revolution which has now established the United States as the leading economic power in the worlds Associated with the rise of the dual banking system the nation has increased tremendously in size as well as in the volume and richness 5700-47 2 of its economic life. The annals of history are replete with illustrations. In this same period, for example, population has grown from more than 30 million to nearly-1^3 million, and the value added by manufacturing establishments has expanded from less than a billion dollars annually to a pre-World War II total of approximately $25 billion. Moreover, the system has facilitated the rise of many new industries and the widespread distribution of the products thereof. The development of automobiles and the electrical industries are cases in point. Indeed, It is difficult to envisage any other system of bank organization which might function as well as the dual banking system, and it is easy to see important reasons why alternative forms of organization could impose serious handicaps. A study of banking in other nations emphasizes the uniqueness of our dual system. As a matter of fact, we should be well advised to call it the American rather than the dual banking system because it is really a counterpart of the Federal structure of Government. Fundamentally, the strength of the dual banking system is nothing more nor less than the strength inherent in our organic political philosophy. Highly developed and intelligent competition is an essential condition for our economic and social progress. The existence of a dual system of banking furnishes the necessary competitive setting. It makes possible the flexibility whereby men can adjust their activities most efficiently to the economic facts of life. As long as the dual system prevails, men in the exercise of their abilities always have an alternative. - 3 - Students of political science observed long ago that the Federal system of government maximizes the opportunity for testing policies while at the same time it minimizes the risks of so doing. Likewise, this same feature is an advantage afforded hy the dual banking system. From time to time the various States have established provisions for bank regulation which proved their worth on a small scale and then were widely adopted. Thus, sound improvements soon permeate the entire banking system: the others wither away with little or no harmful effects. One could argue with a considerable show of reason that this aspect of the dual system is in itself a sufficient justification. We tend to forget, for example, that the early experiences of certain States in the field of deposit insurance contributed importantly to our Federal legislation. In the absence of that experience, I am confident that the Federal Deposit Insurance Corporation would have been quite a different, and certainly a much less satisfactory agency. Cooperation between the Federal and State authorities is the unifying principle which makes the dual regulation of banking a system, just as cooperation between the Federal and State governments makes the United States a nation. limits to competition. This cooperation maintains standards and sets Cooperation between the State and the Federal banking authorities establishes the rules which encourage wholesome competition and prevent it from degenerating into conflict and disorgan ization, Cooperation is the .American way of getting the best out of individuals II. Brief Resume of the Dual Banking System to 1933 Historically, the dual banking system began with the National Banking Act of 1863 . Prior to that time, America tested and after two experiments, finally abandoned in 1836 the idea of a single bank chartered by the U. S, Government, largely because of its monopolistic features. Between 1836 and 1863, the banking system consisted solely of institutions chartered by the States. The principle of "free banking" first enacted by the Michigan Legislature in 1837 rapidly spread to the other States. Calculated to eliminate the old abuses which developed when the chartering of a bank required special legislation, these "free banking" acts provided that charters were to be granted automatically to all bank organizers who conformed to minimum requirements, the most important of which involved capital. Under liberalized charter procedures, State banks increased rapidly in number from about 500 in 183*+ to a peak of 1600 in 106l. In the passing'of time , it became evident that a banking system composed entirely of State chartered institutions was no more in accord with basic American social philosophy than one dominated by an institution operating under the charter of the Federal Government. Moreover, "free banking" legislation was not accompanied by any important advances in bank supervision. Widespread abuses developed, most of which involved the issue of bank notes with inadequate provisions for specie redemption. attempts at correction were undertaken by the various States. Numerous In some instances-, bank commissioners were empowered to examine banks; but nothing - 5 - in the way of fundamental progress was achieved because the inherent weakness in the system stemmed from the fact that the hanking system consisted solely of State institutions* The prgoncy National Bank Act. of war financing occasioned the adoption of the Nevertheless, the structure created by this legisla tion rested on a much firmer foundation. At the time, the Federal Government was confronted with the urgent necessity for marketing its bonds. Organizers of banks were given an opportunity to obtain a charter as a national banking association which carried with it incidentally the right of note issue. Since the note issue privilege involved a pledge of U. S. Government bonds as security, a broad market for these obligations was practically assured. Drawing upon the long and varied experience in banking, the Act of 1863 corrected the major weakness in the State banking system by providing the Nation with a sound hand-to-hand currency. Furthermore, it avoided the error hitherto demonstrated by experience with the first and second Banks of the United States. After the prohibitive tax was imposed in 1865 upon the issue of notes by State banks, the feeling became widespread that banking by State chartered institutions was doomed. The statistics seemed to bear out these sentiments because the number of State banks declined from approximately 1600 in l86l to the country were changing. circulating medium, and by 2J47 in 1868, However, the banking needs of Deposits were growing in importance as 1885 the State banks discovered that they could operate profitably on the basis of their deposit business without the note - issue privilege. reaching 6 - Thereafter, the number of State banks increased rapidly, 2250 in 1890, 5000 in 1900 , and 17,000 in 1913. These years likewise were characterized by tremendous expansion in the economic field, and the dual banking system afforded the necessary flexibility to cope with the current financial problems. Snbodying the best thought then prevailing with respect to bank chartering and supervisory practices, the National Bank Act was effective in bringing these features to the attention of the various legislatures. State Slow but more or less steady progress in improving standards of supervision both at the Federal and the State levels was achieved over the last quarter of the 19th century. Competition between the Federal and the various State authorities in liberalizing charter provisions developed. However, it certainly was much more restrained than that characteristic of the earlier "free banking” era. With the creation of the Federal Reserve System in 1913, State bank-members acquired a mechanism designed to cope at the national level with problems extending across State lines«. This, however, was merely incidental to the primary reasons for the legislation, namely the creation of an elastic currency and provision for central banking facilities. Unquestionably, the system also is one of the milestones in the course of progress towards higher standards of bank supervision. State banks acquired membership in the Federal Reserve System slowly, and by June 1917 only 53 Had Joined out of a list of eligibles totaling approximately 8500* Clarifying legislation subsequently removed - 7 - the misgivings of State banks and the membership increased rapidly, reaching a total of 16^8 in 1922 . Viewed in terms of its philosophical implications to the dual banking system, the establishment of the Federal Reserve provided a mechanism for cooperation among State banks conducting business on a nation-wide scale. For one reason or another these institutions desired to r*?main outside of the scope of the National Banking Act; yet they were confronted with problems extending far beyond the reaches of the States which chartered them. A web of common interests knitted these institutions together, and the Federal Reserve System was a legislative recognition of this fact. It restored a balance to the dual banking system which had shifted off center in the period -of economic change between the Eighties and the First World War. Ill. Contributions of Federal Deposit Insurance Corporation Few will deny that the Federal Deposit Insurance Corporation was a major factor in the restoration of confidence in our banks after the financial collapse of 1933» It is now abundantly clear that wo could have readily slipped into some form of absolute centralization as a logical consequence of the crisis, and thereby sacrificed the advantages of the free enterprise dual banking system. Fortunately, the program of deposit insurance adopted at that time achieved the twofold objective of restoring public confidence in banks and at the same time preserving the system of banking which is peculiarly adapted to the American way of Life. - 8 - Broadly speaking the Federal Doposit Insurance Corporation is a standardizing agency. All hanks which measure up to its standards are eligible for insurance irrespective of membership in the Federal Reserve System, incorporation under the National Bank Act, or the possession of a charter from any particular State, Since losses attending the failure of an insured bank are sustained in the first instance by the Corporation, it fully appreciates the evils resulting from the competitive chartering of banks as well as inadequate supervision of operation's. Accordingly, from its inception the Federal Deposit Insurance Corporation has served as a connection between Federal and State supervisory authorities with the purpose of onlisting their cooperation in mitigating these evils. Efforts of the Corporation to maintain high standards have received the wholehearted cooperation of Federal and State authorities, and many of the difficulties which heretofore besot the dual banking system have largely vanished. The development of a uniform examination report for banks is ono of the major steps in.the direction of closer cooperation between Federal and State supervisory authorities which has been taken since the advent of the Federal Deposit Insurance Corporation. With slight modifications, this form is used by all of the Federal agencies and a majority of the States, Moreover, in almost three-fourths of the States, Joint or concurrent examinations are scheduled with State supervisory authorities. Not only does this arrangement'achieve important savings for both the supervisory authorities and the institution under examination, - 9 - but it facilitates cooperation among all of the interested parties in bringing atout corrective measures when necessary. Here again dual banking i 3 buttressed against weaknesses which tend to call the adequacy of the system into question. Comprehensive and timely information is one of the necessary conditions for intelligent policy with respect to banking. In a very real sense, the life of the dual banking system depends upon the avail ability of facts. Accordingly, the Federal Deposit Insurance Corporation has been steadfast in its efforts to bring about consistency in statistical data through the adoption of uniform condition and earnings report forms. Furthermore, it cooperates with the other supervisory agencies in compiling the pertinent information into a useful body of knowledge. The agreements reached in 1938 among the supervisory authorities with respect to improved methods of asset appraisal and classification furnish still another illustration of Federal Deposit Insurance Corporation in its role as a standardizing agency for the dual banking system. Prior to that time practice was common for the supervisors to identify one of the qualitative category of assets with the term, "slow." Following extensive consultation between the various authorities a new system of classification was adopted which definitely classified assets in terms of the relative credit risk. In addition, a basic change was made in the appraisal of bond investments. For issues of investment merit, valuation at market was abandoned and cost less appropriate amortization was substituted therefor. Admittedly these changes fall short of perfection, but it is well to 10 remember that they are advances in supervisory methods which help to make the dual banking system work in an era of economic change. The executive committee of the National Association of State Bank Supervisors was established as the advisory council for Federal Deposit Insurance Corporation by Chairman Crowley in 1938» Thereby, the Corporation has provided itself with a mechanism for exchanging information with the various State bank supervisory authorities. The exchange of ideas between the segments of the system is essential for the continued existence of dual banking, and the arrangement has proved its worth many times since its inception. Of major importance although more or less incidental to its work as a standardizing agency has been the work of the Federal Deposit Insurance Corporation in articulating the problems of the State banks that are not mombers of the Federal Reserve System. The Corporation is the only Federal agency whose contacts with the State banks are direct and continuing. It is in a position to appreciate their difficulties and to view their aspirations sympathetically. This portion of the banking system is relatively small measured in terms of financial resources, but large numerically, and it is very responsive to the best traditions of American free enterprise. Owing to the fact that the other major parts of the banking sytem could turn to other and long established Federal agencies when they were confronted with a problem requiring a solution at a national levol, it was to be expected that the Stato nonmember banks would turn to Federal Deposit Insurance Corporation in similar circumstances. During World War II, the 11 Corporation cooperated actively with them in a successful effort to secure by means of legislation the right to participate in so-called "V" loans. Other instances of a similar character could be mentioned. In a larger sense, it is fitting and proper that the Federal Deposit Insurance Corporation should be the Federal agency to which the State nonmembor banks may turn. The dual banking system works only so long as the separate parts are able to define their problems and to reach appropriate solutions. Many problems confronting the small State nonmember banks are national in scope. The Corporation has a very real contribution to make to the success of the dual banking system in cooperative efforts to'deal with these problems. To sum up then, the practical man knows intuitively that the dual banking system is good, despite its seeming contradictions. This is the .American system of banking wherein the free play of ingenuity is fettered only by the necessity for cooperation when the commonweal is at stake. In recognition of its obligations to further the public interest by strengthening banks generally, the Federal Deposit Insurance Corporation continues to stand where it always stood--an ardent supporter of the dual banking system.