The Banking Act of 1933 established deposit insurance, regulated interest paid on deposits, prohibited underwriting of corporate securities by commercial banks, and restricted loans to buy securities.
Hundreds of American banks failed every year during the 1920’s, and thousands failed in the period 1930-1933. The existing banking and financial oversight systems were clearly inadequate, and Senator Carter Glass began pushing for reform of the system in 1931. In a report on the bill that became the Banking Act of 1933, the Senate Banking Committee explained that “a completely comprehensive measure for the reconstruction of our banking system” had been deferred. The purposes of the committee’s emergency bill were more modest: It aimed “to correct manifest immediate abuses, and to bring our banking system into a stronger condition.” The new law significantly amended the Federal Reserve Act (1913) and the National Bank Act (1864) and added the Federal Deposit Insurance Corporation
When the stock market collapsed, share prices fell an average of one-sixth of the value they had previously held in the period 1929-1932. Generous credit to stock speculators—funneled through stockbrokers—had fueled the Wall Street boom in the late 1920’s, and the crash was largely blamed on excessive loans to these stockbrokers and stock speculators. A major purpose of the Banking Act of 1933, signed into law on June 16 of that year, was to prevent the “undue diversion of funds into speculative operations.” This meant that banks belonging to the Federal Reserve system (member banks) were forbidden to act as agents to brokers and dealers on behalf of nonbank lenders.
Congress was concerned that businesses engaged in agriculture, industry, and commerce would be deprived of adequate credit. The Federal Reserve Board,
One section of the Banking Act of 1933, often referred to as the Glass-Steagall Act (although this name was originally attached to the entire Banking Act of 1933), ordered that the practice of taking deposits be separated from investment banking activities within one year. This meant that financial institutions had to choose to be either commercial banks or investment houses; investment banks could no longer accept deposit accounts, and member banks could no longer underwrite securities issues of business corporations. Banks with national charters were, however, permitted to underwrite and deal in securities issued by all levels of government in the United States for resale to the investing public. Separation of commercial banking and investment banking was expected to contribute to the soundness of commercial banks and to increase the overall stability of the economy.
In the 1920’s, commercial banks began the large-scale development of affiliates that dealt in securities. By 1930, these affiliates brought more than half of all new securities issues to market, making them a significant threat to established investment banks. Ferdinand Pecora, counsel to the Senate Banking Committee, conducted extensive hearings on abuses by the affiliates, and his investigation generated negative publicity. There is little evidence to support the idea, which prevailed in 1933, that many bank failures were the result of affiliates’ activities in securities. At the time, many small-bank failures were blamed on the poor results from securities portfolios, which had been purchased on the advice of larger correspondent banks eager to promote issues held by their affiliates. As a result of this (mistaken) perception, member banks were forbidden from investing in corporate stock. They could continue to buy corporate bonds for their investment portfolios, however, provided that those bonds were of investment (rather than speculative) quality.
Senator Glass was convinced that banks should confine their activities to short-term business loans, because most deposits held in banks had to be payable on demand. Glass believed that banks should not lock themselves into long-term loans when their deposits, the source of funding for loans, could be quickly withdrawn. In the past, banks had made riskier loans and investments so that they could offer higher interest rates to their depositors—a situation that would occur again in the 1970’s and 1980’s. To encourage safer portfolios, Congress resorted to regulating interest rates. For deposits payable on demand, no explicit interest payments were allowed. The ban on interest was also intended to discourage the exchange of deposits between small banks and correspondent banks; Congress wanted funds to go to local borrowers instead. Small banks, however, continued to hold deposits with correspondent banks. Rather than paying interest, the correspondent banks offered various services free of charge.
Congressman Henry Bascom Steagall spearheaded the inclusion of deposit insurance provisions of the Banking Act of 1933 . For fifteen years he had battled for the reform, which he saw as a way of instilling confidence in the safety of deposits made in local banks. Senator Arthur Hendrick Vandenberg pushed for deposit insurance to take effect immediately, but President Franklin D. Roosevelt was opposed. As a compromise, a temporary plan covering the first $2,500 in insured accounts went into effect on January 1, 1934. In the meantime, infusions of capital strengthened the banks that were permitted to reopen after Roosevelt’s banking holiday, which lasted from March 6 to March 13, 1933.
From 1920 through 1933, thousands of minuscule, small-town banks had failed, and so the Banking Act of 1933 raised the minimum amount of capital required to open a national bank from $25,000 to $50,000. The capital held by each branch of a national bank had to match or exceed the capital required for a one-office bank in the same location. To prevent the creation of unhealthy competition caused by bank proliferation, the Banking Act of 1935 (passed on August 23, 1935) further tightened the requirements for a bank to obtain a charter. The FDIC stood ready to deny insurance if excessive competition posed a threat.
Prior to the stock market crash of 1929, banks in the United States were undiversified institutions that did almost all their business at a single location. As a result, their fates were tied to the fortunes of local economies. To provide some banking services in places where banks had closed, states began to ease restrictions on branch banking, and a heated battle for permission to operate branches began to take place in state legislatures and in Congress. In 1927, national banks with federal charters were authorized to have branches in the same community as their head offices if branch banking was allowed by the state’s law. The Banking Act of 1933 permitted branches to be developed outside the headquarter’s community, so that national banks could branch just as easily as state banks. Interstate branch banking remained forbidden, however.
In 1922, the Federal Reserve banks had begun to coordinate purchases and sales of government securities (known as open-market operations). The 1933 act placed open-market operations under regulation by the Federal Reserve Board; the board could now disapprove policies that had been recommended by the Federal Open Market Committee. Further, all relationships and transactions made between the Federal Reserve banks and foreign institutions were placed under control of the Federal Reserve Board. Both measures diminished the policy-making roles previously played by the twelve Federal Reserve banks, particularly the powerful one in New York City. The 1933 act also gave the Federal Reserve system its first measure of authority over bank holding companies that owned shares in member banks. A bank holding company could avoid supervision if control over a member bank was exerted without the need to vote shares. Involvement of the Federal Reserve system with bank holding companies remained limited.
Exercise of authority over banking by individual states had led to a “competition in laxity” among federal regulators. Over the years, federal authorities had eased restrictions on national banks in order to prevent them from switching to state charters and to encourage state banks to convert to national charters. Many states had weak or inadequate banking supervision, and state banks failed at a much higher rate than national banks in the period 1920-1933.
Supporters of states’ rights had prevented a federal takeover of commercial banks’ chartering, supervision, and regulation. After the Banking Act of 1933, however, states had to share jurisdiction with the FDIC for nonmember banks covered by that agency’s insurance. States retained the power to decide their own policies on branch banking. Some persisted in prohibiting all branches, but most broadened the territory in which branching was authorized. No state allowed the extension of branches across state lines.
Deposit insurance, which was fiercely opposed by some bankers in 1933, became permanent in the Banking Act of 1935. Advocates hoped that, as deposits increased, deposit insurance would stimulate bank lending to the private sector. Bank deposits increased by more than 46 percent from 1934 through 1939, surpassing the record 1930 total by more than $2.6 billion. Total loans, however, failed to significantly increase, reflecting the weak recovery of businesses’ investment spending and the timidity of bank lending officers.
After the FDIC was organized in September, 1933, all member banks were required to join, and solvent nonmember banks were also eligible. Banks paid an initial premium of .25 percent of insurable deposits. By the beginning of 1934, 87 percent of all commercial banks had joined the FDIC, and more than 96 percent of all deposits were covered. By the end of that year, 93 percent of commercial banks had joined, and 98 percent of deposits were covered. All but about 1 percent of applicant banks qualified for deposit insurance. To remain insured, nonmember banks were expected to become member banks by mid-1936. This deadline was first extended and then abandoned in 1939. A majority of American banks continued to be nonmembers, largely because state charters had lower minimum capital and lower reserve requirements than did the Federal Reserve Board.
The FDIC later proved successful in one of its goals: preventing a new wave of bank failures triggered by depositors’ fears. Even as hundreds of banks were forced to close in the 1980’s, depositors did not panic and rush to remove their funds. Ceilings on interest rates did not hamper the gathering of deposits by banks until the 1950’s, when competition with investment outlets that offered returns higher than those permitted under Regulation Q caused some hardships for banks. Interest rate regulations for time and savings deposits were eliminated in 1986.
Banks had begun to separate their commercial and investment banking programs before the Banking Act of 1933 required that they do so. The two leading American banks, Chase National Bank and National City Bank, announced plans to eliminate their affiliates in March, 1933. The Morgan investment banking business, sharply reduced by the Depression, continued under the leadership of several partners who left to form Morgan Stanley. The historic name J. P. Morgan & Company now belonged to a commercial bank that became Morgan Guaranty Trust Company in 1959. Other large investment banks chose to eliminate their deposit-taking activities.
The 1933 act began the process of diminishing the autonomy of the twelve Federal Reserve banks and centralizing power in the Federal Reserve Board in Washington, and the Banking Act of 1935 completed that shift. In many significant ways, however, the American banking system was unchanged by New Deal legislation. Several major problems were left unresolved, including those posed by the dual banking system (of state and national banks), the division of responsibilities among federal agencies, and banks’ limited ability to branch (and thus to diversify their lending and deposit bases). The 1933 act also created some problems by failing to make deposit insurance premiums related to risk and by banning interest on demand deposits, which made it more difficult for banks to get those deposits.
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Benston, George J. The Separation of Commercial and Investment Banking: The Glass-Steagall Act Revisited and Reconsidered. New York: Oxford University Press, 1990. A well-argued case for the repeal of separation of the two types of banking. -
Burns, Helen M. The American Banking Community and New Deal Banking Reforms, 1933-1935. Westport, Conn.: Greenwood Press, 1974. Useful background material and a detailed exposition of the attitudes of bankers regarding proposals that led to the banking acts of 1933 and 1935. -
Chandler, Lester Vernon. America’s Greatest Depression, 1929-1941. New York: Harper & Row, 1970. Provides the economic setting of the era. -
_______. American Monetary Policy, 1928-1941. New York: Harper & Row, 1971. A leading economic historian discusses banking issues as well as central bank policy. -
Friedman, Milton, and Anna Jacobson Schwartz. A Monetary History of the United States, 1867-1960. Princeton, N.J.: Princeton University Press, 1963. Masterful and comprehensive. Covers the banking collapse and legislation of the 1930’s in great detail, from a monetarist perspective. -
Ginzberg, Eli. New Deal Days, 1933-1934. New Brunswick, N.J.: Transaction Publishers, 1997. A lighter, less scholarly treatment of early New Deal legislation. -
Kennedy, Susan Estabrook. The Banking Crisis of 1933. Lexington: The University Press of Kentucky, 1973. Carefully researched, authoritative treatment of events of the period after 1929 and measures to deal with the banking crisis. -
Klebaner, Benjamin J. “Banking Reform in the New Deal Era.” Quarterly Review (Banca Nazionale de Lavoro) 178 (September, 1991): 319-341. An analysis of the limited changes made from 1933 through 1939 in commercial and central banking. -
Krooss, Herman Edward, comp. Documentary History of Banking and Currency in the United States. 4 vols. New York: Chelsea House Publishers, 1969. Volume 4 contains the text of the Banking Act of 1933 and useful commentary by an eminent financial historian. -
Studenski, Paul, and Herman Edward Krooss. Financial History of the United States. 2d ed. New York: McGraw-Hill, 1963. Excellent, concise treatment of developments since 1789 by two leading experts. -
Westerfield, Ray B. Money, Credit, and Banking. New York: Ronald Press, 1938. The most comprehensive treatise of the period. Well written. A less-detailed second edition appeared in 1947. -
Wicker, Elmus. The Bank Panics of the Great Depression. New York: Cambridge University Press, 1996. The first analysis of five major banking panics that occurred during the Great Depression. A thorough discussion.
Panic of 1907
Federal Reserve Act
McFadden Act Regulates Branch Banking
Great Depression
Bank of United States Fails
Credit-Anstalt Bank of Austria Fails
Reconstruction Finance Corporation Is Created
Banking Act of 1935 Centralizes U.S. Monetary Control