The establishment and subsequent expansion of banking services in America contributed to the westward development of the country. It also led to the creation of major businesses. Availability of credit and savings products for individual consumers also gave rise to increased consumption of goods and services provided by American businesses.

Banks provide three services. They give their clients a way to store value for later use (in savings, checking, and other deposit accounts). They make future value available for present use (by offering loans), and they provide a way for individuals to exchange value with other people without being in direct contact with them.Banking

Early Banking

Few banks existed in the colonies. England exerted significant control over the colonists’ financial affairs, and there was limited commerce within the colonies themselves. The general lack of banks and banking services meant that the exchange of goods and services was largely governed by bartering or the use of commodity money, including such goods as beaver pelts, tobacco, rice, and other commodities.

As America gained its independence and enjoyed increased manufacturing and business activity, particularly in the northern colonies, a more efficient method of exchange became necessary. More businesses and individuals, as well as trading partners in other countries, required cash rather than warehouse bills for payment. As a result, the nation’s first three commercial banks were founded.

The first of these was the Bank of North AmericaBank of North America, chartered by the Congress of the Confederation in 1781. This bank was granted near monopoly power for banking services in the Confederation, although the wide distances between major population centers limited its effective reach to Philadelphia and the surrounding area. The bank issued paper currency that, according to its face, was convertible to gold or silver. The bank, however, was allowed to maintain a fractional reserve system, meaning that it was not required to back the issued notes on a one-to-one basis with gold or silver.

The Bank of North America was relatively short-lived. In a recurring situation, businesses and individuals in more outlying areas of the country found it difficult to convert paper money issued by the bank to spendable funds in their communities. (Consider the challenge of traveling from Charleston, South Carolina, to Philadelphia to convert these notes to gold.) They therefore demanded a premium price for goods when paid with banknotes. The resulting inflation increased the demand for conversion of these notes back to gold or silver. The fate of the bank was sealed when demand for conversion exceeded the bank’s gold reserves, leading to its closure in 1784.

New York and Massachusetts chartered their own state banks in 1784–the Bank of Massachusetts, in Boston, and the Bank of New York (founded by Alexander Hamilton, future secretary of the Treasury). These banks had higher reserve requirements than the Bank of North America and, at least initially, confined their operations to New York and Boston. Both banks flourished for centuries. Bank of Boston was acquired by Bank of America in 2005, and Bank of New York merged with Mellon Financial in 2007.

In 1791, the First Bank of the United States, FirstBank of the United States became the first central bank to be chartered by Congress. The bank was to issue a paper currency that would be used to pay government obligations and would be accepted in payment of taxes, effectively giving paper money legal tender status for the first time. These notes were also convertible to gold or silver on presentment to the bank. The unanticipated consequence of this new currency was a flood of money into the economy, which in turn created substantial wholesale price inflation. Private bank charters also began to increase in response to the rising demand for banking services: Eighteen new private banks were chartered by 1796.

From 1800 to the Civil War

The charter of the First Bank of the United States was not renewed by Congress in 1811 as a result of changing political influences, especially between advocates of a central bank with fractional reserves and advocates of one on a pure gold standard with no fractional reserves. Banks once again began issuing their own notes. The continued expansion of the country and its economy encouraged the formation of even more new banks, so by the time the Second Bank of the United States, SecondBank of the United States was chartered in 1816, well over two hundred banks were in existence.

The Second Bank of the United States was also designed to establish a national currency that would be more stable than the multitude of notes issued by state banks. As had been true of the First Bank of the United States’ currency, these notes would be accepted in payment of federal taxes and would be redeemable for gold or silver. The confidence in the new currency inspired by federal support resulted in another significant increase in the money supply, spurring higher demand for products and pushing prices higher.

In response to this situation in 1817, the bank systematically reduced credit availability, insisted that its branch banks redeem notes in gold, and refused to pay more than par for notes issued by the weaker of these branch banks. The net effect of this tightening was a large number of loan defaults, business bankruptcies, and bank failures. Real estate sales activity fell by more than 80 percent over a two-year period, and the country found itself the victim of the first real boom-bust cycle in American history. This experience also set the stage for the refusal of Congress to renew the charter of the Second Bank of the United States in 1832.

The operations of the Second Bank of the United States raised an important constitutional issue, which was adjudicated by the U.S. Supreme Court in the landmark case McCulloch v. Maryland (1819)[MacCulloch v. Maryland]McCulloch v. Maryland (1819). Many states at the time did not support the idea of a national bank. Maryland levied a tax on all banks operating within its borders and not chartered by the state, including the local branch of the Second Bank of the United States. The federal bank refused to pay the state tax, and Maryland sued to compel payment. The Supreme Court determined that the chartering of a bank was a power implied by Article I, section 8, of the Constitution. Under the Constitution, states cannot impede federal laws, so Court ruled that the tax was unconstitutional. This ruling firmly established the doctrine of implied powers, broadening the scope of the federal government’s constitutional authority and creating support for the expansion of federal power that followed.

During the 1820’s and 1830’s, the number of banks in the United States continued to grow, and they issued more private banknotes. At the same time, the silver reserves of these banks grew at a rapid pace as a result of increased importation of Mexican silver. The increased silver reserves encouraged ever more generous lending terms and increased speculation in land and other commodities. This situation came to a temporary halt in 1836, when President Andrew Jackson decreed that payments on government land contracts would no longer be accepted in paper currency but would have to be made in gold or silver. Together with fiscal tightening in Great Britain, this decree reduced inflation, but it also reduced business activity, pushing the country into another recession.

The nation’s boom-bust cycles encouraged congressional leaders to consider a ban on fractional reserve banking as a way to bring stability to the economy. Instead, the government allowed banks to lend against their holdings of treasury notes and then began to accept these bank-issued notes (currency) in payment of federal taxes. These two actions helped legitimize the independent banknotes that Jackson had tried to limit, so by 1860 more than ten thousand different issues were in circulation.

The enormous variety of banknotes in circulation also made it difficult for banks and merchants to determine the value of any given note. The resulting uncertainty eventually led to a slowdown in U.S. business activity, as companies became increasingly reluctant to accept payment in notes issued by far-off banks whose soundness, reserve levels, and even existence could not be readily determined. These issues would slowly begin to fade during the U.S. Civil War, as that conflict brought about drastic changes in the country.

From the Civil War to World War II

In 1861, Secretary of the Treasury Salmon P. Chase, Salmon P.Chase proposed national banking legislation that was enacted in 1863 as the National Currency Act of 1863National Currency Act. For the first time, legislation defined the requirements for national bank charters and established examination and performance standards. These regulations provided stability to the institutions and thus allowed chartered banks to issue currency that would itself have a more stable value. The law also established the Office of the Comptroller of the Currency, a government agency responsible for examining national banks and enforcing the regulations.

The National Currency Act created the first truly national currency. Although notes were issued by individual banks, they were entered on the books of the comptroller and stamped by the Treasury prior to issuance. Banks could issue notes only after they purchased sufficient U.S. Treasury securities from the government to stand behind those notes. Thus, the notes were effectively backed by the federal government. The added security of this backing reduced previous concerns about banknotes’ negotiability and value, resulting in a stable currency. These notes functioned as the national currency until the issuance of Federal Reserve notes in 1914.

In an effort to reduce private banknote issues by state banks, the government began taxing those banks’ notes. This tax had the immediate effect of reducing the number of state banks. However, it also encouraged the development of demand deposits, or checking accounts. Such accounts allowed the transfer of money between bank accounts without the use of paper notes or currency, thus avoiding the tax. The tax also created the dual banking system of state and federally chartered banks.

The new requirement that deposits be backed with Treasury securities created other problems. The value of these securities varied depending on prevailing market interest rates. When the value of Treasury notes fell as a result of rising interest rates, banks reduced loan availability to maintain proper reserve levels. Seasonal changes in liquidity resulting from shifts in farmers’ demand for cash also plagued the banking system. These two issues combined in 1907 to create a serious panic within the banking industry.

The interior of the Dime Savings Bank in Detroit, Michigan, in the early 1900’s.

(Library of Congress)

A commission was appointed to find a solution to these problems; it recommended reestablishing a central bank. Six years later, the Federal Reserve Act of 1913Federal Reserve Act, or Glass-Owen Act, of 1913 established the Federal Reserve and its twelve branches as the nation’s central bank. The new institution would issue Federal Reserve notes, direct obligations of the federal government, to replace the old bank-issued notes that had existed since the founding of the country. Thus the familiar national currency came into existence.

The Federal Reserve Act ushered in a period of relative calm in U.S. financial markets despite the disruptions brought on by World War I. Banks lent more money, providing a relatively easy and stable source of funds to support increased wartime production. After the war, production continued to expand to meet demand for goods. Credit remained readily available, allowing the U.S. economy to grow and consumer consumption to increase. Economic growth and the availability of money also encouraged speculation in the stock market.

New stocks were issued to help finance the expansion of American business, and they were easily marketed to investors. At the time, the banks in New York not only held deposits and provided loans but also acted as the chief underwriters, buyers, and sellers of stocks. As a result, the same banks that created newly public companies’ stocks also provided loans to investors to finance their purchase of those stocks. During the mid- to late 1920’s, then, a person could borrow money from a bank’s loan department, then use that money to purchase stocks from the same bank’s securities department. This situation drove a wave of speculation and increased bank profits, until the speculation ended in Stock market crash of 1929October, 1929, when the stock market crashed.

The crash brought about massive financial losses for individual investors. They sought to sell their shares before they could fall any farther, pulling what little cash they could from the market. Investors who had bought stocks with borrowed money were caught in margin calls: The value of the stock securing their loans fell below a predetermined level and was no longer sufficient to support the loans. Investors withdrew so much money from deposit accounts to cover these margin calls that many banks ran out of cash and were unable to pay their depositors. This downward cycle fed on itself, as bank runs caused several thousand banks to fail over the following three years.

Shortly after President Franklin D. Roosevelt’s inauguration in 1933, two pieces of bank legislation were passed. The Emergency Banking Act of 1933Emergency Banking Act closed every bank in the country for a four-day “holiday.” This closure provided time for bank examiners to review every bank in the country; they permanently closed those that seemed unable to survive and reopened those that had sufficient resources to weather the crisis. This process helped restore some of the public’s faith in the banking system.

Later in the year, the Glass-Steagall Act of 1933Glass-Steagall Act was passed, arguably the most important banking legislation passed until its repeal by the Gramm-Leach-Bliley Act of 1999. This act prohibited commercial banks from acting as investment banks. It also established the Federal Deposit Insurance CorporationFederal Deposit Insurance Corporation (FDIC), which provides insurance coverage of bank deposits (up to $100,000; increased in October, 2008, to $250,000). The FDIC further improved public confidence in the banking industry, and the financial markets once again began to stabilize. This was not a rapid process given the depth and breadth of the Great Depression. However, the slowly improving financial condition of the banking industry allowed banks to begin issuing loans again, and individuals had fewer concerns about the safety of their savings.World War II[World War 02];bankingWorld War II broke out in Europe just as the nation was recovering from the ravages of the Depression. This had the immediate effect of significantly increasing demand for industrial production, especially of war materials needed by the British. This sudden and substantial demand was happily assisted through increased lending by banks. As the war went on, production (and the demand for funds) continued to increase. Another effect of this growth was the rapid expansion of earnings by American workers and service members, leading to an increase in savings deposits. As more deposits were available to banks, more bank loans became available to borrowers, and the country found itself with a growing economy.

After World War II

In the latter half of the 1940’s and the 1950’s, returning U.S. service personnel used their wartime earnings and increased wages from new jobs to purchase homes and consumer goods. A major benefit was provided to returning soldiers by the G.I. Bill[GI Bill]G.I. Bill of 1944, formally known as the Servicemen’s Readjustment Act. This act provided for mortgage insurance from the Veterans Administration for home loans taken out by service members. This had the effect of reducing the risk to banks, giving them the incentive to lend to more people.

Minimal changes occurred in general banking laws or practices over the following four decades. Few banks undertook anything but the most basic forms of lending or other services, with some notable exceptions: Car loans were developed during the 1950’s, with terms increasing from twenty-four months during the early 1950’s to forty-eight and sixty months during the 1980’s. The Credit cardscredit card was also fully developed during this period. The first credit cards were issued during the 1930’s as charge cards designed to increase sales of gasoline. The cards evolved into general-purpose credit instruments, as the first such card was issued in 1958 by Bank of America as the BankAmericard (later known as Visa).

By the 1980’s, banks and other financial institutions were looking for ways to increase their revenues, and they were beginning to chafe at the restrictions still in place from the Glass-Steagall Act. Some relief was provided by the Depository Institutions Deregulation and Monetary Control Act of 1980 and the Depository Institutions Act of 1982. These laws increased competition and innovation in the financial services industry by allowing the development of new types of deposit accounts, such as interest-bearing checking accounts and money market deposit accounts. The acts also allowed Savings and loan associationssavings and loans (S&Ls) to begin lending to businesses. The sudden expansion of lending by inadequately trained lenders resulted in huge loan losses for these institutions. The subsequent failures of many savings and loans resulted in such large losses that the obligations of the Federal Savings and Loan Insurance Corporation (FSLIC) had to be transferred to the FDIC in 1989.

In 1985, national branch banking was declared constitutional after more than two hundred years of banks being limited to maintaining branches in only one state. This change prompted the bank merger mania of the 1980’s and 1990’s, as it suddenly made sense for banks in multiple markets to merge operations. The mergers allowed better utilization of overhead and gave banks access to a more diverse customer base spread across a much larger geographical area. Both of these effects reduced risk and generally resulted in banks issuing more loans. The individual states remained in control of whether banks within their borders would be allowed to branch; Colorado became the last state to authorize full branch banking with the passage of legislation in 1993.

Automated Automated teller machinesteller machines (ATMs) came into widespread distribution, increasing consumer access to funds while providing banks with both a source of fee income and a way to reduce overhead, as fewer tellers and other staff members were required to service customers. Banks continued to expand on automated services, offering Internet banking and other electronic services, further enabling them to reduce staff levels and potentially to generate fee income.

In 1999, the Gramm-Leach-Bliley Act of 1999Gramm-Leach-Bliley Act repealed many of the restrictions enacted by the Glass-Steagall Act, once again allowing banks to maintain ownership in insurance companies, investment banks, and other financial service providers. The law led to another round of acquisitions and consolidations. Despite the continued consolidation of major banking companies, local banks have retained a healthy presence in their communities. These smaller institutions follow the same regulations and are afforded the same insurance coverage as their larger brethren, but they compete based on community attention, knowledge, and service. They remain major providers of credit to small and medium-sized businesses, as well as primary lenders to builders and developers within their communities.

Further Reading

  • Brands, H. W. The Money Men: Capitalism, Democracy, and the Hundred Years’ War over the American Dollar. New York: W. W. Norton, 2006. Biographic study of five figures who shaped the history of U.S. monetary policy and paper currency.
  • Chernow, Ron. The House of Morgan. New York: Atlantic Monthly Press, 1990. Study of J. P. Morgan, who helped stabilize the markets after the Panic of 1907.
  • Deane, Marjorie, and Robert Pringle. The Central Banks. New York: Viking Penguin, 1995. Examination of the United States’ central banks and their role in the national economy.
  • Grant, James. Money of the Mind. New York: Farrar Straus Giroux, 1992. Discusses the role of psychological factors in the history of credit.
  • Green, Edwin. Banking: An Illustrated History. New York: Rizzoli International, 1989. Provides useful illustrations of key institutions, financial instruments, and bankers.
  • Klein, Maury. Rainbow’s End: The Crash of 1929. New York: Oxford University Press, 2001. Details the changes wrought by the stock market crash that began the Great Depression.
  • Mihm, Stephen. A Nation of Counterfeiters: Capitalists, Con Men, and the Making of the United States. Cambridge, Mass.: Harvard University Press, 2007. History of the pre-Federal Reserve United States and the often fraudulent printing and circulation of paper currency and banknotes before the advent of greenbacks.
  • Rothbard, Murray N. A History of Money and Banking in the United States: The Colonial Era to World War II. Auburn, Ala.: Ludwig von Mises Institute, 2002. Detailed examination of the personal and political motives of persons in power that led to bank failures and economic disasters over three hundred years of American history.
  • Warsh, David. Knowledge and the Wealth of Nations: A Story of Economic Discovery. New York: W. W. Norton, 2006. Extended treatment of the history of economics, focusing on the seminal works of Adam Smith in the eighteenth century and of Paul Romer in the twentieth century.

Bank failures

First Bank of the United States

Second Bank of the United States

Credit unions


Deregulation of financial institutions

Federal Deposit Insurance Corporation

Federal Reserve

Federal monetary policy

Morris Plan banks

Postal savings banks

Savings and loan associations

Supreme Court and banking law