the rise of commercial banks

8/12/2019 The rise of commercial Banks

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The rise of commercial banks

Transfer banking.

Goldsmith banking.

From warehouse receipts to promissory notes, financialintermediation and fractional reserve banking.

Negotiable (transferable) banknotes and checks.

Banks reduced the costs of monetary exchange, resulting infractional reserve banking, credit money and financial

intermediation.


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Fractional reserves and money

Customers deposit 1000 oz at a single bank.__________________________________

1000 oz (coins) | 1000 oz (receipts)

Money supply in economy = 1000 oz gold coins, since they arewithdrawn for payment.

Bank loans 100 oz in coins because of fungibility and idlereserves; receipts become notes.

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900 oz (coins) | 1000 oz (notes)100 oz (loans) |

Money supply = 1,100


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Fractional reserves and money

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1000 oz (coins) | 10,000 oz (notes)

9000 oz (loans) |

Money supply = 10,000 oz (worth of notes).

The money supply has grown 10-fold withoutincrease in the underlying commodity


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Note exchange and redemption

Redemption costs and non-local note acceptability

gold/silver still circulated.

Solutions to non-par/non-acceptability branch banking

brokers

banks clearinghouses


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Issued by A Issued by B Issued by C Total claim

Held by A 1000 2000 3000

Held by B 4000 2000 6000

Held by C 2000 2000 4000

Total debt 6000 3000 4000

The benefits of net-clearing


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Potential problems of fractional reserves

Evolution of banking reduces transactions costs and

reduces the need for commodity reserves. But

Over-issue of banknotes and inflation

Banking panics and deflation


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Banking crises and panic

Bank runs

Bank failures

Declines in the money stock Suspension of payments/convertibility.

Ultimate cause: incomplete information aboutbank-specific risk. Runs on or failures of aparticular bank can lead to a general distrust ofmany banks, even healthy ones.


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The Panic of 1907

May 1907 to June 1908: recession in which real output fell11%.

October 14: eight banks in New York required assistance with

withdrawals. October 21: Knickerbocker Trust Co. (third largest in NY)

suffered a run because of its connection to the troubled banks.The run forced suspension of payments.

October 21-23: runs occurred on other large trusts in NY, but

although assistance was given by the NYCHA to preventfailure, a general alarm remained.

October 24: Treasury provides assistance, but bank loans in NYcollapsed and stock market prices collapsed.


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Features of central banks

Bank for other banks; private commercial banks can holddeposits and borrow from the central bank.

Reserves centralized at the central bank; private banks holdclaims on the central bank.

Note and deposit issue serve as high-powered money, and arenot typically redeemed.Monopoly over note issue, usually legaltender.

Other special privileges from the government (if they are notactuallypart ofthe government); e.g. they keep governmentdeposits.

Monetary policy

Lender of last resortmake loans to other banks in times ofliquidity crises

Authority to regulate banks and the financial system.


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Lender of last resort

Classical view (Bagehot and

Thornton): central

bank should lend to any

healthy bank, at a

penalty rate, that is

need of liquidity, by

buying (discounting)

their assets.

Walter Bagehot, 1826-1877


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The Bank of England

A central bank is not a natural product of banking

development. It is imposed from outside or comes

into being as the result of Government favours.Vera Smith, 1936

The Bank of England arose as a private bank given

special privileges in return for lending to the

British government.


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The Bank of England: a timeline

1694: Chartered as private bank to buy public debt

1697: Monopoly of chartered banking and limited liability

1708: Allowable capital doubled, and note issue was prohibited to any bank withmore than six partners

1797: War-time suspension of convertibilityfiat money1797-1821: Inflation; discovery of monetary policy

1816: Move to gold rather than bimetallism

1821: Resumption of convertibility to gold.

1826: Joint-stock banks (non-partnerships) 65 miles away from London wereallowed note issue to provide some financial stability outside London.

1833: Bank of England notes made legal tender

1844: Bank Charter Act split BoE into Issue and Banking departments.

1946: Bank of England Act nationalizes the bank.


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Political Ravishment, or The Old Lady of Threadneedle-street in Danger!,


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The Colonial period

Money and monetary standards

during the American colonial

period followed Britain.

Money was in terms of Britishpounds/shillings/pence,

defined in terms of silver and

gold.

Spanish silver dollars, pieces of

eight defined as 387 grainsof pure silver, or about 4.5

silver shillings.


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The Colonial period

First government-issued

paper money by

Massachusetts in 1690, to

finance soldiers defeatedon raids to Quebec

20 shillings, 1690


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The Colonial period

Colonial governments began issuing bills of

credit, debt promising to pay silver in the future.

These bills were generally transferable withoutendorsement, so they circulated as a medium of

exchange, and were convertible on maturity


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Revolutionary war finance

As with England in the late

1600s, financing the

Revolutionary War was

difficult for the colonies: notaxing authority and couldnt

borrow effectively.

Continental Congress issued

bills of creditpaper money

called Continentals thatwere not tightly linked to gold

and silver33 cent US Note: a Continental.

Issued February 1776


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The first American banks

The Pennsylvania Bank(1780)didnt issue notes.

Bank of North America(1781)incorporated byContinental Congress to help finance government

expenses; issued banknotes.


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Constitutional monetary standards

The Constitution gives sole right to Congress tocoin Money and regulate the Value thereof andforbade state governments from issuing bills of

credit or coining money.

Coinage Act of 1792. US dollar equal to371.25 grains (0.7734 ounces) of pure silver or24.75 grains (0.05156 ounces) of pure gold(nominal silver price was $1.29 per ounce andthat of gold $19.39 per ounce.); mint ratio 15 to1. There was to be free coinage.


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First Bank of the United States

Private bank with 20 yearcharter, 1791-1811.

Motives: a) finance newgovernment; b) facilitate

payment of taxes; c)convenience and resourcesaving of paper money.

Privileges: a) Convertible notesaccepted by government fortaxes and payments; b)

government depository; c)could branch in any state; d)no other banks to beestablished during life.

Alexander Hamilton


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Suspension of convertibility

With War of 1812, US Treasury issued interest-

bearing notes that were held by banks as

reserves, so banknotes increased, leading toinflation and shortage of specie. Suspension of

convertibility followed. At wars end, with

government finances improving, a national bank

was once again proposed as means to improvethe payments system and to resume

convertibility.


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Second Bank of the US and resumption

Chartered 1816 to 1836.

Similar rights and privileges

To provide uniform

currency.Temporary resumption in

1817, but Second BUSover-issue led to

inflation/suspension.Convertibility generally

restored in 1821.

Andrew Jackson

Nicholas Biddle


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Coinage Act of 1834

Reduced gold content of the dollar from 24.75 grains to

23.22 grains pure gold, or Pg = $20.67.

The mint ratio (silver to gold) increased to 16 to 1.

With the relative price of gold still 15.5 to 1, gold

replaced silver as the commodity money.

Thus, from 1792 to 1834, silver was the primary

commodity money; from 1834 to 1860, gold was, eventhough there was a de jurebimetallic standard


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Pre-war composition of the money stock

1859: the money stock in the US was just over

$670 million. 40% specie in circulation, 27%

state bank notes, 33% bank checking deposits.Bank reserves of specie fluctuated between 20%

and 35% of note and deposit liabilities.


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Greenbacks

Feb. 1862: US Government

issued notes to finance the

Civil War, the so-called

Greenbacks.Unbacked by gold or silver

true fiat moneyand

supported by legal tender

laws (see top of notes to the

right).Dollar price of gold doubled

during this period.


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The National Banking System

National Bank Act 1863

Standardized bank notes

110% backed by US

bonds

Legal tender, but

convertible into lawful

money (base money).

Bank note issued by Quakertown National Bank

1897


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The National Banking System

1865: 10% tax on state

banknotes and the rise

of demand deposits.

Bank note issued by Quakertown National Bank

1897


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Resumption of convertibility

Resumption at $20.67 was desired, requiring

deflation as greenbacks were retired.

Resumption Act of 1875 ended the suspension of

convertibility.


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The Crime of 1873

Coinage Act of 1873

eliminated the free-

coinage of silver, in

effect removing silverfrom the monetary

system. This was an

important political issue

in US for years tocome

William Jennings Bryan


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The Founding of the Federal Reserve

System

The Panic of 1907 and the National MonetaryCommission

Federal Reserve Act of 1913

Federal Reserve to issue notes with 40% gold backing,to promote an elastic currency.

Nelson Aldrich


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The Great Depression

Collapse of the bankingsystem average suspensions from 1921

to 1929: 635

average suspensions 1930 to1933: 2299; with 4004 in 1933alone.

Banking Holiday and reforms Creation of the FDIC

Reorganization of the FED

The US stock of gold wasnationalized

Gold re-valued to $35/ounce.


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Bretton Woods

Fixed exchange rates

US to hold gold

Dollars to serve as

reserve currency

Collapse in 1971 as US

inflation increased

Gold outflows andNixons closing of the

gold window in 1971.


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Banking Business

Balance sheet of commercial banks

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Reserves (liquid assets/cash) | Checkable deposits

Securities (mostly government) | Non-transaction deposits

Loans (commercial, consumer, etc.) | Borrowing (Fed, banks)

| Net worth (equity capital)

Loans and securities: 80%

Reserves: 3%

Checking accounts: 10% of total liabilities.

Basic tradeoff of banking: interest earning versus liquidity


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Banking industry

Dual banking system and supervision

Restrictions and government intervention

Branching: National Banking Act 1863, McFaddenAct 1927, Riegle-Neal Act 1994

Scope: Glass-Steagall Act of 1933, Gramm-Leach-

Bliley Act of 1999

Interest rates: Reg. Q, DIDMCA 1980Deposit insurance: FDIC in 1934.

the rise of commercial banks

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