The second type of participation, already enumerated, is that in which the government is merely a supervisor or director of the various banks, and as such acts in a negative way only. Of such supervision the best example to be found is that afforded by the national banking system prior to the adoption of the Federal Reserve system, although on a smaller scale equally good examples are afforded by the state banking systems of the present day. In all of these (and in the national banking system as well) the basic thought is what is called "free banking." Individuals are allowed, under specified conditions, to apply for and receive banking charters. Their operations as bankers must, however, be governed by more or less elaborately developed laws. The National Bank Act, as considered in Chapter XII, requires the maintenance of specified amounts of reserve, limits investments in certain ways, controls the amount of loans that may be made to given individuals or corporations, and otherwise restricts the operations of banks. It could not be expected, in cases where perfectly free banking is permitted, that all those institutions which are allowed to operate would invariably comply with the law. Some would not do so because of lack of knowledge, others because they did not fully understand or interpret the requirements by which they are surrounded, while still others would fail because of indisposition to comply with legal requirements. It is invariably necessary, therefore, to have an active government officer who is charged with the duty of supervising the management of the banks and of seeing to it that such management is in harmony with the law.

The officer who, under the national banking system, performs this function is called the Comptroller of the Currency, and in the several states he may be called Superintendent of Banking or Bank Commissioner. Whatever such an officer may be called, his function, as already stated, is that of applying and interpreting the law. In so doing his method of work is usually that of requiring reports from the different institutions under his control or of subjecting them to examination at the hands of bank examiners, or both. The reports when completed are forwarded to the Comptroller at Washington, and in his office are carefully analyzed and compared. If the figures or the examiner's statements show any violation of law, the bank is promptly notified and asked to refrain from objectionable practices or to correct any methods that may be objected to. In other cases the bank may simply be given a letter of advice indicating possible points of danger. Should the bank fail to observe the instructions or suggestions thus given to it, the Comptroller may, under certain conditions, apply for the withdrawal of its charter; or, if evidence appears of criminal or illegal work on the part of officers of the bank, he may undertake proceedings against them individually.

On the whole, this system of oversight and reporting has worked reasonably well, the difficulty with it being found in its entirely negative character and in the fact that it was not and could not be constructive. These defects were seen at their worst during the latter years of the national banking system, when sharp competition between large banks entirely prevented any harmony of action or unity of purpose on the part of the institutions themselves in protecting the country against disastrous competition until the moment for application of safeguards had passed. It was true that when the real danger came upon the country and a general collapse of the banking system was threatened, it was usually possible to obtain a co-operative effort designed to relieve hard-pressed banks and avoid a general crumbling of the financial structure as evidenced in bank failures. Such material aid was seen in the form of clearing-house agreements, the issuance of clearing-house certificates, and other extraordinary action of a like nature. All such necessities might have been avoided had there been constructive leadership, but this was never provided. Even under the best administration of the Comptroller's office there was never any possibility of restraining banks, which were technically within the limits of the law, from unduly extending credit, with results which have been sketched elsewhere in this volume. As a result, therefore, the Comptroller's office was usually borne along with the current of banking development, his highest ideal of success usually being to keep the banks "clean"- that is to say, free from dishonesty, from obviously irregular or excessive loans, and in as nearly sound a general condition as practicable. But this was a rather low ideal, and one which was far from meeting the conditions of a thorough and effective oversight of banking. Recognition that such was the case was the fundamental influence leading to the organization of the Federal Reserve system with its provision for participation by, or representation of, the public in banking management.

What has been said must not be taken to suggest that the system of public oversight and inspection has been a failure or can be dispensed with, but merely that it is insufficient. There is still much difference of opinion among authorities on banking as to whether such inspection or oversight may not be best provided through a central or co-operative mechanism rather than through the efforts of governments. In the United States such difference of opinion was reflected, before the organization of the Federal Reserve system, in the action of the clearing-house associations in most of the larger cities. These associations usually had as one of their most important functions the institution of examinations for their own members. Effort was made to have the clearing-house examiner a nonpartisan functionary, entirely independent of any particular institution, and simply acting as a general regulator whose duty it was to bring to the attention of the clearing-house committee conditions which were likely to prove bad or dangerous from the standpoint of banking as a whole. In some cities this clearing-house system or plan of mutual examination, when at its best, was a good deal more effective than that of the Comptroller's office, though it was always plain that this method of inspection would not have worked well outside of the larger cities. Country banks were not rich enough or harmonious enough to employ it for themselves; so that in practice the government system of inspection was always necessary. In the Federal Reserve Act, provision was made for the examination of member banks by Federal Reserve banks if the latter found it necessary. The exercise of this function has been more or less in abeyance because of the fact that the Comptroller's powers still continue to be exercised, but at any time the transfer of examination work might easily be effected.

Were it to be thus effected, examination would practically be placed upon a mutual basis and the banks would be in the position of looking after their own affairs, public opinion and the general ethics of the profession establishing an average standard of conduct which must be observed. In foreign countries public examination and inspection has never made much headway. Its place has been taken by careful reports rendered by the banks to the government as the result of the process of self-examination, or through clearing-house examinations, or through examinations carried on by certified accountants, which no bank was compelled to carry through, but which, nevertheless, were exacted by public opinion. It may be said that the prevailing European type of examination, so far as any can be said to exist, is the statement method, and that the negative work done by such officers as the Comptroller of the Currency or Superintendent of Banks in the United States is superseded by positive control proceeding from the central bank and applied through the mechanism of the discount market. In effect this means that the banks must maintain themselves in a sound condition; otherwise they will be unable to obtain rediscount accommodation from the central bank. Bad banking is thus penalized not by legal proceedings or official reprimands, but by refusal to provide further credit for the use of those banks which are guilty of the practices complained of.