The period between 1790 and 1861 was one of experimental banking in a new country rich in natural resources and settled with an energetic, inventive, and independent people who worked things out for themselves locally. But the country was poor in specie, in loanable capital, in financial institutions, and in experience. Such a combination led to a wide variety of experiments which always sought a maximum of benefit from a minimum of specie. Banks of many kinds were developed, and four types of note, issue stand out, based upon or protected by:
1. General Assets.
2. A General Safety Fund.
3. Bond Security.
1. General Assets. Of the banks whose issues rested upon general assets, the best examples were those of New England. The original Bank of Massachusetts was of this type and was singularly free from legal limitations. Later laws restricted the amount of issue to a multiple of the capital and specified the minimum denomination of the notes, but no provision was made for the special protection of the notes. The banks were required to report their condition from time to time to the state. They grew up in a conservative area and were sounder than those in other parts of the country. As a result, in 1814 they alone of all banks did not suspend specie payments. In 1837 Massachusetts adopted a system of examinations by state bank commissioners. Though repealed in 1842, the system was readopted in 1851.
The banks of New England were modeled upon those of Massachusetts, and they maintained intimate relations with the banks of Boston. The Boston banks in 1818 instituted the Suffolk system of note redemption, in order to prevent the note issues of interior banks from driving out of circulation the issues of the sound Boston banks. This system required the country banks to keep, in addition to a sum sufficient for the current redemption of its notes, a permanent deposit with the Suffolk Bank. The notes of any bank which refused to make this deposit were sent home for redemption. A large majority of the New England banks came into the system, some quite reluctantly, and the circulating notes of the area were thus brought to par in Boston. The bank notes were redeemed through this agency on an average ten times a year, and this redemption constantly tested the solvency of the issuing bank and kept the volume of issue elastic.
2. Safety Fund. The safety fund system was illustrated in New York. It was inaugurated at the instance of Governor Van Buren, in 1829, as a protection for notes only, but by accident the fund was made to cover deposits also. Each bank was to pay annually to the State Treasurer a sum equal to 1/2 per cent of its capital until the payments aggregated 3 per cent. Any deficit, after the assets of a failed bank had been liquidated and the proceeds applied to its notes and deposits, was paid from this fund. In 1837 the law was changed to provide for the immediate payment of the notes of an insolvent bank whose debts in excess of assets were less than two-thirds of the bank fund. In 1842 the fund was specifically set aside for the redemption of bank notes alone, and the other liabilities of the bank were charges against the assets. Had the fund not been made to cover both notes and deposits, it would have succeeded, for calculation shows that the annual assessment required to pay the losses from 1829 to 1865 would have been less than 1/4 Per cent of the capital and 3/8 per cent of the average circulation of the banks. The fund should have been proportioned to the volume of the note issue rather than to the capitalization.
3. Bond Security. The panic of 1837 proved the defects of the safety fund system of protecting bank notes as employed in New York State, and the next year the Free Banking Act was passed. Banking was "free" in the sense that any individuals or associations were free to open a bank and to issue notes upon deposit with the State Comptroller of securities of the United States, or of New York, or of any other state approved by the Comptroller. After 1840 the securities of other states were not accepted. Provision was also made, though little used, for the issue of notes against deposit of approved mortgages. Though this method of note issue lacked elasticity, it was relatively sound, and in 1863 it became the model of the national bank note system. Many other states also adopted the method of protection by deposit of securities, but usually without due safeguards, so that in some states an endless chain of debt creation and note issue developed until the securities fell below par.
4. State Credit. The fourth system of note issue was based on state credit, that is, on the credit of banks owned and managed by the state. Though the Constitution forbade the states to issue bills of credit, in 1837 the Supreme Court decided that an issue by a bank owned in whole or part by the state was not thereby prohibited. Such banks had been in operation even before this date, but the experiences of Kentucky, Alabama, Mississippi, Florida, Illinois, Louisiana, and other states, with their note issues, were most unfortunate. On the other hand, the state bank of Indiana was very successful. It based its note on commercial assets and required the payment of its capital in actual cash, whether the subscriptions were by the state government or by private citizens. The state made good profits on its investment and its natural resources were developed very well indeed through the help of the bank.