In New York two systems of regulating note issues were adopted: the safety fund system, and the free banking system. The safety fund system established in 1829 was a plan for the mutual insurance of banks.1 It provided that each bank should pay annually 1/2 of 1 Per cent of its capital into a bank fund in the custody of the state comptroller until its contribution should amount to 3 per cent of the capital. This fund was to be applied to the payment of all the liabilities (except capital stock) of failed banks, after the assets of the bank were exhausted. In 1837, after some experience with failures, the law was amended so that two-thirds of the fund might be used at once to redeem the notes of failed banks, the balance being reserved for other creditors. In 1840-1842, however, so many failures occurred that the fund proved inadequate to meet both notes and deposits, and in 1843 the law was again amended to make notes a first lien upon the entire fund.
This amendment came too late; in 1838 the bond deposit system was established and new banks after that date incorporated under the new plan, leaving a constantly decreasing number of banks to keep up the safety fund. The new constitution of New York adopted in 1846 prohibited the granting or extension of any special bank charters. As all of the safety fund banks held special charters the system gradually died out with the expiration of their charters.
The fundamental defect of the safety fund system was the failure to limit the use of the fund from the start to the prompt payment of the notes of failed banks. It has been estimated that a tax of 1/4 of 1 per cent on circulation would have covered all failures and made the notes of all banks in the system secure. It is significant that the legislature of New York in changing the law in 1842 did not discuss the question of guaranty of deposits. The deposit business had not yet developed to the point where losses to depositors from failed banks approached the importance of losses to note holders. After about 1850, however, deposits increased rapidly and the panic of 1857 made clear the necessity of protecting depositors. The result was the adoption of a specie reserve against deposits, a feature carried over into the national banking system. While notes and deposits are equally liabilities of a bank, note holders are "involuntary creditors,' unable for the most part to discriminate between the good and the bad notes. Depositors are voluntary creditors and so not in need of the same guaranty against loss as note holders.
1 Chaddock: Safety Fund System (Nat. Mon. Comm.).
Though the evolution of the safety fund idea was checked in Now York by the introduction of a new system resulting from political conditions, it was adopted and used successfully in several other states and in Canada. Under the Canadian system, bank notes are a first lien against the assets, and are further protected by the double liability of stockholders. The final resort in case of failure, however, is the "circulation redemption fund," a sum of gold or Dominion notes equal to 5 per cent of the average circulation which every bank is required to keep on deposit with the Minister of Finance.