EARLY AMERICAN COMMERCIAL BANKING

In the early days of the American money market, there was little differentiation of function among capital institutions. There was no sharp line of demarcation between commercial and investment banking. Merchants often acted as stockbrokers, and importers often deal in foreign exchange. Specialized money markets could not exist until the appearance of the highly specialized entrepreneur created a demand for them.

Before the Civil War, the commercial bank was already the most important type of financial institution in the country. It deposits, made loans and discounts, and issued money. Although these functions were the same as those carried on by a modern commercial bank, the nineteenth-century bank operated quite differently from the modern bank.

Banking practice in the big cities differed widely from methods followed in rural areas. Banks in all sections of the country made “accommodation loans,” that is, long-term loans to finance expenditures for fixed capital; but city banks also handled a large volume of short-term commercial loans. When a New York City merchant received a loan from a commercial bank, he submitted his note. In exchange, he received a bank deposit against which he could draw checks, or, less commonly, he received state-bank notes of varying denominations, ordinarily from $5 up. The borrower’s note was payable in specie or bank notes at the end of 30 days, but it was usually renewable. In rural sections, the majority of loans were made to farmers and were for much longer periods than urban bank loans. Usually these loans were made by using state-bank notes. Because American banking was predominately of the rural variety, the early commercial banking system had little liquidity or shiftabilty. In the big cities, theoretical, loans could be liquidated—that is, turned into cash quickly—by simply calling for payment, but this could not be done in the outlying areas. Nor could the security against which most loans were made be sold, that is, shifted to another agency, for no such agency existed.

Ostensibly, bank notes were secured by specie (gold or silver) and were redeemable on demand in specie. In actual practice, however, sporadic break-downs occurred in the system of redemption. In fact, specie payments had to be abandoned either wholly or partly in the midst of every major recession and during every major war. During prosperity, banks increased their note issues up to the limits allowed by law or by the existing state of their reserves. When prosperity was suddenly succeeded by panic, some of the outstanding money supply became redundant. Holders brought their notes to the issuing banks and demanded coin as promised on the face of the notes. But because their assets were neither liquid nor shiftable, banks could not meet these demands for redemption as quickly as they were presented and, consequently, specie payments had to be abandoned.

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