During the greater part of the existence of the Suffolk Bank there was no provision in Massachu setts for keeping a specified reserve. The system worked so well, in fact, that specie was seldom de manded. In 1858, the Massachusetts legislature passed a law providing for a reserve of fifteen per cent against both notes and deposits. Both were thus recognized as liabilities of the bank, equal in every re spect. The notes were not intended for permanent circulation but for redemption when the need for them disappeared, in the same way that our checks and drafts are redeemed today. Under this system the average life of the bank note was found to be about five weeks.
The operation of this plan illustrates the value of a system of quick redemption. New England bank notes were issued according to the banking principle, contracting and expanding in volume according to the demands of trade. During panicky times the banks of the Suffolk system were the last to suspend specie payment. Their notes acquired a wide circu lation outside of New England and, in 1857, five hun dred banks were included in the system.
9. Safety-fund system.—New York State fur nishes two interesting experiments in the field of banking—the safety-fund system and the bond-de posit or free banking system. The first plan is espe cially worthy of note because of the light which it throws on the proposal to guarantee bank deposits. The second plan is of interest because it was adopted later as a model for the national banking system.
The safety-fund system was established in 1829. Each bank was required to contribute annually one half of one per cent of its capital to a special fund in the hands of the state until contributions should amount to three per cent of its capital. Out of this fund all the debts of failed banks (except those due to stockholders on their stock) were to be paid after the assets of the bank had been exhausted. In 1837, the law was amended so that the notes of failed banks could be paid immediately, provided they did not amount to more than two-thirds of the money in the fund. In that year, several banks failed and their notes suffered no depreciation. After 1840, how ever, the number of banks which failed was so large that the safety fund was too small to meet all their obligations, both notes and deposits. Accordingly, in 1843, the law was again amended so that the fund was made applicable only to the payment of the notes of insolvent banks.
In 1838, the bond-deposit system was established and all banks which were incorporated after that date came under the new plan. This weakened the safety fund because there were no new contributions to it and the burden fell upon a constantly decreasing number of banks. In 1846, the new constitution of New York
provided that note holders were to have a first lien on all the assets of a bank and that in case of failure stockholders were to be liable for an amount equal to their holdings of stock. It was provided further that no special charters, such as those under which the safety-fund banks operated, were to be granted or renewed. These were important developments in the field of American banking. The safety-fund system gradually died out with the expiration of the charters, and all claims against it were finally paid in full. The last charter expired in 1866.
10. Free banking or system.— The free banking law of 1838 authorized any person or association of persons who would deposit with the State Comptroller bonds of the United States, of the State of New York or other approved states, or mort gages secured by real estate worth twice the amount of the mortgage, to receive from the State Comptroller circulating notes to be signed and issued as money. This deposit of collateral was intended to insure the note holder against loss. No provision for actual redemption in specie was required. Anyone who possessed the necessary securities might enter the banking business, and it is evident that many of them did. Over 130 new banks were organized before 1840. Failures quickly resulted and it was found that in many cases the securities deposited were not sufficient to meet the notes. Real estate mortgages, however valuable, were not quick assets, hence the law was finally changed so that only the bonds of the United States and of New York were available for deposit.
The notes circulated at first at considerable dis count, but this was overcome to a certain extent in 1840 by an amendment to the law which necessitated redemption of the notes of interior banks in New York and Albany at a discount not greater than one-talf of one per cent. This still gave an advantage to the country banker because of the profit he could make by lending his notes at par and redeeming them at a discount. Hence many banks in the cities issued their notes in the country towns. The business of some of these banks was solely to issue notes. They had no permanent banking house and received no deposits. In 1848, this condition was bettered somewhat by a law requiring banks of issue to become banks of de posit as well, but the law was never strictly enforced. The effect of these various amendments, however, and of the constitution of 1846 was to improve greatly the condition of the issuing banks, so that after 1850 fail ures were infrequent and in almost all cases the notes were redeemed at par. After 1860, there were no failures which resulted in loss to note holders.