Banking in the Early Republic

A knowledge of banking and finance is absolutely crucial to understanding of early American economic, political, social, and even cultural history for four important reasons. First, privately-owned banks, not the national government, created most of the nation's early money stock. Second, banks and bank money deeply influenced the development of America's early economics, the nature of its democratic spirit, and the institutions of its governance. Third, secondary securities (stock) markets helped to establish the credit of the federal, state, and local governments and to finance important businesses. Finally, financial institutions and issues influenced a variety of major aspects of early national life, including minority rights, materialism, religion, social mobility, community, political party formation, the Industrial Revolution, and the emergence of the middle class and of organized labor.

In the Early Republic banking functions were not integrated. Distinct institutions performed different banking functions. Savings banks were banks of deposit, private banks were banks of discount, and commercial banks were banks of issue or circulation. In the Early Republic, savings banks only maintained lodged time deposits for individual use. Loans or credits to purchase unimproved land came from the land owner, be it an individual, a large company such as the Holland Land Company, or the government. Sometimes, wealthy personal friends supplied funds.

Country banks, which were nominally commercial banks, but which broke many of the rules of strict commercial banking, also loaned money for real estate. Insurance and trust companies did likewise. Individuals, country banks, and city banks made personal loans backed only by promissory notes, though the banks usually tried to hide the fact. While many honest brokers existed, some unscrupulous brokers and "monied" individuals violated usury laws to supply short-term unsecured credit at high interest rates. Merchants, brokers, and commercial banks conducted currency exchanges.

Finally, commercial banks, and sometimes other corporations, both public and private, used loans to issue their own promissory notes payable to the bearer on demand. The nature of those bank notes was quite different from today's Federal Reserve notes. The notes of commercial banks were redeemable in specie. By presenting the note at the bank of issue, the bearer received the note's face value in gold or silver. Merchants considered bank notes the equivalent of specie. A bank that could not convert its notes into gold or silver was considered insolvent and could lose its charter.

Although some bank notes were acceptable payment for certain debts to government, early national bank notes were NOT a legal tender. In other words, no one was under an obligation to accept them in payment of debts. Under normal circumstances, bank notes were redeemable only locally or regionally, depending upon the efficiency of the extant banknote clearing systems. The notes of sound banks passed at a discount equivalent to the cost of remitting the note for payment.

By the 1830s, corporations, especially transportation companies like railroads, utilized the idea and commenced raising capital by issuing corporate bonds in addition to the usual sales of equities. Bonds, unlike common stocks, did not confer voting privileges and hence came to be preferred by the managers of businesses who did not want to lose or dilute their control of the corporation.

The amount of money raised through sales of equity and debt was truly enormous by the standards of the day. By 1836, hundreds of companies, banks, insurance companies, transportation concerns, factories, mining companies, hotels, and even theaters, had borrowed hundreds of millions of dollars, for indefinite periods, to finance their operations.

The origins of early U.S. banking have until recently been little investigated since the publication of Adolph Oscar Eliason's slim 1901 dissertation, "The Rise of Commercial Banking Institutions in the United States." Eliason concluded that the "tardy rise of banking institutions was due to the peculiar conditions of colonial trade and industry." “Commercial banking institutions," he claimed, "did not arise until there was a change in these conditions which made the rise and growth of banks necessary." Eliason's view long held sway.

The classic work on early American banking practices is Fritz Redlich's Molding of American Banking. First published in 1947, a second edition appeared in 1951. The work proved popular enough to be reprinted, with an new introduction, by Johnson Reprint Corporation in 1968. The book, which combines a thorough mix of intellectual, business, and economic history, with strongly—worded conclusions, is the source for those interested in the details of the early banking business, including bank organization, personnel functions, and transaction types.