Definition of Free banking system


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historic definition...

Free banking system -- Previous to the panic of 1835 there were no general laws in any of the states providing for the incorporation of banking associations. Each bank operated under a special charter passed for its own benefit. This system of incorporation had aroused much opposition on the grounds of monopoly, favoritism and corruption and logrolling in the various legislatures. After the panic of 1835 there was an agitation in favor of general banking laws under which any body of men associated together for the purpose could by complying with the law engage in the banking business. An essential feature of banking at that time was the privilege of issuing notes and the chief concern of the advocates of a general or free banking system was to provide some method for making such notes secure and acceptable to the public. The device generally decided upon was to require the banks to deposit in the custody of the authorities of the state from which they received their charter approved securities equal in value to the notes issued. The first law of this character was enacted in Michigan in 1837. New York followed in 1838. The New York law, which was very similar in principle to the Michigan law, provided that any person or association of persons might receive from the Comptroller of the state circulating notes and after signing them might issue them as money by first depositing with the Comptroller stocks (bonds) of the United States, of the state of New York or any other state approved by the Comptroller, or bonds and mortgages on improved, productive and unencumbered real estate worth double the amount of the mortgage, exclusive of the buildings thereon, and bearing interest at not less than 6 per cent. The result was a great emission of notes, a great depreciation in the value of the notes, and the failure of many banks issuing them when they were required by subsequent enactment to make provision for the prompt redemption of their notes. The disastrous effects of both the Michigan and New York laws were attributed, however, more to faulty construction and poor administration than to any wrong principle. As the acts were gradually modified and strengthened their actual operation became more satisfactory and the New York law was practically the model for the national banking system. Meanwhile, many other states followed the example of Michigan and New York, but their laws were so loosely drawn and the administration of them was so bad that the grossest frauds were perpetrated and state bank notes became a synonym for worthlessness. Some of the devices resorted to and the disastrous results that followed are described under the head Wildcat money.

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Mark McCracken

Author: Mark McCracken is a corporate trainer and author living in Higashi Osaka, Japan. He is the author of thousands of online articles as well as the Business English textbook, "25 Business Skills in English".

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