Readings in Money and Banking Part 38

The increasing attention paid in recent years by the state legislatures to the regulation of the state banks has been partly due to the rapid growth of the banks in numbers and in financial importance; but it is to be accounted for primarily by a change of view as to the purpose of banking regulation. The antebellum state-bank regulations were intended to secure the safety of the bank note. Although the depositor was protected by many of the regulations, this protection was purely incidental. The view that note-issuing banks alone required governmental regulation persisted for a considerable time after the pa.s.sage of the national-bank act. Since the national banks had a monopoly of the issue of bank notes, the regulation of state banks was considered needless. As the importance of note issue as a banking function decreased, banking regulation, as seen in the national-bank act, began to be considered desirable as a protection to depositors.

THE EVOLUTION OF THE TRUST COMPANY

With the exception of the power to issue notes, which would be unavailable because of the tax on note issue, the powers of the state banks of to-day are essentially the same as the powers of the state banks which were in operation before the Civil War. On the other hand, the trust company is a new type of banking inst.i.tution, the functions of which are even yet not clearly defined. A great part of the legislation with reference to trust companies, therefore, has had to do with defining the powers of these corporations.

The early laws for the incorporation of trust companies show the widest differences of opinion with regard to their field of operation. The one point of agreement appears to have been the idea that a corporation could administer trusts more advantageously and safely than an individual. But the companies in all the States were given additional powers more or less closely connected with their trust powers. Some of the companies, chiefly the very early ones, were empowered to insure lives and to grant annuities. In a considerable number of States the companies were authorized to insure the fidelity of persons in positions of trust and in some States to insure t.i.tles to land. Almost all the companies were empowered to do a safe-deposit business. Among these powers there was a certain apparent connection. The power to insure the fidelity of trustees, administrators, and executors seemed a natural addition to the powers of a company which might act in such capacities.

Similarly, it appeared that the business of insuring t.i.tles to land was one which could be most economically conducted by a corporation which, in its capacity of trustee, would be a large owner of real estate.

One other power was given to practically all the companies--the power to receive deposits of money in trust. The following quotation from the Report of the Ma.s.sachusetts Commissioners of Savings Banks for 1871 shows the use which it was expected would be made of this power:

The trust company in Worcester and the New England Trust Company in Boston, both in successful operation, are the first of such corporations established in this State. They were incorporated after a very careful investigation by the legislature, with power to hold money in trust, and so restricted in making loans and investments as to afford the safety which the character of their business requires. A similar inst.i.tution will soon be organized in Northampton, and others are contemplated. They are well calculated to promote public interests by affording to the owners of capital not engaged in business many of the advantages secured by our savings-bank system for the savings of labor.

The development of the trust company as reflected in the legislation with reference to its powers shows two main tendencies: (1) The companies have to a very large extent given up the insuring of the fidelity of persons in positions of trust and the guaranteeing of land t.i.tles. (2) They have largely increased their banking activities.

1. In some States which formerly authorised trust companies to insure the fidelity of persons in positions of trust, or to guarantee t.i.tles to real estate, the more recent laws do not permit the combination of such business with the business of a trust company.

The fidelity insurance business during the past twenty years has been largely concentrated in the hands of a comparatively small number of companies which have agencies in all parts of the country and which do not undertake a trust or banking business. The elimination of fidelity insurance from the functions of the trust company has not been chiefly or even largely due to adverse legislation, but to the nature of the fidelity insurance business. The most successful conduct of that business appears to require, like other kinds of insurance, that the risks shall be numerous and widely distributed. These conditions are best met by companies which carry on business in many different places.

For the most economical conduct of the t.i.tle insurance business an expensive plant is necessary. The business in each city tends therefore to fall into the hands of a single company, which ordinarily finds it profitable to devote itself entirely to the one kind of business. At the present time, only a very small part of the trust companies in the United States insure t.i.tles to land.

2. The second great tendency in the development of the powers of the trust company--the enlargement of its banking powers--has also been primarily an economic development and not one due to legislative design.

As has already been noted, the early trust companies ordinarily had power to receive trust deposits and to loan money. Some such powers were necessary for the exercise of their trust functions. The opportunity to enlarge the banking powers of the companies lay in the difficulty of distinguis.h.i.+ng clearly between the powers which it was intended to confer upon the trust companies and the banking powers possessed by state and national banks.

In the greater number of the States the wording of the sections conferring powers to do a trust business was such that the trust companies were either held by the courts to be empowered to do a banking business, or, if the power to do such business seemed not to be granted, were able by some change in the method of doing the kind of banking business in question to bring it within the powers actually conferred.

In Missouri, for instance, since 1885 trust companies have been empowered to "receive money in trust and to acc.u.mulate the same at such rate as may be obtained or agreed upon or to allow such interest thereon as may be agreed." The supreme court of Missouri in construing the power thereby conferred has held that a trust company can take only interest-bearing deposits, but that such deposits may be demand deposits payable on check. The rate of interest may, however, be nominal.

In other States the trust companies have attained legal recognition of their banking powers by slow steps. The history of the Pennsylvania trust companies affords an ill.u.s.tration. In the Pennsylvania general corporation act of 1874 no provision was made for the formation of trust companies, but provision was made for the incorporation of t.i.tle-insurance companies. By an amendment to the corporation act in 1881 t.i.tle-insurance companies with a capital of at least $250,000 were given trust and fidelity-insurance powers; but it was expressly provided that such companies were not authorized thereby to do a banking business. In 1885 the trust companies were given the power to receive upon deposit for safekeeping valuable property of every description, and in 1895 trust companies were given power to "receive deposits of money and other personal property and to issue their obligations therefor ...

and to loan money on real and personal securities." In 1900 the United States circuit court of Pennsylvania decided that Pennsylvania trust companies might legally receive demand as well as time deposits.

Pennsylvania trust companies apparently even now cannot discount commercial paper, but they may loan on it as collateral and may purchase it from the holder.

The States in which the banking powers of the trust companies have been most narrowly restricted are Iowa, Michigan, Nebraska, and Wisconsin. In Nebraska a trust company cannot do a banking business. In Iowa trust companies cannot do a banking business except that they may receive time deposits and issue drafts on their depositories. In Michigan trust companies are expressly forbidden to do "a general banking business."

The Michigan commissioner of banking in his report for 1906 complained, however, that the law was not clear as to the banking powers of the companies. In Minnesota the trust companies may receive trust deposits, but may not "engage in any banking business except such as is expressly authorized for such a corporation." In Wisconsin the extent of the power of trust companies to receive deposits was much debated until 1909, when the legislature provided for the incorporation of "trust-company banks,"

which have power to receive time and savings deposits, but do not have power to receive deposits subject to check.

The result of the two tendencies described above--the elimination of the insurance powers of the trust company and the addition of banking powers--has gradually standardized the powers of the trust company, until at the present time the trust company, as it appears in the corporation laws of most of the States, may be fairly well defined as a bank which has power to act in the capacity of trustee, administrator, guardian, or executor.

In a number of States the legislation concerning trust companies deals with them explicitly from this standpoint. The Illinois bank act of 1887 provided that any bank might have power to execute trusts by complying with the trust-company law. In Alabama and Tennessee any state bank may be appointed and may act as an executor, administrator, receiver, or guardian. In Mississippi any bank with a paid-up capital of $100,000 may do a trust-company business. In Georgia any trust company may acquire banking powers by complying with the laws regulating banks. In Texas banks may acquire trust-company powers. The same tendency is shown in the important banking laws enacted in Ohio in 1905 and California in 1909.

The gradual change from the view that the trust company is an inst.i.tution of markedly different character from the ordinary bank of discount and deposit to the view that the trust company is merely a bank exercising functions additional to those exercised by the majority of banks has been the chief influence in determining the form of the legal regulations imposed upon trust companies. As long as the older view obtained, the regulations concerning trust companies were widely different from those imposed upon banks; but as the trust company has increased both the scope and amount of its banking business, the regulation of the banking business of the trust company has tended to become a.s.similated to the regulations imposed upon state banks.

INCORPORATION

Since 1865 state banks and trust companies have been incorporated by the use of one of three methods: (1) By special charter; (2) under the "business incorporation law"; (3) under the general banking law. Not very many of the States have used consecutively all three methods, for the special charter and the "business incorporation law" were used contemporaneously in different sections of the country. Both have given place, in the great ma.s.s of States, to the general banking law. From 1865 to 1875 probably the greater number of the banks formed were incorporated under special acts; from 1875 to 1887 incorporation under the "business incorporation law" was the prevailing method, and since then the general banking law has become the almost universal method of incorporating banks and trust companies.

CAPITAL AND SURPLUS REQUIREMENTS

When the States began to give attention to the regulation of the banking business the question of capital received immediate attention. The national-bank act and the banking laws in New York and the Middle West which had survived from the antebellum period contained provisions concerning the amount and payment of capital. A requirement with regard to capital was recognized as the central point in any system of bank regulation. The capital stock is a buffer interposed between the bank's creditors and losses which the bank may suffer. If there is no capital, losses may fall directly on the creditor, and the larger the capital stock, other things being equal, the less the likelihood of loss to the depositor.

The States and Territories may be divided roughly into two groups according to the amount of the smallest permissible capital for state banks:

1. In the Eastern States and the more easterly of the Middle Western States, the banking laws, with one exception, require that banks shall have a capital of at least $25,000.

2. In the other sections of the United States banks in most of the States are incorporated with a capital as small as $10,000, although in a few of these States the smallest permissible capital is $15,000, $20,000, $25,000, and $30,000, and in one, North Carolina, it is $5,000.

The amount of capital required, except in a few States, is not a uniform amount, but is graded, usually according to the size of the city in which the bank is located. In 29 of the 37 States and Territories which require under a general law a specified amount of capital for the incorporation of state banks the amount of capital is thus graded. The grading of the amount of capital required according to the population of the place in which a bank is located has been chiefly due to the desire to bring about some adjustment between the capital of each bank and the volume of its business. It is a.s.sumed that the larger the business of the bank the greater the chance of its suffering large losses and the larger the capital necessary to protect its depositors against loss. It is also a.s.sumed that the size of the city in which it is located is a rough index of the volume of business done by a bank. Under many of the state banking laws the grades are very numerous. The minute gradation of the capital requirements found in many of the state banking laws is due to the desire to encourage the formation of banks in the smaller cities and towns, for it is to be noted that in the greater part of the state laws the grades are not numerous for the larger places.

Obviously, if any law requiring a minimum capital for banks is to be effective, it must provide specifically for the payment either of all the capital or of a specified sum; otherwise the directors of the bank may require the payment of only a small part of the capital. The provision in the national-bank act concerning the payment of capital has been the model for similar provisions in the banking laws of a large number of the States. Many of the state banking laws likewise contain the same provision as the national-bank act with reference to surplus.

In several States the laws make no provision with reference to the amount of capital required for a trust company. In Connecticut, Delaware, New Hamps.h.i.+re, and Vermont, trust companies are incorporated only under special acts and the amount of their capital is determined in each particular case by the legislature. In Rhode Island trust companies are incorporated by a board which has power to fix the terms of incorporation, including the amount of capital.

The first general laws for the incorporation of trust companies in the United States required such companies to have a much larger capital than that required for banks, but the later legislation shows a distinct tendency in the direction of lowering the requirements in regard to capital. In nearly all of the States, however, the requirement for trust companies is still substantially different from that for state banks.

The smallest permissible capital for a trust company ranges from $5,000 in North Carolina to $1,000,000 in the District of Columbia. The majority of the States, which provide that trust companies must have a specified minimum capital, do not permit the organization of trust companies with a smaller capital than $100,000.

In only one State, Iowa, is the smallest permissible capital less for trust companies than for state banks; in six States it is the same; in all the others it is larger. The acc.u.mulation of a surplus is not required in so many States for trust companies as for banks.

LIABILITY OF STOCKHOLDERS

With the practical prohibition of the issue of state bank notes in 1866 and the consequent decrease in the number of state banks, the liability of stockholders in state banks became in nearly all of the States, except where an additional liability was imposed by the const.i.tution, the same as that of stockholders in ordinary business corporations.

Since 1880, however, provisions imposing an additional liability on the stockholders of banking corporations have been placed in the banking and trust-company laws of nearly all the States in which state banks or trust companies have a.s.sumed any great importance. In the larger number of the States and Territories the liability is a proportionate one, and the stockholders are responsible "equally and ratably and not one for another."

The imposition of the statutory liability on the stockholders of state banks and trust companies has not proved of great service as a protection to bank creditors against loss. As yet little has been accomplished in the way of making the enforcement of the liability effective.

RESTRICTIONS ON LOANS AND DISCOUNTS

The desirability of some legal limitation on the extent of the liability to a banking inst.i.tution which any one person, firm, or corporation may incur is largely due to the fact, that, since the American banking system is a system of independent banks, the resources of many of the banks are necessarily small in comparison with the needs of some of their customers for loans. A large manufacturing concern located in a small town may very well be able to use all the a.s.sets of the local bank. If the local bank were the branch of a larger bank, the mere fact that a large loan was wanted by a manufacturer in a small town would be of no significance, since the amount of the loan would be small compared with the total a.s.sets of the bank.

Moreover, in many banks a controlling interest is held by a person, firm, or corporation that is actively engaged in other business enterprises. Such control is far more likely to be found in small banks than in large, and in a system of independent banks than in one of branch banks. One consequence of the close identification of interest thus brought about between banking and other business enterprises is the probability that loans will be made directly or indirectly to some one borrower to an amount larger than a proper distribution of risks would justify.

The national-bank act in its original form provided that the total liabilities to any national bank of any person, company, corporation, or firm for money borrowed should not exceed one-tenth of the amount of the paid-in capital stock of the bank. The liabilities of the members of the firm or company were to be included in the liabilities of the firm or company. It was provided, however, that "the discount of bills of exchange in good faith against actually existing values and the discount of commercial or business paper actually owned by the person negotiating the same" should not be considered as money borrowed. This section of the national-bank act remained unchanged until 1906, when it was amended so as to permit a single liability to be contracted equal to one-tenth of the capital and surplus, instead of one-tenth of capital only, but it was also provided that the liability should not, in any case, exceed 30 per cent. of the capital stock.

In the banking laws of seven States the limit on the amount of single liability is the same as under the national-bank act. The banking laws of almost all the other States permit a larger amount to be loaned on a single liability than is permitted by the national-bank act.

In nearly all of those States in which trust companies have acquired full banking powers the provision limiting the amount of any single liability applies to both banks and trust companies. In only one State or Territory--New Mexico--is there such a provision for trust companies and none for state banks. In a few States--Kansas, Michigan, Minnesota, Missouri, Montana, Oklahoma, New Jersey, Nebraska, and Wisconsin--there are limitations on the amount of a single liability for banks, but none for trust companies.

LOANS TO DIRECTORS AND OFFICERS

In almost all the banking inst.i.tutions of the United States the directors or a part of them are actively engaged also in other business enterprises; and in many cases they borrow from the banks or trust companies in which they are directors. Moreover, in some banks one or two of the directors own a controlling interest, and are at the same time large borrowers. The possibility, in such cases, that larger loans may be made than the credit of those directors warrant is very considerable. The national-bank act contains no provisions regarding loans to directors, but in the laws of about one-half of the States attempts have been made to devise rules which would prevent the making of loans to directors in excess of the amount to which their credit ent.i.tles them. The requirement that loans to directors shall be formally approved by the board of directors is the one most frequently found. It has been thought that directors would be reluctant to vote for excessive loans to other directors if their vote is to be recorded.

REAL ESTATE LOANS

There is no more characteristic difference between state banking laws and the national-bank act than the fact that, in almost all the States, state banks and trust companies may make loans on the security of real estate, whereas national banks are [were] prohibited from doing so [before the pa.s.sage of the Federal Reserve Act]. In some States, where the influence of the example of the national-bank act was strong enough at the beginning of state-bank regulation to secure the insertion in the state banking laws of the prohibition of real estate loans, it has later been found desirable to amend the laws in this respect. The Pennsylvania general banking law of 1878, for instance, did not permit banks to loan on real estate, but was amended in 1901, so as to permit such loans to be made. In North Dakota and South Dakota, also, similar changes have been made in the banking laws. In 1910 trust companies in all the States and Territories where incorporated under general laws were allowed to loan on the security of real estate. State banks so incorporated may also loan on real estate in all the States and Territories except New Mexico and Rhode Island. In Rhode Island, however, banks may loan on real estate part of their savings deposits.