Transition in Banking

Excerpt:  A brief historical overview of changing banking practices abetted by the Fed’s inflationary expansion of the currency. The main effect of the Fed’s current moves is to bail out the financial institutions. That’s what opponents of creating the Fed feared in 1913. The Fed’s acting as lender of last resort to tide banks over periodic panics was, in 1913, vastly different from today. Banks then were more prudent, confining their lending to short-term self-liquidating advances, usually with maturities no longer than 90 days. Moreover, borrowers were expected to clean up their credit lines, that is, to pay loan balances down to zero at least once a year to demonstrate the strength of their balance sheets.

In the late teens and early 1920s, the only collateral eligible for rediscount at the Fed was bankers acceptances (export-import financing with maturities again of maximum 6 months) and commercial notes representing domestic shipments of goods to creditworthy companies. Not even Treasury Bills were eligible for rediscount in the Fed’s early days. The effect was to confine commercial banks to financing agriculture and commerce. This tended to limit bank credit expansion to the underlying real growth of business.

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