Question

Discuss the creation of the National Banks during the Civil War. Why did it develop into a dual banking system? Discuss the structural weaknesses of banking in the United States during the late 19th and early 20th centuries after the National Banking Act was implemented and how attempts to reform the system led to the creation of the Federal Reserve in 1913.

Answer 1

Creation of National Banks during Civil War & Dual Banking System: -

During the Civil War, the core need of the hour was for the government to be able to raise funds for itself but the currencies circulating during that time in the market were different in each state. To regulate this, the dual banking system was established under which banks were nationalized and a common currency was put into place.

Nationalized banks were controlled by the Central Government whereas state level banks were controlled by the local government accordingly the dual banking system or two-tier banking system came into existence,

Structural Weakness of the Banking System that led to the formation of the Federal Reserve: -

The federal reserve was established in the year 1913 and has since then been the bankers bank in the sense that it controls the supply of money in the economy. Prior to the establishment, the major flaw with the banking sector was that there were constant bank runs. As there were no reserves present in the economy, banks would lend out most of their money and any stock market vulnerability would lead to people rushing to banks to withdraw their money.

Even if there were problems with one bank, customers would soon follow suit in the others and a major crash happened in the year 1907 when banks and their liquidity was seriously impacted. As a result, the Federal Reserve came into existence and allowed for rules to be set in for banks which helped customers in gaining confidence and allowing for bank reserves to come into existence.

Since then, the Federal Reserve has taken numerous steps during crisis and has helped in stabilizing the economy.

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