States in Charge
Following the demise of the Second Bank of the United States in 1836, the American financial system entered a period frequently termed by economic historians as the "free banking era." These were the years 1837-1862: the time between the Second Bank and the first of the National Banking acts. The only banks in the U.S. were those chartered by the states. The federal government neither chartered banks nor regulated the existing state banks.
Under a chartered bank system, a bank could only begin operations by a specific act of a state's legislature. The charter issued by the legislature would specify in what activities the bank could and could not engage, the interest rates that could be charged for loans and paid on deposits, the reserve ratio, the necessary capital ratio and so forth. The issuing state was also responsible for regulating the activities of the banks it created.
The first bank licensed in this manner was the Bank of North America in 1782 and which operated in Philadelphia. It was designed by Alexander Hamilton and modelled after the Bank of England. Although bank-like institutions existed in the colonial period, the Bank of North America was the first bank in the modern sense of the word. The bank was permitted to accept gold and silver coin, also called specie, for deposit and to issue banknotes in exchange. Banknotes were paper bills of credit that promised to pay the bearer the note's face value in specie on demand. The public accepted the banknotes as money because it had faith that the notes would in fact be redeemed by the bank in specie. The banknotes that augmented the money supply proved effective in stimulating economic activity. Its success inspired similar banks to be chartered in New York and Boston a few years later. By the end of Washington's administration, twenty four state banks were in operation along with the Bank of the United States. The number tripled within the next dozen years despite the well-known opposition to banking of the next two Presidents, Adams and Jefferson (Hammond, 144-45).
1853 State Bank Note