The U.S. Bank Insurance and Resolution Experience and Lessons for the European Union

Formative years of the U.S. banking industryFrom the latter part of the nineteenth century on through the outbreak of World War I, the U.S. economy underwent important changes. It entered World War I as a debtor nation, and emerged as a creditor. This war turned the tide in the country's economic development. The growing needs of the Allies and neutral nations generated the necessary momentum for the growth of exports. Rising productivity in agriculture, increased efficiency in industry, and the influx of flight capital from Europe combined to transform the United States into an industrial and financial power. The country's economic momentum resulted in an unprecedented increase in the number of banking facilities which reached by 1920 into 30,000 banks operating 1,300 branches.This momentum reversed in the course of that decade. As depicted in Figure 1, commercial banks suffered important setbacks during the 1920s and early 1930s resulting in significant consolidation of the industry. Mergers and, most important, failures during the 1921-33 period were responsible for the disappearance of about 15,000 banks and losses to depositors in excess of $2 billion. Sizable losses were also sustained by the owners of bank stock, who in addition to the loss of their investment often paid voluntary assessments to meet the claims of bank creditors, in an effort to avert the closing of their bank.Many of the banks which failed during this period were small banks in the agricultural and rural regions of the country. The sharp postwar deflation of 1920-22 and the recession of 1923-24 caused a general retrenchment in economic activity that hit the agricultural sector especially hard. The renewed collapse of agricultural prices in 1929-30, accentuated by severe drought, accelerated the pace of bank failures in farming areas. These failures undermined further the depressed state of economic activity precipitating a general distrust in the banking system, widespread panics and run on banks.With the U.S. financial system in the verge of collapse, legislators became convinced of the need to subject the activities of commercial banks to comprehensive controls. It was under these circumstances that Congress passed the Banking Act of 1933 (Glass-Steagall Act), which was complemented two years later by an equally comprehensive piece of legislation, the Banking Act of 1935. Some of the key provisions of the former included the introduction of a temporary federal deposit insurance plan for the country's 13,201 banks, in the amount of $2,500; prohibition of interest payment on demand deposits and the setting of maximum interest rates on time and savings deposits (Regulation Q); and the strengthening of controls over the use of bank funds for speculative and investment uses.The Banking Act of 1935 addressed issues that covered virtually every aspect of banking. For example, it introduced a new revised insurance plan by providing for the establishment of the Federal Deposit Insurance Corporation (FDIC) with authority over all insured banks that were not in any way supervised by a federal agency. Other provisions amended the structure and functions of the Federal Reserve System, increased its control over the commercial banking activity, and strengthened the influence of the government over the Federal Reserve System.As the effects of the depression started to fade and economic recovery set in, the banking industry began to undergo important structural changes. As seen in Figure 1, the following decades were characterized by a gradual decline in the number of banks and a fast rise in the number of branches. The former was due to a wave of bank mergers while the latter to population mobility and industry shifts out of central cities. The consequent growth of branch banking, initially confined within state boundaries and later expanded to contiguous states, prompted renewed consolidation of the banking industry and growth of interstate branching. …