Bank Clearinghouses (United States)

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In the United States, bank clearinghouses partially fulfilled the functions of a central bank before the establishment of the Federal Reserve System. Bank clearinghouses facilitated interbank settlement of accounts, a necessary part of check clearing processes. Also, during financial crises, when currency and coin was scarce, bank clearinghouses issued certificates representing claims on bank assets. These certificates replaced cash in the interbank settlement of accounts and infused additional liquidity into the banking system, allowing banks to survive the outflow of currency and coin typical of financial crises. On rare occasions these certificates circulated as currency.

New York City banks established the first clearinghouse in 1853. Two years later the concept spread to Boston and soon all the nation’s largest cities had bank clearinghouses. The New York clearinghouse remained the most important because of New York’s (Wall Street’s) strategic role as the financial nerve center of the United States.

Under a bank clearinghouse system, an individual bank, Bank A, presents all its claims against other banks (deposited checks written on other banks) to the clearinghouse each day. The clearinghouse credits Bank A’s clearinghouse account accordingly. All other banks that have received deposits of checks written on Bank A will take these checks to the clearinghouse also, and Bank A will find its clearinghouse account debited to pay for these checks. Whatever discrepancy exists between debits and credits is settled with cash. The clearinghouse system substantially reduces the amount of cash that changes hands in the check clearing process.

Banks operate on the principle that, despite daily withdrawals and new deposits, the average level of deposits at a bank remains steady during normal business conditions, and therefore banks can keep the vast proportion (80 to 95 percent) of customer deposits loaned out. Banks keep reserves, such as vault cash, for those periods of time when withdrawals exceed new deposits. Sound banks, however, often fell prey to their own success by loaning out too much of depositors’ money and coming up short of reserves to redeem deposits during a financial crisis. Bank clearinghouses help banks resist the temptation to overextend loans by forcing banks to speedily honor checks written on their accounts. Also, the New York clearinghouse required weekly reports from associated banks showing customer deposits, assets, and reserves.

The New York clearinghouse issued certificates against bank assets to substitute for cash in interbank settlements during financial crises when accelerated withdrawals of deposits often left banks without cash reserves. The clearinghouse issued certificates against a bank’s assets when a bank put up 100 percent collateral either in bonds, or short-term commercial loans rated at 75 percent of face value. In a financial crisis a bank experiencing a drain on reserves could use certificates to settle up with the clearinghouse. The use of clearinghouse certificates was not legally sanctioned until 1908, but certificates helped ease the strain in every financial crisis from 1873 until 1914. The clearinghouse was essentially serving as a lender of last resort, one of the important functions of a central bank.

Although clearinghouses were strictly private organizations, acting on private rather than public initiatives, they met some of the regulatory needs of the banking system before the United States turned to central banking in 1914 with the establishment of the Federal Reserve System.