The New York Safety Fund System represents one of the early efforts to protect the public from bank failures and is an ancestor to the Federal Depositary Insurance Corporation (FDIC) in the United States. The Safety Fund System required that banks chartered by the state of New York contribute to a safety fund to pay for the redemption of banknotes issued by failed banks.
Under the pre–Civil War banking system individual banks issued their own banknotes, which in principle they stood ready to redeem in specie. Banknotes played the role that checking accounts play in the modern banking system. When banks, failed the public could no longer convert the banknotes of failing banks into gold and silver coins. In the modern banking system, bank failures, in the absence of deposit insurance, leave the banking public unable to withdraw bank deposits in cash.
The legislature enacted the New York Safety Fund Act on April 2, 1829, and the system remained in effect until the era of free banking that began in 1838. Some of the public skepticism toward banks at the time can be read in the wording of the act, which referred to a bank as a “monied corporation.” The act 300 | New York Safety Fund System required that each bank annually contribute 0.5 percent of its capital to a fund
until the bank’s contribution to the fund equaled 3 percent of its capital. The interest earned on the fund, after
allowances for administering the fund, was paid back to the banks. When a bank failed, the safety fund paid the debts of the failing bank, but the fund did not reimburse the owners of the bank for loss of capital. The act put the administration of the fund in the hands of three commissioners, one appointed by the governor, and two by the banking community. The act provided that a bank could be liquidated if the bank was two months
behind in its contribution to the safety fund, had sustained a loss of half of its capital stock, had suspended specie payments on its banknotes for 90 days, or had refused access to bank commissioners. The act also required that bank officers pledge an oath that a bank’s stock was not purchased with a bank’s own banknotes, a common abuse of banking laws at the time.
The safety fund system worked well until 1837, but the crisis of 1837 was more than the fund could handle. The safety fund appears to have remained in existence into the era of free banking, but not on sound footing. In 1842, the act was revised to remove the safety fund from responsibility for bank deposits and debts, but maintained the fund’s responsibility for banknotes. R. Hildreth, writing in 1837 on the banking system, commented on the safety fund, saying: “it does not level the root of the evil; and it has the obvious defect of taxing the honest for the sins of the fraudulent” (Chown, 1994).
Chown, John F. 1994. A History of Money.
Hepburn, A. Barton. 1924/1964. A History of the Currency in the United States.
Myers, Margaret G. 1970. A Financial History of the United States.