The Forestall system of Louisiana banking regulation, established in the middle of a depression in 1842, was one of the most successful and influential systems of state banking regulations, establishing principles that became standard in banking regulation.
The Panic of 1837 had thrown the United States economy into a deep depression that lasted until 1843. The depression was sparked by President Andrew Jackson’s Specie Circular, requiring that only gold and silver specie (coinage) be used to pay for land purchased from the government. The Specie Circular put the brakes on a land boom. Banks across the United States, including Louisiana, suspended payments, meaning they could no longer redeem their bank notes with specie. At that time each bank issued its own bank notes, in contrast to the current practice of issuing checking accounts. Louisiana boasted of nine commercial banks when the Forestall system was put in place. All nine banks had suspended payments.
Among the detailed regulations of the Forestall system was the requirement that customers’ deposits could be loaned out only for 90 days. The capital contributed by bank owners was exempt from this limitation. These short-term loans could not be renewed, and the law required that banks publish the names of borrowers requesting renewals.
The Forestall system also forced banks to maintain specie reserves equal to 30 percent of their bank-note and deposit liabilities. The remaining 70 percent had to be backed by short-term commercial loans.
Amidst the Panic of 1857 an epidemic of payment suspensions spread through the United States. Thanks to the Forestall system, however, Louisiana banks were among the few banks that continued to make specie payments. Other state legislatures, noting the panic-proof resilience of the Louisiana banks, began to insist upon cash reserves. The reserve policy of Louisiana banks enabled them to continue to make remittances to their New York correspondents long after the Civil War had started.
The success of the Forestall system created a predilection for cash reserves in American banking regulation that remains an important element of national banking regulation today. Commercial banks in the United States are required to hold reserves either in the form of vault cash or deposits at a Federal Reserve Bank. Deposits at another financial institution, government bonds, or other forms of seemingly safe assets are not acceptable as legal reserves. The Federal Reserves System usually requires commercial banks to hold reserves that range between 10 to 20 percent of demand deposits.
