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TeachMeFinance.com - explain Safety-fund system historic definition...
Safety-fund system -- The safety-fund system, so called, was
adopted in New York state in 1829. The banks were required
to establish a common fund for the security of the holders of
their notes (and at first for their depositors as well) by a tax
of 1/2 of 1 per cent annually upon the capital stock of the banks
until the fund amounted to 3 per cent of the capital. Any
encroachments on the fund were to be made good by further
taxes at the same rate.
From 1829 to 1841 no demands were made on the fund, but a
series of bank failures in 1841 and 1842 developed the fact that
the law, apparently by oversight, made the safety fund responsible,
not only for circulation, but for all the debts of the insolvent
banks. This discovery resulted in the exhaustion of the
fund, although it was more than sufficient in amount to have
redeemed the notes of the failed banks. The law was
amended, but the damage to the fund had been done, and in
the period while the deficit was being made good and a new
fund accumulated by the annual tax of 1/2 of 1 per cent there
was no security for the payment of notes except the credit of
the issuing banks.
The safety fund system was not terminated until 1866 when
the charters of all the banks operating under it expired. The
surplus left was then turned into the state treasury. In so far
as the system fell short of absolute success the fault seems to
have been due to unsuspected defects in the letter of the law
rather than to any weakness in the principle on which it was
based.
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