Abstract: From Drafts to Checks: Correspondent Banking Networks and the Transformation of the U.S. Payments System, 1850-1914

John A. James and David F. Weiman

Abstract

By the 1850s checks commonly mediated local business transactions within large commercial centers. Despite significant economies in transaction and liquidity costs from their widespread use, checks would not become a national payments instrument until the 1890s. This lag of 40-50 years derives from the greater risk of checks as a payment instrument, which in turn demanded their rapid settlement. For local transactions, banks solved this problem by forming clearinghouses, a centralized network for clearing and settlement. Until the founding of the Federal Reserve, however, this model could not be adapted to non-local, especially interregional, transactions. The obvious question, then, is what supported the diffusion of checks beyond the metropolitan region at the turn of the century. Our answer is the transformation of correspondent banks in money centers from note redemption agents to pivotal nodes in the clearing and settlement of intra- and interregional draft and later check transactions. Like the Fed's Gold Settlement Fund, New York correspondents constituted the linchpin of this emerging national payments system. Our empirical analysis depicts the systemic spatial-economic order of correspondent banking. Using quantitative and qualitative evidence, we first document the long lag in the diffusion of checks as an interregional payments instrument. With Comptroller of the Currency data, we then delineate the hierarchy of correspondent centers with New York at the apex. Finally, to track changes in the cost and risk of making long-distance payments in deposits relative to paper currency, we analyze regional domestic exchange markets where local banks bought and sold excess reserve balances in New York. In conclusion we present data from the New York Clearing House gauging the relative effectiveness of the pre-Fed check payments system, including the role of New York correspondents as dealers in the domestic exchange.