During the Great Depression, one Chicago banker foresaw the inherent problems of federal deposit insurance and the extensive government regulation it would entail, and refused to join the FDIC.

He took this stand to protect his depositors and to warn against the financial reforms that were being legislated.

Chicago had the greatest number of bank failures and the largest amount of deposits held in failed banks of all the major U.S. cities in the early years of the depression. Of 225 banks in Chicago in December 1929, two-thirds had failed by the end of 1932. Of the 19 national banks operating in 1914, only four survived the 1930s without having to merge with other banks.

Nichols Versus the FDIC

One was First National Bank of Englewood. Its president, John Milton Nichols, earned the nickname "100%" as a result of his move early in the depression to protect his bank and its depositors by liquidating all non-government securities and loans and replacing them with cash and U.S. government securities.

By 1935, the bank's holdings of cash and government securities equaled 101% of total deposits.

Nichols saw little and for the new deposit insurance system, and began to fight the FDIC.

When temporary deposit insurance was begun in 1934, Nichols' bank was the only one of the 6,000 banks required to subscribe to federal deposit insurance that refused to join the FDIC.

Refuses to Pay

FDIC general manager L.E. Birdzell wrote to Nichols, telling him to send the premium immediately. Nichols refused to pay until he received a written response from comptroller of the currency J.F.T. O'Connor about the penalty for a refusal to join.

In late January, Nichols received a letter from O'Connor stating that he must comply by July 1, 1934.

Nichols continued his battle past the July 1 deadline, calling the FDIC a "damnable piece of political trickery" designed to bring about government ownership of all banks.

In a July 18 letter, Nichols lectured the head of the permanent FDIC, Leo Crowley, on the principles of sound banking. He said, "Within three hours time I could sell our securities and transport to our own vaults far more than enough cash to pay every depositor in full. Where is there a bank that can do any better?

"Tearing into sound banking institutions and supporting the weak ones can have but one ending."

Tripping to Utopia

After the passage of the Banking Act of 1935, O'Connor again warned Nichols that he must join the permanent fund. Nichols held out until September, when he relented and joined the FDIC, though he did not end his protest.

Nichols responded to Crowley, "After having forced the dictators of America to rewrite their law definitely setting forth each bank's contingent liability in connection with the FDIC, I suppose we should let bygones be bygones and link arms with the rest of the boys who are merrily tripping their own way down the path to Utopia, with emphasis on the tripping."

As a result of the costs imposed by the deposit insurance program, Nichols had already asked depositors with less than $3,000 to withdraw their funds and had declined to open new accounts.

Beginning Dec. 15, 1935, Nichols assessed all accounts exceeding $109 a 75-cent fee for each $1,000 on deposit to pay for the insurance. Nichols said the fee would bring home to the depositor "just one more phase of the misdeal."

Nichols continued to operate on the 100% reserve principle throughout the 1930s. However, after nominal interest rates on government securities fell below 1%, Nichols announced that the bank would cease paying interest on more than $2 million in savings accounts beginning Jan. 1, 1941.

He told his depositors that the bank's directors felt that lending to the private sector would not be profitable and that the only alternative was to purchase direct obligations of the United States government.

By June 1941, the bank that had once held more than $6 million in deposits held only $48,000. It was voluntarily liquidated in August 1941, with Nichols giving as a primary reason that he did not wish to be forced to make loans to the government.

Nichols' story is an important lesson for today when, faced with increased regulations, banks are shifting into government securities and reducing private sector loans. Faced with increased costs, banks are making a reasonable decision, but the practice raises the question of the future of commercial banks.

While banks may be making a marginal shift into government securities, this is not likely to substantially erase regulatory burdens, create a growing industry, or produce banks as safe as Nichols' bank.

Some would argue that in the present environment, a better alternative would be a complete shift toward narrow banking, which would eliminate the need for deposit insurance by fully protecting depositors through the holding of sound assets - the system envisioned by Nichols.

Furthermore, narrow banking would allow bankers to conduct lending and other operations through uninsured affiliate organizations which would be free from regulatory burdens and could therefore be competitive with other lending institutions.

A narrow banking system would not only protect depositors, but also create a way for bankers to compete in other areas without being hindered by regulatory burdens.

Policy Challenge

The lesson provided by Nichols' experience is that, under extraordinary conditions, bankers will take measures to remain in business and protect their depositors.

The challenge for policy makers is to provide a regulatory climate that is mutually beneficial for the banks and the public.

Nichols reacted by holding only sound assets and felt that the government policy response was wrong.

The question that remains is whether we will have reasonable reform or continue, as Nichols observed over 50 years ago, "merrily tripping along our way down the path to Utopia" with an arrival that will prove, as Nichols would have predicted, to be C.O.D.

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