Suffolk System

Dual currency problem in Boston during 1800s.
Country banks' notes are redeemed at a discount due to the cost and inability for them to redeem the notes. Merchants face trouble because they have both country banks notes and Boston bank notes that are of good quality. They have to bear the full cost of any possible fluctuation of the redemption rate changes.

But Gresham's Law didn't kick in this situation.
(1) The notes of Boston Banks didn't disappear though diminished relative to those of country banks in response to the growing reliance on demand deposits and to the increasing competition of country banks agents in Boston.
(2) The value of "bad" notes are changing and the "good" notes are redeemed constantly at par. The purchasing power of the bad notes changed constantly. There is no incentive for arbitrager to drive good notes out of circulation.

A rising preference for deposit banking tends to diminish the importance of city bank notes. The existence of large deposits in city banks restricted the ability of these institutions to increase their issuance of notes.

The fundamental plan of Suffolk System
(1) each country bank was required to maintain a permanent deposit at Suffolk Bank of 2000 bucks or more depending on their sizes, plus an added deposit sufficient to redeem all its notes that were received by the Suffolk Bank

(2) Boston banks were required only to maintain permanent deposits

(3) no interest was paid on any of these deposits

(4) in return the Suffolk Bank agreed to accept at par from depositor banks all the bank notes they received from other New England banks in good standing and to credit such deposits to the account to the depositor bank on the day following receipt.

The principal motive was the desire of Boston banks to increase their bank note circulation.

The Suffolk System increased the acceptablity of the country notes by making them acceptable at par.
 The most striking achievement of the Suffolk System for Boston was the ultimate elimination of the discount on country banknotes.

 Membership in the Suffolk System was restricted to banks whose notes could be accepted safely by the public.

Although the Suffolk could not prevent the undesirable newcomer from issuing notes, it could prevent the wayward bank notes from getting extensive circulation, by withholding membership in the Suffolk System.16 This acted as an effective safeguard when State legislatures were extremely lenient in granting bank charters and when State banking legislation was inadequate.

By requiring that members' deposits represent reserves against their notes in circulation, the Suffolk Bank centralized the reserves of the system.

There is some evidence that the Suffolk System contributed to banking stability; at least it served to avert greater disaster to New England banks during economic panics.

How, then, did a system that seemed so entrenched in 1851, collapse seven years later? This end was, to a considerable extent, due to the populous desire of country banks for over–expansion of their notes.

Within a banking system where every bank possesses the ability to issue notes which circulate as money there is a tendency for over–issue by many individual banks, leading to discounting of bank notes and a general deterioration of sound credit.

Systems of bank note clearing and redemption are a necessity for the smooth operation of relatively free banking with a gold coin standard, whether the system is privately operated as with the Suffolk System or governmentally operated as the Safety Fund System in New York.