Academic journal article Atlantic Economic Journal

Implications of the Dual Banking System in the US

Academic journal article Atlantic Economic Journal

Implications of the Dual Banking System in the US

Article excerpt


Prior to the National Bank Act of 1864, commercial banks were organized under charters granted by state legislatures. With the National Bank Act, federally chartered banks were introduced. Since then, banks in the U.S. have two charter options. The first option is to get a federal charter. A federally chartered bank is regulated by the Office of the Comptroller of the Currency (OCC) and complies with federal laws. The second option is to get a state charter. A state-chartered bank obeys state laws and is regulated by state supervisors. It may choose to be a member of the Fed or the Federal Deposit Insurance Corporation (FDIC), which would become its primary federal regulator. The "dual banking system" refers to these parallel state and federal banking systems that co-exist in the U.S.

In the beginning, there were significant regulatory differences between state and federal banks such as differences in their lending limits, their ability to branch interstate and the list of activities that they were permitted to take. Over time, these regulatory differences have mostly disappeared with two exceptions. First, national banks are held exempt from certain state laws to establish uniform national standards. For instance, until the 1994 Riegle-Neal Act, a national bank was able to charge its out-of-state credit card customers an interest rate on unpaid balances allowed by its home state, notwithstanding that the rate was impermissible in the state of the bank's customers. Another example is that the U.S. Supreme Court authorized insurance agent activities in small towns for national banks and this preempted Florida insurance laws that would otherwise prohibit a national bank from selling insurance in a small town. Comizio and Lee (2011) analyze implications of these types of exemptions and finds that exemptions provided a distinct charter advantage to national banks. Consequently, state banks operating on an interstate basis began to convert to federal banking charters.

The second difference between state and federal charters that has not disappeared is the way the budget of their regulators is determined. State-chartered banks pay an assessment fee for supervision "only" to their state without paying fees directly to the FDIC or the Fed. The FDIC and Fed have other income resources. In contrast, the OCC relies almost entirely on supervisory assessments for its funding needs. Blair and Kushmeider (2006) show that for banks of comparable asset size, operating with a national charter generally entails a greater supervisory cost for banks than operating with a state charter. Rosen (2003) suggests that this difference in budgeting mechanisms might influence how a bank is treated. The implication is that expensive regulators might treat their customers better.

This paper focuses on other implications of these differences between state and federal banks that have not been analyzed by the literature before. It first looks at how these remaining differences could influence the way state and federal banks were managed. For this purpose, the paper analyzes their risk and return behaviors as well as funding choices and activity mixes. Since banks play a central role in monetary transmission mechanism, differences between state and federal banks could also influence how they respond to monetary policy changes. In the second part of the empirical section, the paper focuses on the implications of these differences on the credit channel of monetary policy.

Literature Review

The empirical literature has studied some of the consequences of having multiple regulators in the banking sector. Rosen (2003) looks at whether switching among the FDIC, Fed and OCC is beneficial for U.S. banks. They find that bank returns' rise and failure rates remain unchanged for banks that switched their regulators. Rezende (2011) examines switches among three regulators and looks at whether commercial banks improve their supervisory ratings by switching regulators. …

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