Vol. 2002-1-2
Can the Dual Banking System Be Saved?
No feature of this country’s banking system is better known or more firmly fixed in history (or mythology) than “dual banking.” It is an arrangement unique to the United States that has now lasted for 139 years. Several years ago the Chairman of the Federal Reserve’s Board of Governors told the Senate Banking Committee that the Administration’s plan to transfer the Fed’s bank regulatory authority to an independent federal agency “would effectively end the dual banking system: It would become an empty shell if a state-chartered entity had no choice of federal regulator.” (Federal Reserve Bulletin, May 1994, p. 382). During the past year or so the Comptroller of the Currency has insisted that the present archaic procedures for financing federal bank regulation are undermining the dual banking system, telling audiences that: “A lively vigorous dual banking system should not be founded on the maintenance of a federal subsidy for state banks.” (Remarks by John D. Hawke Jr., before the Exchequer Club, Washington, DC, December 20, 2000). And when I called a friend recently – someone with extensive experience in bank regulation – to say that my next report would likely focus on dual banking, his response was: “Don’t tell me that there is anyone alive who still believes that there is a dual banking system.” Depending on the vantage points of these three commentators, the strange thing is that each statement is quite defensible!
It is my view that the dual system of banking is still very much alive but bears slight resemblance to the system established in 1863, when federal legislation authorized the chartering of national banks. I suspect that some bankers believe that it has remained unchanged since 1863. Most others know that it has changed significantly but usually are not entirely certain just how much, or why. And there are still those who speak confidently of the value of dual banking but have not a clue as to how it operates or what its future may be. (Note: “dual banking” is convenient shorthand for “state-federal dual banking,” an arrangement under which bank chartering and supervision may be done by either state or federal authorities. This is the sense in which I use it here. Later, when I describe what I see as an emerging variation, I use the term “federal dual banking” because there is no state involvement).
I did not title this report: “Should the Dual Banking System Be Saved” but, rather, “Can” it be saved, thereby revealing my assumption (or bias) that the dual system is not only valuable and worth keeping but also that it may be facing difficult times ahead. It is responsible, in large part, for this nation’s unusual banking structure, the principal feature of which is a very large number of full-service banks, the great majority of which are of small size. Banking is still largely “free” in the United States, meaning that any group of citizens is eligible to apply for a bank charter. Duality offers, among many things, alternative routes of entry into banking. Just the number of new banks chartered each year – recently about 200 per year – is more banks than can be found, in total, in some countries or even in clusters of countries.
The claim that the U.S. is “overbanked” is heard frequently, here and in other countries. If so, it has been overbanked for almost two centuries. Notwithstanding the problems attributable to overbanking, which are many, I sometimes have the heretical thought that, on balance, the energy, vitality, and competitiveness produced by our “overbanked” system may have had something to do with this nation’s remarkable economic development over two centuries. Moreover, having some slight knowledge and experience with doing banking outside of the United States, I have toyed with the equally heretical view that other nations – France, the UK, or Canada for example – have a bit to learn from the U.S. system, and in fact may suffer from being “underbanked.”
To be sure, dual banking is not without its problems. For example, bank failures are not unusual but, fortunately, are not of major significance except during unusually depressed periods. Not surprisingly, the U.S. was the pioneer among advanced nations of the world in devising an effective deposit insurance system in 1933, which has contributed significantly to financial stability, despite some bank failures. But this stability has not been purchased at the cost of giving up protection against stultifying or oppressive regulation, a hallmark of dual banking.
More broadly, dual banking has provided a vigorous, competitive system, continually refreshed with a flow of new ideas and new entrants. This report begins with a bare-bones look at what the dual banking system is today, and discusses briefly the means by which this unusual system has managed to survive for 139 years, often in the face of very serious attacks (Section I). Also noted are some recent developments that suggest the possibility of important new changes in dual banking. Section II focuses on the challenges that face dual banking and assesses their significance. Section III wraps things up, offering a few concluding observations.