The Dual Banking System Is Alive and Well

Few fields of law are as heavily influenced by history than that dealing with banks and other financial institutions. Since the earliest days of the Republic, this country has had a dual or overlapping system of state and federal chartering and regulation of banks, and while there may be those who wonder why this odd method of establishing banks remains important, it is my belief that it is essential if we are to maintain a healthy balance between states’ rights and federalism.

In 1781, shortly after Cornwallis’ surrender at Yorktown, the Continental Congress established the Bank of North America under a national charter in an attempt to deal with the financial problems surrounding the recently ended hostilities with England. In 1782, however, the Bank of North America was re-incorporated under a Pennsylvania charter and became just one of several state banks that were established following the Revolutionary War.

In 1790, Secretary of Treasury Alexander Hamilton submitted a report to Congress titled “Report on a National Bank” that called for the establishment of a national bank that could help create a strong and prosperous nation and augment the productive use of capital of this emerging nation. Without boring you with the intricacies of how the new national bank was established (as I do with my law school classes) and the political fights that ensued between Hamilton and Thomas Jefferson over the establishment of a national bank (Jefferson contended that since the Constitution did not specifically call for the establishment of national banks, none could be formed), suffice it to say that the Bank of the United States was established and operated as a central bank until its charter expired 20 years later. Following the expiration of the bank’s charter (something that does not occur today, of course), the bank’s operations were taken over by a private banker named Stephen Girard who operated the bank as a private banking firm in the same building and with the same staff. During this time, other entrepreneurs opened more state banks and commercial loans more than doubled between 1811 and 1816.

The War of 1812 damaged the banking system significantly, and again, without belaboring the entire history of banking in the early years of the Republic, The Second Bank of the United States was formed in 1816. However, the directors of the Second Bank were not competent, and all types of financial fraud, including insider loans (remember those from the Jake and C. H. Butcher days?) plagued the industry.

In a case that reached the United States Supreme Court, McCulloch v Maryland, Chief Justice Marshall sustained Congress’ power to charter a bank and denied Maryland’s efforts to tax national banks. This decision is best known today for its sweeping interpretation of the federal commerce power, but it is equally important to banking as a practical matter: if a state could tax a national bank, then the bank could not survive as a national institution. It is this interpretation that stands as the hallmark of the Comptroller of the Currency’s assertion that the OCC has exclusive power to dictate the way national banks will be operated.

From McCulloch through today, there have been both state and national banks, and while the historical reasons for the dual banking system may seem cloudy, the reality is that the system of permitting both the federal and the various state governments to charter and regulate banks serves a vital purpose. The dual banking system provides for a system of checks and balances that keeps one regulator or the other from running amuck and either over-regulating or under-regulating banking. While I was with state government from 1983 to 1995, we worried constantly that Congress would merge the federal banking agencies into one super regulator and that this combined agency would not have any incentive toward reasonableness. Imagine an agency that combined the FDIC, the OCC, the Federal Reserve, and the Office of Thrift Supervision (the OTS), and you would have an agency that could do as it pleased without any give and take. While the Dodd-Frank Act did merge the OCC and the OTS, placing national banks and federal thrifts under one regulator, efforts to otherwise consolidate the regulatory agencies have not been successful. The reason for supporting the dual banking system, despite the Department of the Treasury’s recent efforts to do away with state banking departments, should be clear. To effect reasonable regulation, agencies should argue and cajole and compromise until, at last, the end result is something that all can support. Much like Congress and the General Assembly that survive on compromise, the federal banking agencies are stronger apart than they would be together because they are forced to study the issues in collaboration before they come out with an inter-agency directive.

The Conference of State Bank Supervisors, the professional association of state banking commissioners, likes to call state banks “laboratories for change.” State legislatures can generally act faster on issues than can Congress because they are affecting only that state’s interest and not the national interest. States can try new things, can permit banks to explore new avenues for expanded products and services. Without the state banking system, some of the changes in banking over the years would not have occurred — or would have taken years to implement — because when one state sees that something works, it implements the change for the benefit of its banks and their customers.

Banks enjoy the freedom of choosing their regulators. A group of organizers of a bank to be located in Tennessee can choose to form a national bank and be regulated by the OCC, and they won’t see another regulator unless they also form a holding company (then the Federal Reserve comes into the picture) or suffer severe problems that mandate the intrusion of the FDIC into their lives. In the alternative, they can form a Tennessee-chartered bank and select either the FDIC or the Federal Reserve as their primary federal regulator. Why would a bank choose a state charter over a national charter if it means that it has to deal with two regulators rather than one? Proponents of the state system tout lower costs of regulation and proximity of the regulator as the primary advantages. It is simply easier to call up the commissioner of financial institutions (a lawyer by training who will give you his direct dial number and e-mail address) and get a meeting with him and/or his staff on very short notice, than it is to get an audience with the comptroller of the currency.

There are no substantive differences between state and federal regulation. Both regulators generally enforce the same rules and regulations, and a safe and sound bank will be safe and sound under either system. It is all about giving businesses choices and providing those laboratories for change that have made the banking system in this country the finest in the world — despite the problems of the last few years. Those of us who have practiced in this arena for decades know that “this, too, shall pass,” and that as the economy gains steam, borrowers will again be able to repay their loans, and banks will stop failing. At this writing, no Tennessee bank has failed in this economic downturn, but even if we have some failures eventually, the system remains strong, especially as compared to Georgia, California, Florida, Nevada, and other states hardest hit by the vagaries of the recession.

I have formed both state and national banks and have both as clients. There is a place in this economy for banks like Bank of America, a national bank, that chooses to do business on a national scale and prefer one regulator, and a place for community banks like Traditions First Bank in Erin, Tenn., that effectively serves customers in a much smaller area (its president is a lawyer, by the way!).

If your clients ask you whether it’s better to do business with a state bank or a national bank, you can say with confidence that it doesn’t much matter. All deposits are safe up to $250,000 in any bank. All banks have the same powers, and with technological advances, even the smallest banks can offer sophisticated services. Larger banks with more capital can make larger loans, but that has nothing to do with which agencies regulate the bank.

Do business with banks that hold your IOLTA accounts without moaning about it; that give you great service; whose tellers don’t change every day or so; and that won’t let you get too leveraged for your own good.

So speaketh the Bank Lady.


Kathryn Reed Edge KATHRYN REED EDGE is a member of Miller & Martin PLLC, a regional law firm with offices in Nashville, Chattanooga and Atlanta. She heads the firm’s Commercial Department and concentrates her practice in representing financial institutions. She is a past president of the Tennessee Bar Association.