The United States Banking System

The United States Banking System

The United States banking system differs from other countries central banks. For reason that, the United States has more banks per-capita, and the banks possess fewer assets because the U.S. government imposed strict regulations. Early in the United States history, the public and government feared big banks, so state and federal governments passed regulations that forced banks to be smaller and encouraged a large number of banks to form. The United States, furthermore, has a dual banking system. A bank chooses a charter from a state government or from the U.S. federal government. A charter is a document that legally establishes a corporation and allows a financial institution to participate in banking activities. A national bank receives a charter from the federal government, while a state bank receives a charter from a state government.

If a bank receives a charter from the federal government, then three government agencies can regulate that bank, which are:

-Comptroller of the Currency, an office in the U.S. Treasury Department, regulates national banks. This office also grants charters on behalf of the U.S. federal government, and it requires national banks to be members of the Federal Reserve and Federal Deposit Insurance Corporation. As of 2010, the United States had roughly 1,500 national banks and 50 foreign national banks.

-Federal Deposit Insurance Corporation (FDIC) insures deposits at member banks. If this agency insures, then it also regulates. As of 2009, the FDIC had 8,195 member banks.

-Federal Reserve System (Fed) is the central bank of the United States and the lender of the last resort. When a bank encounters financial difficulties and cannot receive a loan from other financial institutions, then the bank can ask the Fed for a loan. Moreover, the Fed regulates banks.

A state-chartered bank could have fewer regulations. A state government agency regulates its state banks, and many states require their banks to join the Fed and/or FDIC. Therefore, a state bank could have one or more regulatory agencies to deal with. U.S. government imposed another restriction upon the U.S. banking industry – the McFadden Act.

The McFadden Act prohibited a commercial bank from opening a branch in another state. This law put national and state banks on equal footing and helped foster competition. However, this law kept small inefficient banks in business, causing the United States to have the largest number of banks in the world. The United States had 14,217 banks in 1986, which fell to 9,459 banks by 2010.

Some states imposed more restrictions upon their banks than other states. For example, some states had imposed unit banking that restricted a bank to one geographic location. Unit banking restricts a bank to a single geographical location, such as in one city, and the bank cannot branch to other cities. Currently, no states enforce unit banking. Furthermore, branch banking allows a bank to have two or more banking offices owned by a single banking corporation within a geographical area. Geographic area can be a city, county, or statewide.

Currently, 45 states allow statewide branch banking. Different institutions evolved in the United States that differ from commercial banks. They include savings institutions and credit unions, and they are not commercial banks. Thus, they have their own regulatory agencies. These institutions either have a charter from the federal government or a state government. The Federal Home Loan Bank System (FHLBS) is a U.S. government agency similar to the Federal Reserve. The FHLBS regulates nearly 8,000 savings institutions. Moreover, the FDIC insures deposits at savings institutions. Most credit unions have charters from the National Credit Union Administration, which issues charters on the federal government’s behalf. This agency also insures the deposits at credit unions while the FDIC does not.

Why did U.S. and state government propagate such a complex system?

Financial sector is an extremely important sector of the economy, and every country around the world regulates its financial markets. Government uses six reasons to regulate a banking system and its financial markets, which include:

Reason 1: Governments want the financial system to be stable. Banks contribute to a nation’s money supply. A wave of bank failures could trigger a large contraction in the money supply, shrinking the economy and triggering a severe recession. Many economists believe the Great Depression would not be severe if a wave of bank failures had not swept across the country.

Reason 2: Money supply and financial markets are intertwined. If the central bank uses the money supply to influence the inflation, business cycle, or interest rates, the central bank also affects the financial markets. Consequently, central banks need government regulations to control monetary policy effectively and help achieve low inflation and low unemployment.

Reason 3: The U. S. government wants to promote efficiency in the financial inter mediation process.

Reason 4: The U.S. government wants to provide low-cost financing for home buyers. This desire led to the U.S. Housing Bubble that occurred between 1997 and 2007.

Reason 5: Financial markets depend on accurate information. Governments ensure borrowers provide accurate information to investors. In the United States, the Securities and Exchange Commission (SEC) requires publicly traded companies (i.e. a company sells stock to the public) to disclose financial information based on acceptable accounting standards.

Reason 6: The U.S. government wants to protect consumers. Financial system, such as a bank can be very complicated. Many depositors do not understand the financial instruments, and therefore, they are not able to gauge the soundness of the institution or make rational decisions. In a competitive market like TVs, DVDs, computers, and cell phones, the consumers can easily evaluate and compare different products.