Banks can be chartered by either federal or state authorities. Why do we have a dual banking system today? Alan Greenspan discussed this topic in a 1998 speech.
He starts from the chartered banking era from 1781-1838, and I’ll follow his comments through the National Banking Act of 1864, though his remarks go beyond that point. The National Banking Act, which came in two parts, created federal competition to state chartered banks, introduced a national currency, and placed a tax on currency issued by state banks. It is not entirely clear if the intent of was to drive state banks out of business, but if that was the intent it was a failure. State banks responded by specializing in demand deposits (checking accounts) and they persist and remain strong to this day. Here are Greenspan’s remarks followed by recent remarks from Richard Fisher, president of the Dallas Fed, who discusses why we have allowed dual banking to persist as well as some peculiarities about dual banking history in Texas. Texas is interesting because it did not allow state banking as early as other states and it, along with a few other western states, had stringent restrictions on branching:
Chartered Banking (1781-1838): At the very beginning of our banking history, American banks ... were ... supervised by the market. But--in contrast to other countries--our banking system evolved the dual structure that so distinguishes our country from others. Those seeking to circulate bank notes in the United States in our earliest days usually sought a ... charter ... almost solely at the state level. Entry into the banking business was far from free. Indeed, by the early 1800s chartering decisions by state authorities became heavily influenced by political considerations. ... The regulation and supervision of early American banks were modest and appear to have been intended primarily to ensure that banks had adequate specie reserves to meet their debt obligations, especially obligations on their circulating notes...
Free Banking (1837-1863): The ... intense political controversy over the charter renewal of the Second Bank of the United States, and the wave of bank failures following the panic of 1837 led many states to reconsider their fundamental approach to banking regulation. In particular, in 1838 New York introduced a new approach, known as free banking, which in the following two decades was emulated by many other states. ... The perception of the free banking era as an era of "wildcat" banking marked by financial instability and, in particular, by widespread significant losses to noteholders also turns out to be exaggerated. ... Nonetheless, it is fairly clear that the strength of banks varied from state to state, with regulation and supervision uneven.
As a consequence mainly of the panic of 1837, the public became aware of the possibility that banks could prove unable to redeem their notes and changed their behavior accordingly. Discounting of bank notes became widespread. Indeed, between 1838 and the Civil War quite a few note brokers began to publish monthly or biweekly periodicals, called bank note reporters, that listed prevailing discounts on thousands of individual banks...
National Banking (1863-1913): During the Civil War, today's bank structure was created by the Congress. It seems clear that a major, if not the major, motivation of the National Bank Act of 1863 was to assist in the financing of the Civil War. But the provisions of the act that incorporated key elements of free banking provide compelling evidence that contemporary observers did not regard free banking as a failure. These provisions included free entry and collateralized bank notes. The 1863 act introduced competition to state banks, but in 1864, the Congress adopted an important amendment which called for taxing the issuance of state bank notes. It is not clear if the intention was to assure only one kind of currency or to force the states out of the banking business. But whatever its purpose, with the tax on notes the number of state banks fell from about 1,500 in 1864 to 250 by the end of the decade.
Any forecast at that time would quite reasonably have concluded that state banks would become historic relics. Such a projection, however, would have been quite wrong... Forced to find a substitute for notes, state banks pioneered demand deposits. Within ten years after the note tax, state banks had more deposits than national banks--a lead maintained, I might add, until 1943. By 1888, only 20 years after the low point, there were more state banks than national banks (approximately 3,500 vs. 3,100), a lead maintained to this day...
But why have we allowed dual banking to persist? Here's Richard Fisher, president of the Dallas Fed, on that question as well as some specifics on dual banking in Texas:
...America’s dual banking system dates back to the National Bank Act of 1864, which gave the country national banks alongside existing state-chartered banks. Texas had to wait a bit longer for a dual banking system. ...[T]he 1845 state constitution specified that “no corporate body shall hereafter be created, renewed or extended with banking or discounting privileges.” This provision remained in the 1876 constitution, so for decades Texans had access only to nationally chartered banks and private banks. It was not until a constitutional amendment was approved in November 1904 that state banks came into existence in Texas... Today, the state-chartered banking system is competitive and strong. As of June 30, 330 of the 637 Texas banks had state charters. In the past three years, 13 of the 23 newly chartered commercial banks—or 57 percent—chose state charters. The dual banking system provides ... for decentralization of authority. As Chairman Greenspan has said, banks’ freedom to choose their regulator is a key protection from the potential for unreasonable regulatory behavior. The doctrine of choice creates a healthy dynamic among regulators. Under the dual banking system, state-chartered banks have fostered many innovations, resulting in an ever-widening array of products and services. State banks pioneered demand deposits, and a state-chartered bank introduced the NOW account. The first banks to offer variable-rate mortgages and home-equity loans came under state regulation...
So, he gives two reasons for dual banking, one perhaps a consequence of the other. First, it promotes competition among regulators which avoids unreasonable and excessive regulation. Second, by having competition in the banking system (here’s an example) and the additional freedom that dual regulation allows, financial innovation has been implemented in large part by state banks, and that has helped develop the financial services industry.
