Commercial Bank Regulation

Banking has always been a relatively regulated industry, mostly to increase the safety of deposits and to reduce bank failures. Banks and bank holding companies are regulated in the types of products they may offer (primarily financial products); the number and locations of their offices; the minimum cash reserves they must maintain; the minimum capital they must maintain; the interest rate they may pay on deposits; the amount of lending to any single borrower; and the ability to merge with other banks.

Some of the regulations date back to the earliest days of the United States,when there was widespread public fear of allowing banks to have excessive or monopolistic power. Many of the country's earliest settlers remembered having poor experiences with banks in their native countries and welcomed regulations that would prevent U.S. banks from establishing branch offices or entering into other lines of business.

Additional regulations were imposed in the mid-1930s. during the Great Depression, when the number of commercial banks dropped from 25,000 to 14,000, mostly because of bank failures. Bank safety soon became the major public-policy concern of the day. Among other things, restrictions were placed on the interest rates payable on bank deposits, the entry of new banks, bank involvement in securities activities, and on loans collateralized by securities. Federal deposit insurance was also adopted.

Bank Regulators

Commercial banks are regulated and supervised at both the federal and state levels. Unlike other types of business firms, banks require special charters from either the federal or state governments. Federally chartered banks are required to include the term "national" in their name. They are supervised by the Office of the Comptroller of the Currency, an agency established by the National Bank Act of 1863 and housed in the U.S. Treasury Department. Federally chartered banks are required to belong to the Federal Reserve System, which, as the nation's central bank, sets its monetary policy. They are also required to be members of the Federal Deposit Insurance Corporation (FDIC), which provides deposit insurance through the Bank Insurance Fund (BIF).

State-chartered banks are subject to their state's banking laws and are regulated by their state's banking agency. Because state-chartered banks may join the Federal Reserve, and almost all choose to be insured by the FDIC, they are also subject to federal regulations and supervision. In other activities banks, like other businesses, may come under both the jurisdiction of the antitrust laws, administered by the Department of Justice, and the securities regulations, administered by the Securities and Exchange Commission.

Deposit Insurance

To remain solvent, banks must meet all demands for deposit outflows in full and on time. Because bank deposits make up most of the country's money supply, and banks operate the country's payments system through their check-clearing network, bank failures may reduce a nation's money supply and interfere with the efficient operation of the payment system. That in turn can affect trade and income within a community. In addition, the fear that a bank may be insolvent and thus not able to reimburse depositors in full may cause depositors at neighboring banks to doubt the financial solvency of their institutions and start withdrawing deposits in massive bank runs. The loss of deposits not only reduces the money supply but also forces banks to sell assets quickly to meet the demands, which further increases the likelihood of failure. Thus, failures may spill over from one bank to another.

Bank Failures

The United States has suffered periodic bouts of bank failures throughout its history, culminating in the major banking crisis of the early 1930s, when nearly 40 % of the nation's banks failed. In his first official act in office in March 1933, President Franklin D. Roosevelt closed all the nation's banks for at least one week until the banks could prove they were economically viable. To prevent more bank failures, as well as discourage depositors from running on banks to withdraw funds, Congress in 1933 established a system of federal deposit insurance for ensuring depositors in an amount of up to $2,500 per account. Accounts are now covered up to $100,000.

Deposit insurance has been highly succession at preventing bank runs and collapses of the money supply. But by reducing the concern of depositors, it has added an element of risk by indirectly encouraging banks to invest in riskier assets and operate with lower capital. During the 1980s such "moral hazard" behavior within the banking industry created major financial problems for the industry, as well as for the nation.

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