A Brief History of U.S.

Banking Regulation
Since the earliest days of the nation, it has been a controversial issue

By MATTHEW JOHNSTON

Updated October 06, 2021

Reviewed by
MICHAEL J BOYLE
Fact checked by
SUZANNE KVILHAUG
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Alexander Hamilton once observed, "Most commercial nations have found it

necessary to institute banks, and they have proved to be the happiest
engines that ever were invented for advancing trade."1

Since Hamilton's day, the United States has grown into the largest economy
in the world.2 That growth has been accompanied by ever-evolving banking
regulation, which has swung like a pendulum over the past three centuries
between greater and lesser control. Competing forces like the desire for
financial stability versus more economic freedom, or the fear that too much
power is concentrated in too few hands, have kept the pendulum swinging
back and forth.

Here is a brief history of banking regulation in the U.S.

KEY TAKEAWAYS

 As the U.S. evolved into the world's largest economy, its regulatory
framework has evolved as well.
 Early regulations aimed to foster economic financial stability through
centralized control of the banking system. Opponents, however,
maintained that such regulatory authority gave the federal government
too much power in comparison to the states.
 In the years following the Civil War, an assortment of financial crises
and bank panics led to new regulations. The Great Depression of the
1930s also gave rise to significant reforms.
 The 1980s saw a move toward deregulation, soon followed by re-
regulation in the wake of the subprime mortgage crisis and the Great
Recession of the early 2000s.
Investopedia / Sabrina Jiang

The First and Second Banks of the United States

The First Bank of the United States was established in 1791. Although it
helped bring a degree of economic stability to the young nation, many feared
that it gave undue powers to the federal government and considered it
unconstitutional. As a result, its charter was not renewed in 1811.

The U.S. government turned to state banks to finance the War of 1812, but
with the significant over-expansion of credit that followed, it became apparent
that financial order needed to be restored.3 In response, the Second Bank of
the United States was chartered in 1816. It, too, would succumb to political
fears over the amount of control it gave the federal government and it was
dissolved in 1836.4

The End of Charters, the Rise of Free Banking

Obtaining an official legislative charter was highly political at both the federal
and state levels, depending more on political connections than proven
competence in financial matters. The bribing of legislators was fairly common.

By the time the Second Bank dissolved, a new era of free banking was
emerging, with a number of states passing laws in 1837 that abolished the
requirement that banks obtain an officially legislated charter to operate.5 By
1860, a majority of states had passed such laws.

During this time of free banking, anyone could operate a bank on the
condition that all the notes it issued were backed by proper security. While
that helped reinforce the credibility of banknotes, it did not guarantee
immediate redemption in specie (gold or silver), which would serve to be a
crucial point.

The era of free banking suffered from financial instability, including several
banking crises. It also made for a chaotic currency market, characterized by
thousands of different banknotes circulating at varying discount rates. This
instability and disorder led to a renewed call for more regulation and central
oversight in the 1860s.

From the Civil War to the New Deal

The free banking era, characterized as it was by a complete lack of federal
control and regulation, ended with the National Banking Act of 1863 (and its
later revisions in 1864 and 1865), which aimed to replace the old state banks
with nationally chartered ones. The Office of the Comptroller of the Currency
(OCC) was created to issue these new bank charters as well as see to it that
national banks maintained the requirement to back all their notes with
holdings of U.S. government securities.6

The new national banking system helped return the country to a more uniform
and secure currency but ultimately at the expense of an elastic currency that
could expand and contract according to commercial and industrial needs. The
growing complexity of the U.S. economy highlighted the inadequacy of an
inelastic currency, which helped fuel frequent financial panics throughout the
rest of the nineteenth century.7

It became apparent during the bank panic of 1907 that America's banking
system was out of date. A committee gathered in 1912 to examine the
situation and found that the nation's money and credit were becoming
increasingly concentrated in the hands of relatively few men. The Federal
Reserve Act of 1913 was approved during the presidency of Woodrow Wilson
to wrest control of the nation's finances from banks while creating a
mechanism to enable a more elastic currency and greater supervision over
the banking infrastructure.8

Although the newly established Federal Reserve improved the nation's

payments system and created a more flexible currency, the country soon
faced another financial crisis, exacerbated by the 1929 stock market
crash and banking panics in 1930 and 1931.

The Great Depression, which began in 1929 and continued, by some

measures, until 1941, led to new regulations instituted by President Franklin
D. Roosevelt as part of his administration's New Deal. The Glass-Steagall
Act of 1933 created the Federal Deposit Insurance Corporation (FDIC) , which
implemented the regulation of deposit interest rates while
separating commercial banking and investment banking. The Banking Act of
1935 served to give the Federal Reserve, also called the Fed, more
centralized power.9

1980s Banking Deregulation

The period following the banking reforms of the New Deal up until about 1980
was marked by a relative degree of banking stability and economic
expansion. Still, critics argued that regulation also made American banks less
innovative and competitive than they were previously. The heavily regulated
commercial banks were losing increasing market share to less-regulated and
more innovative institutions. This led to a wave of deregulation throughout the
last two decades of the 20th century. Those changes included:

 Congress passed the Depository Institutions Deregulation and

Monetary Control Act in 1980, which served to deregulate financial
institutions that accept deposits while strengthening the Fed's control
over monetary policy.1011
 Restrictions on the opening of bank branches in different states that
had been in place since the McFadden Act of 1927 were removed
under the Riegle-Neal Interstate Banking and Branching Efficiency Act
of 1994.12
 The Gramm-Leach-Bliley Act of 1999 repealed significant aspects of
the Glass-Steagall Act as well as the Bank Holding Act of 1956, both of
which had served to sever investment banking and insurance services
from commercial banking.13 From 1999 onward, banks could now offer
commercial banking, securities, and insurance services under one
roof.

These moves helped to accelerate a trend toward greater consolidation and

conglomeration in the banking sector, with more than 4,300 bank mergers in
the 1980s and more than 6,000 in the 1990s.14

As banks became bigger, their financial services and products became more
complex. Banks started to offer new products like derivatives. They also
started packaging traditional financial assets like mortgages and selling them
to investors through the process of securitization.

Banking Regulation Following the Global Financial

Crisis of 2008
The subprime mortgage meltdown beginning in 2007, the ensuing global
financial crisis, and the need to bail out banks deemed "too big to fail" caused
the government to rethink the financial regulatory framework. In response to
the crisis, Congress passed the Dodd-Frank Wall Street Reform and
Consumer Protection Act in 2010.15
Some of Dodd-Frank's protections were rolled back under the Trump
administration in 2018. In particular, the new rules loosened restrictions on
institutions with under $250 billion in assets and eliminated the need for them
to pass stress tests.16

Then, in 2021, the newly arrived Biden administration signaled its intention to
tighten the government's oversight of banks. A July 2021 executive order on
promoting competition in the American economy called for greater scrutiny of
bank mergers by the Department of Justice and federal banking regulators.
"Excessive consolidation," the order explained, "raises costs for consumers,
restricts credit for small businesses, and harms low-income communities."17

What Is a Central Bank?

A central bank is a public financial institution responsible for overseeing a
nation's monetary system. The central bank of the United States is the
Federal Reserve System, which describes its mission as carrying out "the
nation's monetary policy guided by the goals set forth in the Federal Reserve
Act, namely 'to promote effectively the goals of maximum employment, stable
prices, and moderate long-term interest rates.'"18

What Is a National Bank?

National banks in the United States are financial institutions that are
chartered by the U.S. Treasury and members of the Federal Reserve
System. Examples include Bank of America, Chase Bank, Citibank, PNC
Bank, U.S. Bank, and Wells Fargo.

What Is the Dodd-Frank Act?

The Dodd-Frank Act of 2010, more formally known as the Dodd-Frank Wall
Street Reform and Consumer Protection Act , is a major set of financial
reforms enacted in the wake of the Great Recession of 2007 to 2009. Among
other provisions, it clamped down on speculative trading by banks, increased
government oversight of the banking sector, and gave the government the
power to liquidate ailing banks. It also created the Consumer Financial
Protection Bureau.

The Bottom Line

Since the founding of the United States, there have been numerous attempts
to centralize the control and regulation of the country's banking system. Prior
to the Civil War of the 1860s, fears of concentrated power and political
corruption served to undermine such attempts. But as the banking system
grew, the need for greater regulation and federal control became more widely
accepted. That led to the creation of a nationalized banking system during the
Civil War, the creation of the Federal Reserve in 1913, and the New Deal
reforms of the 1930s and 1940s.

While more regulation led to a long period of financial stability, banks began
losing business to more innovative financial institutions, resulting in a move
toward deregulation in the 1980s and 1990s. But it wasn't long before the
mortgage meltdown of 2007 and the most severe economic crisis since the
Great Depression led to a call for re-regulation and to the passage of the
Dodd-Frank financial reforms of 2010. The Trump administration rolled back
some of those rules, but much of Dodd-Frank remains in place and the Biden
administration has indicated its desire to restore and tighten bank regulations,
particularly with regard to mergers.

If history is any guide, the story is far from over and the regulation pendulum
will continue to swing.