ABC's of Banking

Provided by the State of Connecticut, Department of Banking, based on information from the Conference of State Bank Supervisors (CSBS) 

Banks and their Regulators

Bank regulation, or supervision, involves four federal agencies and fifty state agencies. At first glance this regulatory scheme seems hopelessly complicated, but it's not that hard to understand once you know what each agency does.

State and Federal Charters

You may have seen or heard the term "dual banking system." This refers to the fact that both states and the federal government issue bank charters for the need and convenience of their citizens. The Office of the Comptroller of the Currency (OCC) charters national banks; the state banking departments charter state banks. In addition, the Office of Thrift Supervision (OTS) chartered federal savings banks and savings associations.  The OTS merged into the OCC in July 2011, effectively changing supervision of these entities to the OCC.  The words "national," "federal" or "state" in a institution's name have nothing to do with where it operates; rather they refer to the type of charter the bank holds.

Chartering agencies ensure that new banks have the necessary capital and management expertise to meet the public's financial needs. The charterer is an institution's primary regulator, with front-line duty to protect the public from unsafe and unsound banking practices. Chartering agencies conduct on-site examinations to assess banks' condition and monitor compliance with banking laws. They issue regulations, take enforcement actions and close banks if they fail.

The Deposit Insurer

The Federal Deposit Insurance Corporation (FDIC) insures the deposits of banks up to a maximum of $250,000 per account holder. (Find more deposit insurance information at the FDIC website). All states require newly-chartered state banks to join the FDIC before they can accept deposits from the public. Under the 1991 Federal Deposit Insurance Corporation Improvement Act (FDICIA), both state-chartered and national banks must apply to the FDIC for deposit insurance; previously, national banks had received insurance automatically with their new charters.

The FDIC is the federal regulator of the approximately 5,000 state-chartered banks that do not belong to the Federal Reserve System. It cooperates with state banking departments to supervise and examine these banks, and has considerable authority to intervene to prevent unsafe and unsound banking practices. The FDIC also has backup examination and regulatory authority over national and Fed-member banks.

The FDIC deals with failed institutions by either liquidating them or selling the institutions to redeem insured deposits.

The Central Bank

The Federal Reserve System ("the Fed") controls the flow of money in and out of banks by raising or lowering its requirements for bank reserves and by buying and selling federal securities. It lends money to banks at low interest rates (the "discount rate") to help banks meet their short-term liquidity needs, and is known as the "lender of last resort" for banks experiencing liquidity crises. Together, the FDIC and the Federal Reserve form the federal safety net that protects depositors when banks fail.

Membership in the Federal Reserve System is required for national banks and is optional for state banks. While many large state banks have become Fed members, most state banks have chosen not to join. The Federal Reserve is the federal regulator of about 1,000 state-chartered member banks, and cooperates with state bank regulators to supervise these institutions.

The Federal Reserve also regulates all bank holding companies. Its regulatory focus is not so much on the banks within a holding company as on the umbrella structure of the holding company itself. Holding companies must apply to the Federal Reserve to acquire new subsidiaries or to engage in new activities. The Fed monitors the capital condition and general financial health of holding companies, and may take enforcement actions against them. The Federal Reserve is also responsible for federal oversight of foreign banks operating in the United States.

How Did We Get So Many Regulators?

Many people have said that we would never design our current regulatory system as it is if we were starting from scratch. But our current system has evolved with the country, and has changed with the country's needs.

The states were the first to charter banks in the United States. The Federal government chartered the First and Second Banks of the United States in the early 19th century. These were the first national banks, and they performed functions similar to today's Federal Reserve System. From 1837, when the Second Bank's charter expired, to 1863, there were no national banks and no federal regulators.

The National Bank Act of 1863 created the Office of the Comptroller of the Currency, and authorized it to charter national banks. The original purpose of both the OCC and national banks was to circulate a universal currency, thus making tax collection easier and helping to finance the Civil War. The dual banking system took shape in the late 19th century, as states reformed their chartering policies and regulatory systems in response to the National Bank Act.

A series of money shortages early in the 20th century made it clear that the country needed some central authority to monitor and control the money supply. The Federal Reserve Act of 1913 established this authority through a network of twelve Federal Reserve Banks, overseen by a Board of Governors. The Federal Reserve System had regulatory authority over all its member banks; this was the first time a federal agency had direct authority over state-chartered banks, although state bank membership in the Federal Reserve was voluntary.

The FDIC was created by the Banking Act of 1933, in response to the avalanche of bank failures that followed the stock market crash of 1929. The FDIC originally insured deposits up to $5,000. The 1933 Banking Act required all state-chartered banks to join the Federal Reserve within a certain period of time or lose their deposit insurance, but this requirement was eventually repealed. The FDIC established its own standards for state nonmember bank acceptance into the fund.

Bank holding companies were new corporate entities that began appearing in the 1940s. The banks were all regulated, but no one regulated the holding company subsidiaries that weren't banks, and no one watched the flow of resources among affiliates within the holding company. The Bank Holding Company Act of 1956 gave the Federal Reserve regulatory responsibility for these companies, while leaving the supervision of banks within holding companies in the hands of their traditional regulators.

In 1989, the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) expanded the FDIC's supervisory and enforcement authority, and extended its responsibilities to include the thrift deposit insurance role held by the former Federal Savings and Loan Insurance Corporation (FSLIC).

Most recently, 1991's FDICIA also expanded the authority of federal regulators to intervene in troubled institutions. FDICIA also mandated specific enforcement actions for unhealthy institutions -- the first time prescribed "early intervention" provisions had been included in federal statutes.

Lesson Four: Deposit Insurance