Dual Banking System: Meaning, History, Pros and Cons

What Is a Dual Banking System?

A dual banking system is the type that exists in the United States, in which state banks and national banks are chartered and supervised at different levels of government.

Under the U.S. dual banking system, national banks are chartered and regulated under federal law and supervised by federal agencies. State banks are chartered and regulated under state laws and supervised by their respective states’ banking departments. The dual system is not perfectly clear-cut, however, with some state banks answering to regulators on both levels.

History of the Dual Banking System

The dual banking system in the U.S. was born during the Civil War era. President Abraham Lincoln’s Treasury secretary, Salmon P. Chase, led the effort to create the National Bank Act of 1863, with its main objective to raise money for the North to defeat the South. This had to be done via the issuance of a common currency at the national level. Up to that point, state banknotes were in circulation.

The 1863 Act created competition to state banks, and legislators went a step further the next year by passing an amendment to tax the issuance of state banknotes. The number of state banks dropped dramatically, but a key innovation by state banks—demand deposits, which allowed depositors to withdraw their money anytime—led to a strong comeback in the number of state banks. Within 10 years of the 1864 amendment to tax state banknotes, state banks claimed more customer deposits than national banks.

The law that launched the modern dual banking system is generally considered to be the 1913 Federal Reserve Act, in which Congress created the Federal Reserve System to serve as the central bank of the United States and guide the nation’s monetary policy.

The Dual Banking System Today

Today, all 50 states, plus the District of Columbia, have their own bank regulators.

National banks are regulated by the Federal Reserve System (Fed) or the Office of the Comptroller of the Currency, depending on their structure. The Federal Reserve also has some regulatory authority over certain state-chartered banks, as does the Federal Deposit Insurance Corp. (FDIC).

In addition, the Consumer Financial Protection Bureau (CFPB), created in 2010, regulates both state and national banks with assets of $10 billion or more to ensure their compliance with consumer laws.

Pros and Cons of the Dual Banking System

The dual banking system allows for the co-existence of two different regulatory structures for state and national banks. This translates into differences in how credit is regulated, including legal lending limits, as well as variations in rules from state to state. On the negative side, that adds a certain level of complexity for bankers and consumers that wouldn’t be present in a single banking system.

However, the dual structure appears to have withstood the test of time, and many economists maintain that it encourages a sound and vibrant banking system. National banks can offer efficiencies that come from economies of scale and product and service innovations derived from the application of their greater resources.

State banks, on the other hand, can be more nimble and flexible in responding to the unique needs of customers in their own state or even town. Their innovations, when successful, can then be picked up by other states.

Proponents of state chartering maintain that state regulators better understand the communities they serve. As the Arkansas State Bank Department puts it, “As the primary regulator of a state bank, the Arkansas Bank Commissioner and State Bank Department are little more than a short drive or brief telephone call away from the banking institutions they regulate.” 

The dual banking system also allows banks to choose how they wish to be chartered, and they can switch from national to state chartering, or vice versa, with government approval.

The Bottom Line

For historical reasons, the United States has a dual banking system in which banks are chartered and regulated on either the state or federal level, and sometimes both. Proponents of the system maintain that each type of bank, national or state, has certain advantages and that the two complement each other and create a more vital and innovative banking system. On the other hand, bankers and consumers face additional complexity that a single banking system wouldn’t have.