Front Page Titles (by Subject) The Political Economy of Bank Regulation - Literature of Liberty, Spring 1982, vol. 5, No. 1
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The Political Economy of Bank Regulation - Leonard P. Liggio, Literature of Liberty, Spring 1982, vol. 5, No. 1 
Literature of Liberty: A Review of Contemporary Liberal Thought was published first by the Cato Institute (1978-1979) and later by the Institute for Humane Studies (1980-1982) under the editorial direction of Leonard P. Liggio.
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The Political Economy of Bank Regulation
“The Political Economy of Banking Regulation, 1864–1933.” Journal of Economic History 42 (March 1982): 33–42.
Changes in banking regulation in the United States were the result of protracted political struggles among different interest groups seeking to politically influence the structure of the banking industry. White analyzes the evolution of government banking regulation from the Civil War to the Great Depression by examining the actions of three interested parties: the banks, the public, and the government regulators, both state and federal. Coalitions within these interest groups determined policy, with the most effective political coalition being the smaller unit banks. This illustrates the workings of the “economic theory of regulation.”
A dual banking system of state regulated banks and national chartered banks arose in response to the regulatory restraint of the National Banking Act of 1864. This Civil War legislation, by prohibiting branch banks and regulating the size and activities of national banks, gave rise to state and local “free banking” laws of the 1880s and 1890s, by which the less restrictive and “competitive” state regulators made entry into the banking industry much easier. By 1900 state-chartered banks were growing more numerous than national banks.
Confronted by vigorous competition from state banking authorities chartering new banks, federal officials (under President Cleveland in 1895) recommended that national banks be allowed to branch. The unit banks in small towns and rural areas realized that their profits would be threatened by federally chartered city banks branching out into their territories, and so in 1898 lobbied Controller Charles Dawes to kill the branching bill in Congress. This regulatory rivalry among state, national, banking, and public sectors on the eve of World War I led to the faster growth of national over state banks, with the anti-branching lobby further strengthened by the vested interests of the new small financial institutions.
The Federal Reserve Act of 1913 did not alter the structure of the banking system, but by reducing reserve requirements it sought to siphon off state banks into its regulatory control; state banks responded by lowering their reserve requirements. These regulatory changes fit into the “economic theory of regulation.” In effect “favorable regulation will be supplied to the individuals or groups that have valued it most by voting and lobbying the government.”
In the absence of a monopoly banking regulator, federal and state governments have competed to regulate banks. Rivalry between regulators has led to a dilution of reserve requirements, but why have restrictions on branch banking remained virtually unchanged? Among the divided banking industry, unit bankers in small town and rural areas possessed more political pressure and were aided by the decentralized character of the Federal Reserve System which fought “monopolistic interest.” In Congress the unit bankers thwarted most efforts of federal officials and the larger banks (such as A.P. Giannini's Bank of America) to legislate branching by national banks. The 1920s witnessed some branching but only in a few states since no coalition to fight for branching appeared. Even after the onset of the Great Depression, the unit bankers (in league with state regulators) successfully limited the branching opportunities of the Banking Act of 1933 and maintained their favorable regulations.