America's Regulatory System: Another Labratory for Democracy

The American government is a federalist system, in which power is shared with a national government and individual states. While for some this seems confusing, we are repeatedly taught there is great advantage to this division of power. The tenth amendment to the Constitution allows for the states to govern in areas not discussed in the Constitution. Scholars note this creates a laboratory for democracy, since each state can take a different approach towards handling its own affairs, especially since our Constitution leaves a significant amount of space for states to make laws.

Often the public and politicians complain that regulation of our financial system is complicated and argue it would be better if it were centralized and managed by a single regulator. Little do they understand that our seemingly strange regulatory framework is a direct result of a federal system, and the same advantages of having shared powers allow the states to have their own regulators as well.

A financial institution can be chartered (licensed) by either a national authority or state authority. The Office of the Comptroller of the Currency (OCC) charters national banks, and the National Credit Union Administration (NCUA) charters national (“federal”) credit unions. Each state can also charter banks and credit unions.  Delaware, Wyoming, and South Dakota do not provide charters for state credit unions. North Dakota is the only state to charter, own, and operate its own bank - the Bank of North Dakota.

What is the advantage of selecting a state charter over a national charter? Again, it has to do with our federal system. In theory, state chartered institutions will obey state banking laws and state credit union laws, and national charters will follow national banking laws and national credit union laws. Now it is virtually universal that financial institutions are required to carry deposit insurance if they wish to keep their state or national charter. These most popular insurance programs, run by the FDIC for banks and NCUA for credit unions, will demand federal oversight for all participants. In this way, federal agencies maintain certain de facto oversight of state chartered institutions that must carry nationally managed deposit insurance.

In this unique situation where state chartered institutions have national oversight, often national and state regulators work together to regulate state institutions; whereas, national chartered institutions only have one direct regulator. State institutions can benefit from the diversity of opinion from having dual regulators. While some contradictions may exist, the state regulators usually have an interest in doing what is best for the local communities; whereas, national regulators are viewed as taking a standardized approach towards enforcement for all institutions.

Other peculiarities that arise have to do with resources. State regulators have the benefit of understanding the local economy better, but national regulators have greater resources at their disposal to train regulators and enforce laws. Unique solutions to these problems exist. National regulators often open their training programs to state regulators, and national regulators make efforts to provide field offices to be closer to the communities in which their regulated institutions reside.

The result of all these quirks leads to a democratic approach towards licensing and regulating a financial institution. Owners or members of these institutions can select either a national or state charter, depending on their preferences. They can even choose amongst different states to take advantage of different laws. If a national charter is selected, they will have one regulator; but if they are state chartered, they will likely have some national oversight with regulatory duties being shared with state authorities as well.

This is another example of how the federal system creates a laboratory that can provide for several approaches and unique solutions. Fifty different states mean fifty different jurisdictions can have different regulations, and local laws can be tailored to local needs. This shows that a single regulator for all institution types would undermine the federal system and force states to give up their authority, leading to a more centralized government. While a single regulator would appear to simplify the system, it is an example of how simpler is not always better, and how it can lead to a loss of local control.