The Bonfire of the Banking Regulators?
Despite numerous reforms, the US financial regulation system remains a patchwork of federal and state agencies with overlapping mandates and conflicting objectives. Two new books underscore the need to streamline bureaucracy, simplify regulations, and separate money creation from financial intermediation.
Willem H. Buiter
RALEIGH, NORTH CAROLINA – As US President Donald Trump intensifies his campaign to dismantle the regulatory state, Peter Conti-Brown and Sean H. Vanatta’s new history of American bank supervision, Private Finance, Public Power, has proven more timely than its authors likely anticipated.
The institutional history they provide offers a useful lens for understanding financial and political developments, even in the uber-disruptive age of Trump.
But readers expecting a comprehensive overview may be disappointed that the authors abandoned their original plan to cover the neoliberal era – which began with Ronald Reagan’s election in 1980 and ended with the 2007-08 global financial crisis (GFC) – and the more interventionist period that followed.
This omission is distinctly unhelpful, given that the political and economic forces that drove the passage of the 2010 Dodd-Frank Act – enacted in response to the GFC – closely resemble those that shaped New Deal-era banking reforms.
While the book makes occasional references to more recent episodes of financial instability and aggressive regulatory interventions (particularly by central banks), a more expansive account of the past 45 years would have greatly enriched Conti-Brown and Vanatta’s historical narrative.
But even without such a comprehensive overview, this well-written book sheds light on America’s complex and often chaotic financial system, underscoring the need for a radical simplification of the regulatory frameworks that govern deposit-taking banks and other financial intermediaries.
Another recent book, Dan Awrey’s Beyond Banks, comes close to such radicalism by advocating a structural separation between the issuance of monetary IOUs and private financial intermediation.
This would demonetize bank liabilities and allow for a less stringent and intrusive regulatory regime for banks.
Too Many Regulators
As Conti-Brown and Vanatta observe, the current system of bank supervision in the United States is extremely fragmented, with oversight responsibilities divided among the Federal Reserve, the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), and various state authorities.
The Financial Stability Oversight Council (FSOC), established in 2010, is responsible for coordinating the management of systemic risk across different government agencies.
It has ten voting members: the Treasury Secretary, the heads of eight federal financial regulatory agencies, and an independent insurance expert, as well as five non-voting members, three of whom represent state-level regulators.
In their book, Conti-Brown and Vanatta trace the messy evolution of US financial oversight over its first two centuries, revealing its internal tensions and contradictions.
As institutions that hold demand deposits and invest heavily in illiquid assets, banks are inherently vulnerable to runs.
To eliminate this risk, either uncapped deposit insurance or a well-resourced lender of last resort (LOLR) is necessary.
But as the authors explain, the development of deposit insurance was not just about maintaining systemic stability; it was also shaped by social and political pressures to shield households and small firms from the fallout of bank failures.
As early as 1790, Alexander Hamilton, the first US treasury secretary, proposed establishing a privately owned but publicly funded central bank modeled on the Bank of England (BoE).
The Philadelphia-based First Bank of the United States was chartered by Congress in 1791, at a time when only five banks operated nationwide.
Its charter was allowed to lapse in 1811, and a Second Bank of the United States – also headquartered in Philadelphia – was created in 1816.
It became a Pennsylvania state-chartered bank in 1836, before closing in 1841.
Unlike its short-lived predecessors, the Fed managed to endure.
Established in 1913, it was created mainly as a LOLR, decades after British banker and author Walter Bagehot outlined the core principles for managing banking panics.
In his seminal 1873 book Lombard Street, Bagehot argued that central banks should lend freely during crises, albeit at a penalty rate – to limit what we now call moral hazard – and only against sound collateral or assets that would be safe under normal market conditions.
The Fed serves as both the fiscal and financial agent of its beneficial owner – the US government.
It issues fiat currency, acts as the primary financial supervisor, and serves as the LOLR.
Conti-Brown and Vanatta highlight the historical development of the system’s distinctive structure: a Washington-based Board of Governors functioning as a federal agency, alongside 12 quasi-private regional Reserve Banks spread around the country.
To be sure, the Fed is not the only modern central bank with a confusing and outdated institutional design.
The BoE, for example, was nationalized (finally) in 1946, shifting from private to public ownership.
Much like other inefficiencies in the US banking system, there is no compelling reason why Congress cannot eliminate the Fed’s hybrid public-private ownership structure, yet it has remained intact.
The 1933 Glass-Steagall Act established the FDIC, which today – in addition to its original mandate of consumer protection, deposit insurance, and managing bank receiverships – also supervises state-chartered banks and savings associations outside the Federal Reserve System.
The OCC, established in 1863 as an independent bureau of the US Treasury, has never acted as a LOLR because it lacks the authority to issue legal tender.
Nowadays, its only role relevant to financial stability is chartering banks.
It could thus assume responsibility for restructuring and winding down failing institutions from the FDIC, although the Fed would need to take the lead in cases involving larger or more complex entities.
The GFC made America’s regulatory landscape even more crowded.
The Federal Housing Finance Agency (FHFA), for example, was established in 2008 to oversee government-sponsored enterprises (GSEs) such as Fannie Mae, Freddie Mac, and the 11 Federal Home Loan Banks.
While there is little justification for the government to act as an intermediary in the residential mortgage market, the reality is that these GSEs now provide more than $9.5 trillion in funding to mortgage markets and financial institutions, making public oversight essential.
Yet GSEs are not backed by the full faith and credit of the US government, and the FHFA does not have the financial capacity to serve as a true backstop.
They should be regulated and supervised by the Fed.
Too Many Banks
The problem, historically, has been that the US has far too many banks.
Chartering competition between the OCC and state banking authorities has led to a proliferation of mostly small, inefficient, and financially fragile institutions.
In 1880, there were 620 state-chartered banks. By 1910, that number had surged to more than 12,000, and by 1920, there were nearly 30,000 individual banking firms.
The fragility of this system was laid bare in 1931, when a severe panic led to the closure of 2,293 banks.
On the eve of President Franklin Roosevelt’s March 1933 Bank Holiday, the US had 5,938 national banks out of a total of 18,390.
In 1953, the US still had 14,552 banks and roughly 6,000 federally insured credit unions – small, bank-like nonprofit cooperatives that primarily served local communities and specific member groups, such as employees of a particular company.
Although the number of banks began to decline in the 1980s, the system remains highly decentralized, with 4,487 FDIC-insured banks and 4,653 federal credit unions.
Given that banking benefits from economies of scale and scope, diversifying assets and funding sources across states is often a sound economic strategy.
This implies that the large number of small banks in the US is likely the result of legal and regulatory barriers to consolidation rather than any efficiency advantage.
Conti-Brown and Vanatta highlight many of these obstacles, from public and political opposition to mergers and takeovers to state-level bans on branch banking.
US states’ preference for chartering their own banks – often supervised by state authorities and backed by state-run deposit insurance – has likely hindered the efficient allocation of credit.
The legacy of this misguided decentralization persists today, most notably in the continued existence of state-chartered banks, the majority of which are supervised by the FDIC and operate outside the Federal Reserve System.
Regrettably, Conti-Brown and Vanatta do not provide data on how the size of the financial sector has evolved relative to the broader US economy, or on the banking sector’s share of overall financial intermediation.
But in terms of financial and economic risk, many non-bank financial institutions are not meaningfully different from banks.
Even traditional “narrow” banks – deposit-funded entities that held primarily illiquid, bank-originated loans to maturity – engaged in risky financial intermediation.
By the Great Depression, their asset composition had broadened to include marketable securities that remained liquid under normal conditions but became vulnerable during periods of market turmoil.
The number of non-bank financial intermediaries such as investment banks, insurance companies, and pension funds grew rapidly from 1980 until the onset of the GFC.
In September 2008, the Fed bailed out American International Group (AIG), the country’s largest insurer at the time, with a series of loans that totaled $182 billion.
In exchange, the Fed acquired a 79.9% equity stake in the company.
In recent decades, the rapid growth of cross-border finance has had a profound impact on the Fed’s approach to supervision and risk management.
Effective oversight now depends on close cooperation and coordination among national financial authorities, especially central banks.
But even during the two centuries covered by Private Finance, Public Power, financial activity extended well beyond traditional narrow banks.
As economic historian Giorgio Pizzutto has shown, non-bank financial intermediaries played a significant role in the 1929 financial crisis.
Cross-border banking also helped shape the US economy during the gold-standard era of the late nineteenth and early twentieth centuries.
Although the Great Depression and World War II curtailed cross-border private financial flows, the establishment of the Bretton Woods system in 1944 revived cross-border banking.
Too Many Targets
Another persistent problem is that US bank regulators and supervisors have too many, often conflicting, objectives.
This is reflected in the tension between micro-prudential oversight – which focuses on the stability of individual financial institutions and the protection of their customers – and macroprudential regulation, which aims to maintain the stability of the financial system as a whole and manage its broader economic impact.
Although the term “macroprudential” was coined in the late 1970s, concerns about systemic financial risk date back much further.
Conti-Brown and Vanatta do not explore when or how macroprudential oversight began to complement traditional micro-prudential approaches, but such considerations were central to the Fed’s establishment in 1913.
Even Hamilton’s proposal for a national bank may have been partly driven by the need to contain systemic financial risks.
The tension generated by this macroprudential role is arguably even more pronounced today.
At times, the Fed may find it impossible to meet its monetary-policy objectives – maximum employment, stable prices, and moderate long-term interest rates – while simultaneously fulfilling its role as LOLR.
And since financial stability is a prerequisite for achieving these goals, it must take precedence.
Overloading institutions tasked with ensuring financial stability by giving them additional mandates – even those that are socially or politically important – risks undermining their effectiveness.
As Conti-Brown and Vanatta recount, US banking regulators have been gradually assigned numerous responsibilities over the years, ranging from consumer protection and anti-discrimination to community reinvestment.
More recently, there have been calls to incorporate climate-related objectives into the core mission of financial oversight.
Although well-intentioned, such demands are misguided.
Addressing social and environmental problems should be the responsibility of institutions designed explicitly for that purpose.
Financial regulators, on the other hand, should focus on identifying the implications of these issues for financial stability and monetary-policy objectives, and the risks that may emerge as a result of policies and rules aimed at addressing them.
Streamlining Financial Oversight
A fragmented supervisory landscape undermines accountability and effectiveness.
The FSOC is a case in point: the chair of the Securities and Exchange Commission is a key voting member, as is the chair of the Commodity Futures Trading Commission (CFTC).
The director of the Consumer Financial Protection Bureau (CFPB) also holds a voting seat on the FSOC, despite the agency – established in 2010 to protect consumers from abusive practices – having no mandate related to financial stability.
Meanwhile, the Federal Trade Commission, established in 1914 to enforce antitrust laws and promote consumer protection alongside the Justice Department’s Antitrust Division, is not represented on the FSOC – properly, I believe.
The current patchwork of financial supervisors heightens the risk of regulatory capture, whereby the authorities adopt the perspectives and objectives of the firms and industries they are supposed to oversee.
As Private Finance, Public Power demonstrates, this dynamic has been a persistent feature of the US banking system from its inception, sustained by the revolving door between Washington and Wall Street. In extreme cases – several of which the book documents – it has led to outright corruption.
Admittedly, the extent of regulatory capture also reflects broader shifts in societal values.
When free-market ideology prevails, norms governing the relationship between regulators and regulated entities tend to become more permissive.
Although this trend was especially pronounced during the four decades that preceded the GFC, Conti-Brown and Vanatta show that it began much earlier.
The best way to clear the regulatory clutter is to expand the Fed’s mandate.
For example, there is no compelling economic justification for maintaining state-chartered banks.
Phasing them out would eliminate the FDIC’s supervisory role.
Deposit insurance could then be handled by the Fed, which already has – or should have – the balance-sheet data needed to help determine appropriate insurance premiums.
Similarly, the FDIC’s consumer-protection duties could be assumed by the CFPB, which was created for that purpose.
This separation would help prevent any confusion between the pursuit of important sociopolitical goals and the task of monitoring and managing financial risk.
Other FDIC responsibilities, such as managing receiverships and ensuring that large, complex financial institutions can be wound down safely, could be transferred to the OCC or, preferably, to the Fed.
Once state-chartered banks are eliminated, the FDIC itself could be dismantled.
Currently, the only financial stability-related task of the OCC is chartering banks, which the Fed could do more effectively.
Eliminating state-chartered and state-supervised banks and insurance companies would reduce the number of non-voting FSOC members from five to two.
Among the ten voting institutions, the FDIC and OCC are largely redundant.
The CFPB, which plays no meaningful role in managing financial risk, should lose its FSOC seat or become a non-voting member.
The Fed should also be given responsibility for supervising GSEs.
Moreover, it should serve as the conservator of Fannie Mae and Freddie Mac until their assets are privatized, making the FHFA redundant.
Lastly, the regional Federal Reserve Banks should be restructured as regional branches of a unified central-banking system wholly owned by the federal government.
The same logic applies to cryptocurrencies.
Stablecoin deposits, which function as monetary IOUs, should fall under the Fed’s regulatory and supervisory purview.
Other crypto assets should be regulated and supervised by the SEC or CFTC.
As decentralized finance continues to grow in the US and around the world, regulatory oversight should be based on the underlying financial and economic characteristics of each arrangement.
Critically, any simplification of the US regulatory framework – whether for banks or non-bank institutions – must proceed in an orderly and deliberate fashion.
But as Conti-Brown and Vanatta note, meaningful regulatory innovation has historically followed major financial and economic crises, while prolonged periods of stability have led to excessive deregulation and weakened oversight.
Given this, the comprehensive reforms the US banking system needs are unlikely to materialize anytime soon.
The Fed also remains behind the curve in developing a central bank digital currency (CBDC).
Private Finance, Public Power offers valuable insights into why regulation so often lags behind financial innovation.
But as the French put it, tout comprendre n’est pas tout pardonner – to understand everything is not to forgive everything.
The Shadow Monetary System
While Private Finance, Public Power explores the evolution of American banking regulation, Awrey’s Beyond Banks focuses on the past, present, and future role of monetary IOUs, such as bank deposits.
These IOUs are liabilities that can be withdrawn on demand at a fixed nominal value and function as a widely accepted means of exchange.
In advanced economies, paper currency plays a limited role in legitimate transactions.
Its appeal lies in the anonymity it offers, which also makes it attractive for illicit activities.
Central-bank reserves – checkable deposits held by banks and other financial intermediaries – are important for wholesale financial transactions.
Today, most retail payments are made using checkable deposits issued by financial intermediaries, primarily private banks.
These institutions extend credit and purchase the debt of households, firms, and governments.
Their assets include a modest amount of central-bank reserves, but are otherwise dominated by long-term, often illiquid and risky instruments.
On the liability side, they issue the IOUs used as a means of payment, as well as various forms of longer-term debt.
Because deposits are widely accepted and can be withdrawn on demand at a fixed nominal value, banks have become the custodians and gatekeepers of the financial infrastructure that enables money to cross locations, jurisdictions, and time.
But a shadow monetary system is rapidly evolving and expanding.
It includes digital deposit issuers and mobile payment platforms like PayPal, Alipay, and WeChat Pay, as well as decentralized cryptocurrencies, ranging from floating currencies like Bitcoin (not an IOU) to stablecoins such as Tether and Circle, which are pegged to conventional currencies or commodities.
The growth of the shadow banking system is fueled by technological advances that enable faster, cheaper, and more accessible payments.
But safety remains a significant concern.
All issuers are vulnerable to runs, and participants in the shadow monetary system lack access to key protections such as a LOLR and deposit insurance.
Conventional bank payment systems, while safer, are also notoriously slow and expensive – particularly for cross-border transactions.
Checkable deposits are meant to be withdrawable on demand, at face value, and on a first-come, first-served basis.
But since most bank assets are illiquid or at risk of becoming so when market confidence falters, even solvent banks remain susceptible to runs.
To mitigate this risk, authorities have established a three-tiered financial safety net: first, central banks act as LOLR; second, deposit insurance protects depositors in the event of bank failure; and third, expedited resolution mechanisms ensure quick access to insured funds.
While these safeguards make bank money safer, they often come at the expense of efficiency.
This unintended consequence of regulatory policies designed to reduce the moral hazard created by deposit insurance, LOLRs, and expedited resolution erects barriers to entry, stifles innovation, and creates demand for a shadow monetary system that offers less secure but more convenient forms of payment.
As new technologies change how money is issued, stored, and transferred, our institutional, legal, and regulatory systems will need to adapt.
Can Good Digital Money Drive Out the Bad?
Gresham’s Law says that bad money drives good money out of circulation.
Awrey updates this economic principle for today’s financial system, observing that in stable markets, new money providers often gain market share at the expense of safer but inefficient incumbents.
But when markets become unstable, users abandon these new forms of private money in favor of traditional ones – in other words, under certain conditions, good money can drive out the bad.
Awrey argues convincingly that the dominant means of payment should not take the form of liabilities issued by financial intermediaries.
Instead, he proposes a model of narrow banking aimed at eliminating the risk of bank runs.
Under this framework, new issuers of digital money would be required either to obtain a conventional banking license or commit to investing all their proceeds in the safest and most liquid financial asset: central-bank reserves.
I would go even further: all issuers of monetary IOUs – whether new or existing – should be required either to give up on financial intermediation and issue only money fully backed by central-bank reserves, or to transfer all deposit-related liabilities to an independent subsidiary.
That subsidiary would hold only central-bank reserves as assets and maintain monetary IOUs as its sole liability.
Such a system would render the three pillars of the current financial safety net for banks largely unnecessary.
Micro-prudential regulation could be streamlined and eased, enabling banks to take on greater risks and engage with a broader range of assets and non-deposit liabilities.
More broadly, it is not self-evident that the private sector should remain the primary provider of payment infrastructure – especially when CBDCs offer a viable and efficient alternative for both retail and wholesale transactions.
Awrey pays little attention to CBDCs.
This is a surprising omission, given his recommendation that stablecoins be fully backed by central-bank reserves.
Why not take the next logical step and make central-bank reserves themselves directly available to the public as a means of payment?
In a traditional, centralized finance model, this would mean allowing every individual and legal entity to open an account directly with the Fed.
Alternatively, the Fed could guarantee retail accounts managed by commercial banks and other financial institutions – including those within the shadow monetary system – on the Fed’s behalf.
Under such a system, only wholesale account managers would hold central-bank deposits.
If distributed-ledger technologies like permissioned blockchains live up to their potential, both retail and wholesale accounts with the Fed could be managed on-chain, using decentralized protocols.
If hosted on a permissionless blockchain, CBDC wallet ownership could remain private, even if transaction histories are publicly visible.
CBDCs could plausibly overtake bank deposits as the dominant means of payment and liquid store of value, provided several key conditions are met: they must pay interest, support both online and offline transactions, impose no limits on account balances or transaction sizes, and be interoperable with foreign counterparts.
For reasons that remain unclear, both the Fed and the European Central Bank (ECB) oppose paying interest on CBDCs; the ECB has also proposed capping account size.
But since CBDCs could pay negative interest rates – and if physical zero-interest cash were phased out – the effective lower bound on nominal interest rates could be eliminated.
This would enhance the effectiveness of monetary policy during periods of excess capacity, below-target inflation, low neutral real interest rates, or an overvalued exchange rate.
While legal-tender status would remain exclusive to CBDCs, meaningful competition could still emerge.
Private payment platforms backed solely by central-bank reserves could still compete by developing faster, cheaper, and more reliable payment systems than those offered by the Fed and other central banks.
Awrey’s analysis points to a future in which the primary means of payment are CBDCs and private deposits fully backed by central-bank reserves, issued by entities with no other assets or liabilities.
Banks that do not issue monetary IOUs would not need the three-tiered financial safety net and could be released from the regulatory frameworks designed to oversee deposit-taking institutions engaged in meaningful financial intermediation.
Freed from these obligations, they could focus on non-monetary financial intermediation and compete on an equal footing with non-bank entities.
If the loss of deposit funding threatens the ability of banks to extend credit, the Fed could offset the impact by lending them the proceeds from CBDC issuance – and potentially also from the reserves generated by privately issued, fully backed digital money.
In fact, if these two very different books offer a single, clear takeaway, it is this: to build a simpler, more stable, and more innovative financial system, we must demonetize bank liabilities by separating the creation of monetary IOUs from financial intermediation.
Dan Awrey, Beyond Banks: Technology, Regulation, and the Future of Money (Princeton University Press, 2025).
Peter Conti-Brown and Sean H. Vanatta, Private Finance, Public Power: A History of Bank Supervision in America (Princeton University Press, 2025.)
Willem H. Buiter, a former chief economist at Citibank and former member of the Monetary Policy Committee of the Bank of England, is an independent economic adviser.
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