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Key Takeaways

• The dual regulation of the U.S, banking system — which relies on both federal and state agencies – is a fragmented regulatory structure where multiple regulators with overlapping jurisdictions complicate policy implementation and create inconsistencies.
• The drawbacks of this convoluted regulatory system were evident in the delayed response to the failures of Silicon Valley Bank and First Republic Bank in 2023 and, earlier, the collapse of Washington Mutual in 2008, the largest bank failure in U.S. history.
• Potentially problematic regulatory competition is already evident in the emerging fintech sector.
• The Trump administration should target unnecessary duplication and inefficiencies by establishing performance measures to assess regulators.

The U.S. banking system is burdened by a convoluted regulatory architecture, where multiple agencies — federal and state — oversee financial institutions with overlapping jurisdictions and, at times, competing interests.

Originally intended to enhance oversight, the system instead is a fragmented regulatory structure where multiple regulators with overlapping jurisdictions complicate policy implementation and create inconsistencies and inefficiencies (Agarwal et al. 2014).

President Trump’s incoming administration now has an opportunity to address some of these flaws.

The failures of Silicon Valley Bank and First Republic Bank, where regulators shifted blame and acted too late, reveal a system that is reactive rather than proactive. It is time to question more whether this multi-regulatory framework truly fosters stability or instead stifles innovation, responsiveness, and accountability.

Nearly 70 percent of commercial banks in the U.S., including SVB and First Republic, operate under a dual regulatory system where state and federal regulators alternate oversight. Some banks are also regulated by multiple federal regulators such as the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation.

Benefit or burden

Proponents argue this dual system enhances resilience by offering multiple perspectives and reduces political interference by giving banks some choice over their primary regulator (Tiebout 1956). Additionally, alternating oversight between federal and state regulators may allow for a more efficient division of labor, addressing both major and minor concerns. Some suggest that this system fosters an implicit “good cop/bad cop” dynamic, where the stricter federal oversight facilitates richer information gathering by state regulators, ultimately leading to more effective regulatory implementation.

However, this structure also has clear costs: inconsistent enforcement, regulatory arbitrage — in which banks take advantage of differences in regulations to their benefit — and delays in addressing emerging risks.

The 2008 collapse of Washington Mutual, the largest bank failure in U.S. history, is a case in point. A congressional investigation found that WaMu’s downfall was exacerbated by oversight issues between the Office of Thrift Supervision and the FDIC. [1] Their inability to act decisively, due to poor co-ordination, allowed vulnerabilities to fester.

A study by Agarwal et al. (2014) highlighted significant inconsistencies in the enforcement of banking regulations (see Figure 1). The figure plots the change in CAMELS rating, a key measure of a bank’s financial health, across periods of regulatory oversight. White vertical zones indicate when state regulators were in charge, while gray zones mark periods of federal supervision.

Figure 1: Regulatory Inconsistencies in Banking Oversight: The Impact of Alternating Federal and State Supervision on CAMELS Ratings

Source: Agarwal et al. (2014).

This pattern reveals a striking dynamic: Federal and state regulators, despite overseeing the same banks in rotation, rarely apply the same rules in the same way. More than 70 percent of U.S. banks, including SVB and First Republic Bank, operate under this fragmented system. State regulators, in particular, tend to be more lenient, often because these banks are deemed “too big to fail” within their local economies.

As the graph shows, CAMELS ratings (in which 1 is considered good and 5 poor) rose —indicating a given bank was rated poorly — when federal regulators examined that institution and declined — indicating the same bank, at virtually the same time, was rated as doing better — when examined by state regulators. This regulatory disparity underscores the challenges of maintaining consistent oversight in a dual regulatory system.

Recent events reflect the persistence of these issues. At SVB, for instance, early warning signs — its bond portfolio losses and concentrated depositor base (Jiang et al. 2024) — went unaddressed, with regulators either failing to enforce standards or having their efforts diluted by overlapping authorities. Research shows that such inconsistencies create opportunities for regulatory arbitrage, where banks exploit disparities to engage in riskier practices (White 2011 and Agarwal et al. 2014).

These problems extend beyond banks to the emerging fintech sector. Non-bank and fintech firms are driving innovation in payments and lending; yet jurisdictional battles among regulators, state versus federal or even between federal agencies, have stalled the development of sound regulatory frameworks.

Policy implications

Streamlining the regulatory framework is difficult. Any significant consolidation regulation will require congressional approval, a challenge that has historically derailed broader reforms. For instance, while the Office of Thrift Supervision was eliminated under the Dodd-Frank reforms after the financial crisis in response to Washington Mutual’s collapse, additional consolidation efforts faced strong political resistance. Likewise, eliminating the entrenched dual federal and state bank regulatory system altogether may be impractical.

But much more can be done by the Trump administration to target unnecessary duplication and improve co-ordination. It should seek to consolidate oversight responsibilities between the regulatory bodies, address inefficiencies between federal and state regulators, and implement tools such as a performance scorecard to assess regulators. A clear example of regulatory overlap is the dual oversight of national banks by the OCC and the FDIC, both of which conduct separate examinations of the same institutions.

Importantly, it can also align regulatory incentives to ensure agencies prioritize financial stability and sound supervision over bureaucratic interests. It is also time to challenge the assumption that more regulation equals more safety. Overregulation imposes heavy costs — compliance expenses alone have risen by nearly $50 billion annually for financial institutions since 2008 [2] — and disproportionately harms smaller banks. Rather than adding endless layers of oversight, reform must emphasize accountability: Banks should bear the consequences of their risks.

The U.S. banking system remains vital to global finance, but its outdated regulatory architecture threatens its resilience and public trust. By reducing complexity, fostering accountability, and aligning incentives, we can create a smarter, leaner framework that promotes both stability and innovation, allowing American finance to thrive and lead the way forward.

Footnotes

[1] See “Wall Street and the Financial Crisis: the Role of Bank Regulators," .

[2] See Hogan, Thomas, "Costs of Compliance with the Dodd-Frank Act," Rice University Baker Institute for Public Policy, September 6, 2019.

References

Agarwal, Sumit, David Lucca, Amit Seru, and Francisco Trebbi, “Inconsistent Regulators: Evidence from Banking,” The Quarterly Journal of Economics, Vol. 129, Issue 2, May 2014.

Jiang, Erica Huawei, Grego Matvos, Tomasz Piskorski, and Amit Seru, “Monetary Tightening and U.S. Bank Fragility in 2023: Mark-to-Market Losses and Uninsured Depositor Runs?” National Bureau of Economic Research, 2024.

Tiebout, Charles, “A Pure Theory of Local Expenditures,” Journal of Political Economy, 64, 1956.

White, Eugene, “To Establish a More Effective Supervision of Banking: How the Birth of the Fed Altered Bank Supervision,” Working Paper, 2011.