Joint Determination of Regulations by the Regulator and the Regulated: Commercial Bank Reserve Requirements, 1875–1979

Abstract

We apply the theory of clubs to bank decisions on choosing membership in the national system and being subject to federal regulations, or remaining outside the system and opting instead for state regulation. Although costs to national membership are typically higher, member banks can use their influence to reduce these costs. This is expected to be more prominent for the larger banks, which retain greater influence on the regulators. Thus, the theory predicts that membership depends on costs, which in turn depend on membership. We test these relationships in a system of simultaneous equations for the periods 1875–1913, 1914–34, and 1935–80. Our results are consistent with the notion of large bank memberships responding to changes in reserve ratios, and reserve ratios responding to membership rates for large banks. In addition, we find bank sensitivity to national reserve ratios to be the lowest when the Fed was given additional discretion in setting reserve ratios post-1935, and federal regulator responsiveness to large bank membership was the greatest during this time as well.