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ESSAYS ON ISSUES

THE FEDERAL RESERVE BANK
OF CHICAGO

SEPTEMBER 2006
NUMBER 230a

Chicago Fed Letter
Federal preemption of state bank regulation: A conference
panel summary
by Erin Davis, associate economist, and Tara Rice, financial economist

The Chicago Fed’s 42nd Annual Conference on Bank Structure and Competition, which
took place May 17–19, 2006, included a panel on federal preemption of state banking
regulation. The panelists discussed the wide-ranging impact of rules issued by the Office
of the Comptroller of the Currency, the federal agency that regulates national banks.

Between 1995 and 2005, the
number of out-of-state bank
branches in the U.S. grew from
under 100 to almost 25,000.

In its new rules issued in 2004, the Office
of the Comptroller of the Currency
(OCC) said that its regulations “preempt”—that is, override—a number of
state laws that conflict with a national
bank’s exercise of its banking powers.1
Preemption is a particularly timely issue
in the Federal Reserve’s Seventh District,
where the Illinois Speaker of the General
Assembly recently requested that official
state entities not patronize banks that do
not comply with Illinois state law.2 In this
Chicago Fed Letter, we briefly review the issues surrounding the preemption debate
and summarize the panelists’ comments.

The panel on preemption brought together banking and legal experts to
discuss the implications for the U.S.
banking industry. Among them were
Philip Strahan, associate professor of
finance, Carroll School of Management,
Boston College; Arthur Murton, director,
Division of Insurance and Research,
Federal Deposit Insurance Corporation
(FDIC); James Roselle, associate general
counsel, Northern Trust Corporation;
Arthur Wilmarth, professor of law, George
Washington University Law School; and
Hal Scott, the Nomura Professor and
director of the Program on International
Financial Systems at the Harvard Law
School. Douglas Evanoff, senior financial
economist and vice president, Federal
Reserve Bank of Chicago, moderated

the session, which was cosponsored by
the Chicago Fed and the George J. Stigler
Center at the University of Chicago.
The preemption debate

In the United States, banking is regulated by a complex web of national and
local regulatory bodies. State banks
(those chartered at the state level) are
supervised by either the Federal Reserve
System (FRS) or the Federal Deposit
Insurance Corporation and by their chartering state. In contrast, national banks
(those chartered at the national level)
are supervised by the OCC, a division of
the U.S. Department of the Treasury,
and (currently under debate) are subject
to many of the laws of the states in which
they, and their subsidiaries, operate.3
This two-charter model spawned the
dual banking system, discussed in greater
detail in this article.
For most of this nation’s history, banks
were largely prohibited from expanding
either inside or outside the state in
which they were headquartered. While
restrictions on intrastate expansion were
gradually eliminated through changes
in legislation, many restrictions remained
with regard to interstate branching. The
passage of the Riegle–Neal Interstate
Banking and Branching Efficiency Act
(IBBEA) of 19944 removed the remaining federal restrictions on interstate

expansion. Strahan discussed the staggering expansion of multistate banks
that has resulted; between 1995 and
2005, the number of out-of-state bank
branches in the United States grew from
under 100 to almost 25,000.5 As a result
of their new multistate operations, banks
found themselves subject to the regulations of every state in which they operate,
in addition to various federal regulations.
The problem was that as banking organizations grew geographically, they
found themselves subject to multiple,
often contradictory, sets of state regulations. Banks then began to question
whether they should be subject to state
laws and began to lobby for a single set
of regulations under which interstate
banks and branches could operate.
One result of this was the passage of
the Riegle–Neal Amendments Act of
1997, which sought to streamline the
regulations governing state banks by
rectifying an unintended consequence
of the original Riegle–Neal Act. The
original act was thought to have disadvantaged state banks that branch into
states with more restrictive laws by requiring these banks to adhere to the laws
of their host states; meanwhile, national
banks were, for the most part, not subject to the laws of their host states. The
amendment sought to level the playing
field by having host state laws apply to
out-of-state state banks only to the extent
that they apply to out-of-state national
banks. The amendment also required
the OCC to conduct an annual review
of the applicability of state laws to national banks and to report its findings
in its annual report.
The OCC increasingly asserted its power
to preempt state laws for national banks
and defended its right to do so in numerous court battles. It formalized its position on preemption in January 2004,
when it issued rules that said state laws
do not apply to national banks if such
laws “obstruct, impair, or condition” the
banks’ federally authorized activities
and that only the OCC has “visitorial”
powers for national banks.6 The problem
for states was that the OCC’s regulations
appear to preempt many state laws
dealing with issues of fair lending and
consumer protection.7 National banks

applauded the move, but state bank regulators argued that the OCC had overstepped its authority and, in so doing,
had weakened consumer protections
and fair lending requirements.
Benefits and costs of preemption

National banks typically favor preemption because it lowers their operating
costs and eases the administrative burden of complying with multiple regulations. As Roselle explained, multiple
sets of regulations are costly for banks
not only because of the technology and
training costs but also the increased likelihood of making costly administrative
errors. As an illustration, he discussed
the difficulty of complying with the state
of Alabama’s regulations. If a bank inadvertently made a mortgage-backed
real estate loan in Alabama without
meeting the local business registration
requirements, Roselle said, the loan
could be declared void and uncollectible. Preemption helps banks avoid such
risks by creating a single set of regulations for national banks operating across
state lines. Those benefits should eventually be passed on to consumers in the
form of lower prices.

to local risks. Finally, Strahan noted, it
increases market oversight of financial
institutions and improves the nation’s
overall economic performance.
Preemption, however, could result in
banks abandoning one regulatory system
in favor of the other. If banks do so in
large numbers, it could upset the balance
of the dual banking system and alter its
costs and benefits.
To some extent, such a shift has begun
to occur. Preemption has intensified
regulatory competition by making national charters more attractive, relative
to state charters, to banks operating in
multiple states. Increased competition,
Strahan explained, could have one of
two negative outcomes. First, it could
result in a “race to the bottom,” in which
banks play competing regulators off
against one another, making the regulators unwilling to impose appropriate
standards on the banks they regulate.
Alternatively, it could result in a “single
winner,” in which banks all migrate to a
single regulator because that regulator
relaxes its rules in some way to reduce
the regulatory burden to banks. Strahan
pointed out that in some markets this

As banking organizations grew geographically, they found
themselves subject to multiple, often contradictory, sets of
state regulations.
Preemption, Strahan argued, is part of
a larger trend toward financial openness in banking, which in turn benefits
both banks and consumers. For example, the increased openness allows firms
to expand geographically and achieve
greater economies of scale and scope.
In fact, recent research has examined
the effect of geographical deregulation
on efficiency and pricing in the banking
sector.8 These studies find that bank
performance improves after geographical restrictions on bank expansion are
lifted; operating costs are reduced and
reductions are passed along to bank borrowers in the form of lower loan rates.
Financial openness also allows banks
to create more geographically diverse
portfolios and become less vulnerable

has already happened; most credit card
banks are now located in Delaware or
South Dakota because of those states’
lenient usury laws.
Some level of regulatory competition,
on the other hand, may be desirable.
Strahan explained that competition is
helpful because it limits regulators’ ability to tax an industry excessively. The
dual banking system in the U.S., argued
Wilmarth, has been successful largely
because competition between regulators
provides important checks and balances for oversight standards. These checks
and balances are in danger of being lost,
he suggested, because of the substantial threat to the dual banking system
that OCC preemption raises.

State versus national charters

Preemption: Recent events

As a result of the OCC’s new policy on
preemption, this competitive balance
has indeed shifted in favor of national
banks, as they have opted for uniform
OCC regulation; multistate banks are
migrating to national charters. This
trend has included several major banks,

As a direct result of the OCC’s new regulations, the Financial Services Roundtable9 asked the FDIC to issue preemptive
regulations that would restore some
balance by giving state banks greater
“parity” with national banks. The FDIC
responded with its recent Notice of

Despite the growth in out-of-state bank branches, one panelist
maintained that the current regulatory regime forces banks to
build a complex corporate structure to operate across state lines.
such as JPMorgan Chase and HSBC,
which recently switched to national charters. Statistics also bear out this trend.
For example, as Murton illustrated, the
share of banking assets held by national
banks had been around 55% since the
mid-1980s but increased dramatically
between 2003 and 2005 to 64% of assets.
Similarly, Strahan showed that the share
of deposits held by out-of-state national
banks increased from 28% to 38% between 2004 and 2005 in states with predatory lending laws, while their market
share in states without such laws remained
fairly stable at around 29%. Meanwhile,
the deposit share of in-state state banks
fell from 37% to 30% over the same period in states with predatory lending
laws. These statistics indicate that preemption has increased the attractiveness of the national charter for some
banks and that banks are responding
to these changes.

Proposed Rulemaking.10 As Murton
explained, the proposed rules would
allow a state bank to operate anywhere
under the laws of its home state to the
same extent that a national bank operating in that host state can operate under
national law.

Not all banks, however, prefer national
charters. In fact, the charter a bank
chooses depends largely on its size.
Murton showed that state charters still
far outnumber national charters; in 2005
there were about 6,200 state-chartered
banks versus only 1,800 nationally chartered banks. The lesson from these statistics is that smaller banks tend to choose
state charters. Murton added that newly
established (de novo) banks overwhelmingly choose state charters. Smaller-sized
banks choose state charters in part,
Roselle explained, because state regulators are seen as more accessible than
national regulators and may be more
responsive to banks’ concerns.

The panelists emphasized that banking
has increasingly become a national, rather than a local, business. As stated earlier,
the number of banks operating interstate branches has grown dramatically
since IBBEA was enacted in 1994. This
response, said Strahan, demonstrates
that the ability to operate across state
lines is valuable to banks.

The FDIC has received a mixed reaction
to the proposal. Some letters praised the
proposed rules because they would restore parity between state and national
charters, while others argued that the
FDIC does not have the authority to enforce the proposal. Wilmarth argued that
the proposal does not go far enough to
be truly effective. As he pointed out, the
proposed rules would not apply to banks
operating in states in which they do not
have physical branches, nor would they
apply to banks’ operating subsidiaries.
Bank operations under the dual
banking system

Despite this growth, Roselle maintained
that the current regulatory regime forces
banks to build unnecessarily complex
corporate structures to operate across
state lines. He described Northern Trust
Corporation’s organizational structure, which is similar to that of many
large banks. Its lead bank is an Illinois

state-chartered bank. But it also has
national bank charters in four other
states. The corporation operates trust
companies in four states, one supervised
by the OCC and the other three by state
banking agencies. Finally, it has a federal savings bank (FSB) with branches
in 16 states; it chose the FSB charter for
the national branching capabilities associated with it. Such a complex organizational structure, Roselle argued, is
undesirable for two reasons. First, operating multiple companies is costly and
increases regulatory risks. Second, the
complex framework makes it difficult for
Northern Trust to meet its customers’
expectation that they will be served
seamlessly nationwide.
Alternatives to the current system

Several of the panelists suggested ways in
which they thought the current regulatory system could be improved. Wilmarth
argued that the courts should overturn
earlier decisions allowing the OCC to
preempt state laws. If they do not, he
said, Congress should pass legislation to
clarify that the OCC does not have the
power of preemption. If neither occurs,
Wilmarth argued, the viability of the dual
banking system could be threatened.

Michael H. Moskow, President; Charles L. Evans,
Senior Vice President and Director of Research; Douglas
Evanoff, Vice President, financial studies; Jonas Fisher,
Economic Advisor and Team Leader, macroeconomic
policy research; Richard Porter, Vice President, payment
studies; Daniel Sullivan, Vice President, microeconomic
policy research; William Testa, Vice President, regional
programs and Economics Editor; Helen O’D. Koshy,
Kathryn Moran, and Han Y. Choi, Editors; Rita
Molloy and Julia Baker, Production Editors.
Chicago Fed Letter is published monthly by the
Research Department of the Federal Reserve
Bank of Chicago. The views expressed are the
authors’ and are not necessarily those of the
Federal Reserve Bank of Chicago or the Federal
Reserve System.
© 2006 Federal Reserve Bank of Chicago
Chicago Fed Letter articles may be reproduced in
whole or in part, provided the articles are not
reproduced or distributed for commercial gain
and provided the source is appropriately credited.
Prior written permission must be obtained for
any other reproduction, distribution, republication, or creation of derivative works of Chicago Fed
Letter articles. To request permission, please contact
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email Helen.Koshy@chi.frb.org. Chicago Fed
Letter and other Bank publications are available
on the Bank’s website at www.chicagofed.org.
ISSN 0895-0164

Another option would be to follow the
Roundtable’s proposal, which would
allow a bank’s home state to preempt the
laws of other states in which that bank
operates. This proposal would therefore
increase parity between state and national charters by giving state banks an ability
to operate under a single set of rules.
Unlike the other four panelists, Scott did
not endorse modification of the current
regulatory system for banks; instead,
he advocated that this system be used
as a model for regulation of the securities and insurance firms. Securities
firms are regulated by both state and
1

2

3

4

They explicitly preempt state laws governing deposit-taking and lending and also
preempts other laws that interfere with a
national bank’s exercise of the powers
granted to it by federal law. At the same
time, the rules introduced stronger predatory lending regulations for national banks.
The preemption regulations do not preempt state laws incidental to banking, such
as contracts, torts, and zoning.
Specifically, the Speaker asked that state
agencies, pension funds, and state universities require banks, including national banks,
to certify that they and their affiliates comply with the provisions of the Illinois High
Risk Loan Act.
See Federal Reserve Board, 2005, The
Federal Reserve System: Purposes and Functions,
report, Washington, DC, June, available
at www.federalreserve.gov/pf/pf.htm, for
more information on bank regulation in
the United States.
Pub. L. No. 103-328, 108 Stat. 2338 (1994)
(codified in 12 U.S. C.).

federal authorities and are partially preempted from state laws, while insurance
firms are regulated entirely by states and
are exempt from federal regulations.
Many of these firms, however, are operating in national markets and are subject
to inefficient, overlapping regulation.
Scott argued that they should be allowed
to operate under federal regulation,
preempted from state laws.
The debate goes to the Supreme Court

Office of Insurance and Financial Services
challenging the OCC’s ability to preempt state laws. The commissioner is
appealing a lower court’s decision that
upheld a national bank’s right to operate in Michigan through an operating
subsidiary that is subject to federal, and
not state, laws and regulations. The outcome has not been decided; however,
this case will likely set the stage for additional reaction by individual states.

Shortly after this conference, the U.S.
Supreme Court agreed to hear an appeal
by the commissioner of the Michigan
5

These figures include only domestic
branches of domestic commercial banking
companies; see Christian Johnson and Tara
Rice, 2006, “Assessing a decade of interstate
bank branching,” Federal Reserve Bank
of Chicago, working paper, forthcoming.

6

For contrasting views about the legality and
wisdom of the OCC’s regulations, see
Arthur E. Wilmarth, Jr., 2004, “The OCC’s
preemption rules exceed the agency’s
authority and present a serious threat to the
dual banking system and consumer protection,” Annual Review of Banking and Financial
Law, Vol. 23, pp. 225–364; and Howard N.
Cayne and Nancy L. Perkins, 2004, “National Bank Act preemption: The OCC’s new
rules do not pose a threat to consumer

8

Sandra E. Black and Philip E. Strahan, 2002,
“Entrepreneurship and the availability of
bank credit,” Journal of Finance, Vol. 67,
No. 6, pp. 2807–2833; Jith Jayaratne and
Philip E. Strahan, 1998, “Entry restrictions,
industry evolution, and dynamic efficiency:
Evidence from commercial banking,” Journal
of Law and Economics, Vol. 41, NO. 1, pp.
239–273; Randall S. Kroszner and Philip E.
Strahan, 1999, “What drives deregulation?
Economics and politics of the relaxation of
bank branching restrictions,” Quarterly Journal of Economics, Vol. 114, No. 4, November,
pp. 1437–1467.

9

The Roundtable is an industry group that
represents 100 of the largest financial services
companies that serve American consumers.

10

The FDIC notice is available at www.fdic.gov/
news/news/financial/2005/fil10905.html.

Visitorial powers include examination of
the bank, inspection of the bank’s books
and records, regulation and supervision
of bank activities, and enforcement of
compliance with applicable federal or
state laws concerning those activities.

7

protection or the dual banking system,”
Annual Review of Banking and Financial
Law, Vol. 23, pp. 365–410.


Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102