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May 1995

Volume 1 Number 2

The Impact of Interstate Banking and Branching Reform:
Evidence from the States
Susan McLaughlin

Federal interstate banking and branching reform is about to become a reality, with the first
phase of new legislation going into effect later this year. Past experience at the state level
suggests that reform will accelerate the pace of industry consolidation but may not lead
immediately to nationwide banking.

The Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994, signed into law by President
Clinton on September 29, eliminates most restrictions
on interstate bank acquisitions and makes interstate
branching possible for the first time in seventy years.
The act will permit bank holding companies (BHCs)
to acquire banks anywhere in the nation as of
September 29, 1995, subject to certain limitations, and
will invalidate the laws of thirty-six states that currently allow interstate banking only on a reciprocal or
regional basis.1 As of June 1, 1997, BHCs will also be
able to convert their banks in various states into
branches of a single interstate bank.2
Some advocates of reform claim that the 1994 act
will make U.S. institutions more efficient by allowing
them to convert their bank subsidiaries into bank
branches and thus eliminate duplicative overhead
costs. Others argue that it will promote safety and
soundness in the banking industry by removing barriers
to geographic expansion and helping BHCs better
diversify their assets and liabilities. But whether the
new law will in fact improve bank efficiency and asset
diversification substantially has yet to be demonstrated: previous research, which has focused largely
on the comparative cost structures of BHCs and branch
banks, has yielded no conclusive evidence regarding
reform’s likely impact.

This edition of Current Issues seeks more concrete
evidence of the effects of banking reform by tracking
the actual changes in bank behavior that followed the
liberalization of state branching and interstate banking
laws from 1988 to 1993. Although federal banking and
branching laws have not changed for decades, many
states lifted restrictions on branching within their
borders and began to permit out-of-state institutions to
acquire their banks during the 1980s. Data on BHCs’
responses to state-level reforms enacted between
June 30, 1988, and June 30, 1993, provide a laboratory
in which to study the impact of these changes and to
draw some inferences about the likely effects of the
Riegle-Neal act. 3 The analysis yields the following
findings:
• BHCs responded quickly and in large numbers
to intrastate branching reforms by consolidating two or more banks within at least one state
in which they operated.
• However, fewer BHCs took advantage of
interstate banking reforms enacted during this
period to expand into additional states.
Moreover, most of the first-time interstate
entries observed were delayed responses to
reforms enacted before June 1988.

CURRENT ISSUES IN ECONOMICS AND FINANCE

• BHCs that did enter new states during the
period typically acquired banks in neighboring, rather than distant, states.

analysis gives a mixed picture of BHCs’ responses to
reform.
Gradual, localized expansion across state borders.
Interstate banking activity, which was already substantial by June 1988, grew between June 1988 and June
1993. The number of BHCs that operated commercial
banks in two or more states increased from 134 to 159
during this period. The growth of interstate activity

These findings provide a basis for projecting the
likely speed and breadth of the 1994 federal reform’s
impact on U.S. banks. Specifically, they imply that
federal reform will speed industry consolidation by
facilitating mergers of banks located in different states
but may not lead immediately to the formation of coastto-coast banking companies through bank acquisitions.

The apparent preference of BHCs for
incremental, regional expansion . . . casts
some doubt on the potential of reform to
yield substantial diversification of banks’
assets and liabilities in the near term.

How BHCs Responded to State Reforms, 1988-93
The analysis focuses on the relationship between
changes in state branching and interstate banking laws
and changes in BHC structure. Y-9C4 and call report
data were used to construct snapshots of the structure
of all domestic and foreign-owned BHCs operating two
or more commercial banks in the United States on
June 30, 1988, and/or June 30, 1993.5 These dates mark
the beginning and end of a second wave of changes in
states’ bank branching and interstate banking laws following an initial period of liberalization in the early
to mid-1980s. Additional data from the National
Information Center database shed light on the timing of
changes in the ownership and structure of BHCs’ commercial banking operations during the period. The
Federal Reserve Board provided most of the information on state laws, although several state banking agencies verified the Board’s information. Overall, the

looks more impressive when measured as an increase in
banking assets held by interstate BHCs. The share of
total U.S. banking assets held by interstate BHCs rose
from 56.8 percent on June 30, 1988, to 88.5 percent by
June 30, 1993.
Ninety-five BHCs, many of which were already
operating across state borders on June 30, 1988, moved
into new states during the period, executing a total of
135 first-time interstate entries. Nine of these were de
novo entries; the other 126 represented acquisitions of

Table 1

Pattern of BHC Geographic Expansion between June 30, 1988, and June 30, 1993
States Allowing Entry as of 6/30/88
Panel A: All First-Time Entries Occurring
During the Period
Expansion into nearby vs. distant states:
Entries into neighboring state (% all entries)
74 (54.8%)
Entries into noncontiguous state (% all entries)
20 (14.8%)
Expansion within vs. between geographic regions:
Entries into other state in BHC’s region (% all entries)
67 (49.6%)
Entries into state outside BHC’s region (% all entries)
27 (20.0%)
Expansion within vs. between subregions:
Entries within BHC’s subregion (% all entries)
51 (37.8%)
Entries into state outside BHC’s subregion (% all entries)
43 (31.9%)
Total
Panel B: Time between Reform and Entry by
Out-of-State Bank Holding Company
Average number of months between time that entry
became possible under state law and entry date
Minimum
Maximum

States Allowing Entry after 6/30/88

Total

27 (20.0%)
14 (10.4%)

101 (74.8%)
34 (25.2%)

30 (22.2%)
11 (8.1%)

97 (71.9%)
38 (28.1%)

20 (14.8%)
21 (15.6%)

71 (52.6%)
64 (47.4%)

94 (69.6%)

41 (30.4%)

135 (100.0%)

49.8
6.0
86.5

15.9
3.5
59.5

Sources: Federal Financial Institutions Examination Council, Reports of Condition and Income; National Information Center Database.

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2

existing banks. Table 1 classifies each of these entries
according to the laws of the home state of the expanding BHC and the state it entered, and distinguishes
between those entries that could have been accomplished under existing law as of June 30, 1988, and
those made possible by reforms enacted during the
period studied. The data presented in Panel A indicate
that fewer than one-third of the interstate entries
observed were made possible by state laws enacted during the period. Most of the entries observed represented delayed responses to state laws enacted before
June 30, 1988.

Table 2

All First-Time Entries into New States Where
State Law Did Not Impose Regional Restrictions
on Interstate Acquisitions
Total
Expansion into nearby vs. distant states:
Entries into neighboring state (% all entries)
45 (61.6%)
Entries into noncontiguous state (% all entries)
28 (38.4%)
Expansion within vs. between geographic regions:
Entries into other state in BHC’s region (% all entries) 42 (57.5%)
Entries into state outside BHC’s region (% all entries) 31 (42.5%)
Expansion within vs. between subregions:
Entries within BHC’s subregion (% all entries)
32 (43.8%)
Entries into state outside BHC’s subregion (% all entries) 41 (56.2%)
Total
73 (100.0%)

Panel A also shows that BHCs exhibited a preference for intraregional, rather than interregional, expansion during this period. Over 70 percent of first-time
entries were made within the geographic region in
which the BHC’s home state was located; 50 percent of
these entries occurred within the BHC’s own subregion.6 A more meaningful way to evaluate the expansion patterns of BHCs may be to examine the share of
BHC entries made into neighboring states rather than
within geographic regions, because regions are somewhat arbitrarily defined. Nearly 75 percent of all firsttime entries represented moves into a neighboring state.

Sources: Federal Financial Institutions Examination Council, Reports
of Condition and Income; National Information Center Database.

The speed with which BHCs responded to
state branching reforms by consolidating
their banks suggests that many institutions
expected to gain substantial benefits from
bank consolidation and branch conversions.

states for at least part of the period studied. To investigate this possibility, the analysis in Panel A of Table 1
is repeated in Table 2 for the subset of BHC entries that
occurred at a time when the host state did not restrict
access on a geographic basis. As Table 2 indicates,
most of these entries were made within the BHC’s
region or between neighboring states. This result suggests that BHCs might have tended to expand into
nearby states even in the absence of the regional compacts formed by many southern and midwestern states.
The apparent preference of BHCs for incremental,
regional expansion is not surprising; many banking
markets span neighboring states, and nearby banks may
be less costly or less risky to acquire than those in more
distant locations. Nevertheless, this result casts some
doubt on the potential of reform to yield substantial
diversification of banks’ assets and liabilities in the
near term.

states that began to permit interstate banking after June
1988 continued to prohibit some types of interstate
acquisitions, such as purchases of recently formed
banks or acquisitions that would boost the acquirer’s
share of the state’s deposits above a specified ceiling.
In some cases, the lag between reform and entry may
also reflect the presence of firm-specific factors (insufficient capital, absence of suitable acquisition targets)
or market-specific conditions (recession) that discouraged interstate acquisitions. This analysis does not control for such factors.

Rapid, widespread consolidation within state
borders. Although interstate branching has largely
been prohibited by federal law since 1927, some insight
into the potential impact of federal branching reform
can be derived by analyzing BHCs’ responses to
intrastate branching liberalization. Thirteen of the sixteen states that prohibited statewide branching as of
June 30, 1988, changed their laws to permit statewide
branching through bank mergers during the period
studied. By comparing the rate of bank consolidation
in these thirteen states with that observed in states
already permitting statewide branching as of
June 30, 1988, it is possible to assess the speed and
breadth of BHCs’ responses to reform.

BHCs’ preference for expansion into nearby states
may also reflect the fact that many states limited access
to their markets to institutions located within nearby

Nearly a quarter of the 4,790 banks owned by BHCs
with multibank operations in the United States on
June 30, 1988, had been merged into other institutions

The data presented in Panel B indicate that many
BHCs did not move into new states until years after
entry became possible. BHCs may have been slow to
respond because of residual barriers to entry: many

3

CURRENT ISSUES IN ECONOMICS AND FINANCE

by June 30, 1993. This consolidation boom clearly
reflects the erosion of banks’ market share in both
deposit and lending markets during the 1980s as a
result of deregulation and increased competition by
nonbank firms. Much of the consolidation could not
have occurred, however, without specific state reforms:
nearly two-thirds of the banks merged into other institutions were located in the thirteen states that reformed
their branching laws during the period observed. 7 As
Panel A of Table 3 indicates, the consolidation rate in
these thirteen states—measured as the share of all
banks in existence at June 30, 1988, that were merged
into other banks during the period—was higher than the
rate observed in states that allowed statewide branching
throughout the period. This difference was statistically
significant at the 5 percent level.

branching reforms by consolidating their banks suggests
that many institutions expected to gain substantial
benefits from bank consolidation and branch conversions, although the data do not provide any
information on the size or nature of these benefits.

If pent-up demand for interstate branching
is substantial, then the Riegle-Neal act
may speed consolidation even more than the
data on intrastate mergers suggest.

This perception was not universal, however; some
BHCs did not merge their banks even after state law
permitted statewide branching through mergers. In
some cases, the costs of converting subsidiaries to
branches may have exceeded any savings from consolidation. In other cases, the BHC may have chosen
to maintain separate subsidiaries in order to reap the
benefits of decentralized management, or to operate
both national and state banks in a given state in order
to arbitrage current or future differences in state and
national bank powers.

If branching restrictions prevent BHCs from consolidating their operations as much as they would like, we
should see branch conversions increase sharply immediately after the Riegle-Neal act takes effect and then
taper off over time. The data presented in Panel B are
consistent with this premise: conversion rates were
generally higher for states that had recently reformed
their branching laws than for those that had allowed
statewide branching for some time.
The speed with which BHCs responded to state

Table 3

Consolidation of BHCs' Banks within State Borders between June 30, 1988, and June 30, 1993
Panel A: Number (Percentage) of Banks Consolidated in States with Different Bank Branching Laws
In 35 States Allowing
In 13 States Allowing
Statewide Branching as of 6/30/88
Statewide Branching as of 6/30/93
Banks owned by BHCs on 6/30/88 that:
Still existed on 6/30/93
989 (69.4%)
1815 (63.5%)
Same owner
51.1%
46.9%
New owner
18.2%
16.6%
Had been merged with other banks by 6/30/93
301 (21.1%)
691 (24.2%)
Same owner
16.5%
18.7%
New owner
4.6%
5.4%
Failed/closed by 6/30/93
136 (9.5%)
353 (12.3%)
Total

1426

In 3 States Prohibiting
Statewide Branching as of 6/30/93a
429 (85.0%)
58.4%
26.5%
65 (12.9%)
8.7 %
4.2%
11 (2.2%)

2859

505

Panel B: Banks Consolidated in States That Allowed Statewide Branching through Mergers at Different Times
State Allowed It
State Enacted It between
State Enacted It between
State Enacted It between
before 1/1/83
1/1/83 and 6/30/88
7/1/88 and 12/31/89
1/1/90 and 6/30/93
Number of banks
as of 6/30/88
406
1020
1404
1455
Percentage of banks
consolidated by 6/30/93
18.2
22.3
25.8
22.7

State Prohibited It
as of 6/30/93
505
12.9

Sources: Federal Financial Institutions Examination Council, Reports of Condition and Income; National Information Center Database.
a

Arkansas, Iowa, and Minnesota prohibited statewide branching throughout the period but liberalized their branching laws during this time, making
consolidation within a part of the state possible.

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Mixed Implications for Federal Reform
Between June 30, 1988, and June 30, 1993, BHCs
responded to state branching liberalization relatively
quickly, and in large numbers, by consolidating some
or all of their banks in different parts of those states.
BHCs were somewhat slower to respond to interstate
banking liberalization by expanding into new states.
Although most of the bank consolidation that occurred
can be traced to branching laws enacted during the
period, most of the first-time BHC entries into new
states during this time could have been accomplished
under state laws enacted before June 30, 1988.

Notes
1. A reciprocal law allows entry by an out-of-state BHC only if that
BHC’s home state extends similar access to the state’s own institutions. Regional laws allow entry only by BHCs based in states
located in a specified region and prohibit entry by BHCs located in
other areas.
2. The law will also permit BHCs and banks to establish de novo,
or newly chartered, interstate branches to the extent authorized by
state law.
3. Some states lifted restrictions on de novo branching within their
borders during this period. However, this analysis examines only
state reforms that permitted branching through mergers of existing
banks, since the Riegle-Neal act explicitly authorizes only this
mode of interstate branching.

The extent of the consolidation activity observed
among BHCs is consistent with the claim that branching liberalization will benefit many institutions, presumably by enabling them to reduce their operating
costs as they convert bank subsidiaries into bank
branches. In states that do not enact laws prohibiting
interstate branching before the June 1, 1997, deadline
established by Riegle-Neal, federal reform will take
the banking industry from zero to full interstate
branching. In contrast, many states that enacted
statewide branching during the period studied had previously allowed limited branching within their borders—for example, permitting banks to branch within
counties, or between neighboring counties. If pent-up
demand for interstate branching is substantial, then the
Riegle-Neal act may speed consolidation even more
than the data on intrastate mergers suggest.

4. Y-9C reports are filed quarterly by all BHCs with consolidated
assets of $150 million or more and by certain other multibank holding companies. These reports reflect the BHC’s financial condition
on a consolidated basis.
5. As of June 30, 1988, 852 BHCs that were not owned by another
company operated two or more commercial banks in the United
States; by June 30, 1993, this number had risen to 875.
6. Regions and subregions are defined according to the Census
Bureau’s guidelines.
7. Most of these thirteen states had previously allowed some
degree of branching (through bank mergers) within cities, counties,
or regions of the state; some of the mergers observed in these states
might have occurred even without branching liberalization.

How federal reform will affect the geographic diversification of banks’ assets and liabilities is more difficult to predict. Diversification will only occur as
BHCs move into states whose economic characteristics
are not strongly correlated with those of the states in
which they already operate. Since neighboring states’
economies are likely to be more similar than those of
states located in different regions of the country, the
speed with which diversification occurs will depend on
how quickly BHCs begin to expand outside their core
operating areas. Past experience at the state level suggests that BHCs may continue to expand primarily into
nearby states even after interstate banking reform takes
effect in September. However, by making nationwide
banking possible for the first time, the law may alter
the calculus behind BHCs’ expansion decisions and
prompt some BHCs to expand quickly into other
regions of the country in order to establish national
banking franchises.

5

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CURRENT ISSUES IN ECONOMICS AND FINANCE

About the Author
Susan McLaughlin was formerly a financial analyst in the Banking Studies Department of the Research
and Market Analysis Group, and is currently a member of the Foreign Exchange Function’s Reserve
Management Staff.

The views expressed in this article are those of the author and do not necessarily reflect the position of
the Federal Reserve Bank of New York or the Federal Reserve System.

The Federal Reserve Bank of New York provides no warranty, express or implied, as to the accuracy, timeliness, completeness, merchantability, or fitness for any particular purpose of any information contained in documents produced
and provided by the Federal Reserve Bank of New York in any form or manner whatsoever.

Current Issues in Economics and Finance is published by the Research and Market Analysis Group of the Federal
Reserve Bank of New York. Dorothy Meadow Sobol is the editor of the publication.
Subscriptions to Current Issues are free. Write to the Public Information Department, Federal Reserve Bank of
New York, 33 Liberty Street, New York, N.Y. 10045-0001, or call 212-720-6134.