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FRBSF
WEEKLY LETTER
July 19, 1985
The Joy of Interstate Banking: I
Public policy in this country over the last fifty or so
years has opposed a nationwide interstate banking
structure-at least in principle. Both the
McFadden Act of 1927 and the Douglas AmendmenHo the Bank Holding Company Act represent
fairly clear statements of Congress' opposition to
full-service nationwide banking. However, efforts
to circumventthe intent ofthis policy have been
numerous, and market pressures have achieved
substantial accommodation. Large banking
organizations now conduct a wide range of banking activities across state lines through their nonbank subsidiaries.
The only restrictions on interstate banking that
appear still to be binding are those on interstate
branching and deposit-taking. But as even these
restrictions begin to crumble, legislators are being
forced to reconsider their policies toward the
interstate activities of banks. Two developments,
in particular, are generating much debate. First,
the Supreme Court in June upheld the constitutionality of a New England regional interstate
banking agreement at a time when similar
regional interstate banking legislation is being
enacted in a number of other states. Second,
"nonbank" banks, which skirt restrictions on
interstate branching by not being banks in a
technical sense (i.e., they do not offer both demand deposits and commercial loans), are
currently being chartered in a number of states.
This Letter discusses the regional (state) legislation
affecting interstate banking. A follow-up Letter
will discuss the actors and the nonbank bank and
other issues affecting the move toward fullservice, nationwide interstate banking.
The future has almost arrived
Interstate banking already exists to a considerable
extent. Some 7600 offices of out-of-state banking
and savings and loan (S&L) organizations currently grace the Republic, providing interstate banking
services through consumer and mortgage finance
companies, loan production offices, Edge Act
Corporations and grandfathered multi-state banking offices. Moreover, a plethora of banking services currently are provided across state lines
without a bank office. These include credit cards,
nondeposit services through automated teller
machines (ATMs) not owned but leased and
shared by banks, and the solicitation of business
(including deposits) through advertising as well as
by mail and toll-free telephone lines..
Moreover, brokerage firms, which technically are
barred from engaging in the business of banking,
have been able to provide deposit-like services
across state lines through money market mutual
funds. Since the funds technically are shares rather
than deposits (although they are equal in volume
to 60 percent of the checking deposit component
of M 1), they are not subject to the "no mixing of
banking and commerce" constraint of Sec. 21 of
the Glass-Steagall Act. Nor do any of the constraints of G lass-Steagall, the McFadden Act or the
Bank HoldingCompany Act apply to thrifts, which
increasingly have assumed the character of commercial banks.
Finally, some 276 "nonbank banks"have been
tentatively approved by the Comptroller (orily
about 14 are in operation, including entities
owned by J.e. Penney, Merrill Lynch, Gulf and
Western, and Parker Pen Company), and another
106 applications have been submitted, many of
them by large bank holding companies. Because
nonbank banks offer a full range of services other
than both demand deposits and commercial
loans, they are noHechnically banks and therefore
none of the restrictions against interstate banking
or against combinations of banking and commerce applies.
State banking legislation
While national banking legislation prohibits
nationwide banking, it does permit states to enact
legislation of their own to allow out-of-state
banking organizations to enter their boundaries.
This provision, known as the Douglas Amendment to the Bank Holding Company Act, allows a
bank or bank holding company to acquire a bank
subsidiary in another state if the laws of the latter
state specifically allow such acquisition. The
Douglas Amendment has been interpreted by the
states as a specific delegation by the Congress to
the states of authority to regulate this form of interstate commerce. Senator Douglas himself said that
FRBSF
his amendment "would leave the way open for
states to make explicit provisions for interstate
purchases and acquisitions (of banks) if they so
decided."
Currently, twenty-five states have enacted or are
considering interstate banking legislation under
the Douglas Amendment. The forms of this state
legislation run the gamut from allowing nationwide to allowing regional banking, entry by
establishing new banks ("de novo") to entry only
by buying existing banks, and reciprocal to nonreciprocal entry. Reciprocity refers to whether the
state from which a banking organization is
branching also allows entry by bankingorganizations from the destination-state. Alaska and Maine
wantto allow nationwide non-reciprocal entry
through the acqu isition of existing banks, whereas
New York wants nationwide reciprocal entry
through new or acqu ired ban ks. Other states want
various selective regional compacts.
Besides Alaska, several other western states now
have interstate banking provisions. Oregon's recentlyenacted legislation is regional in focus in
that itwill allow (as ofJuly 1987) banks in any state
in the Twelfth Federal Reserve District to acquire
an Oregon bank that is at least three years old, but
wi II not perm it entry de novo and does not requ ire
reciprocity. Oregon's law also provides that in the
eventthatthe Supreme Court ruled against regional compacts (which theCourtdid notdo in its
recent decision), or if Congress were to enact
legislation authorizing nationwide banking for
national and state member banks, its interstate
banking law automatically would become national ratherthan regional in its application.
Utah allows entry by acquisition on a reciprocal
basis with eleven western states not including
California, while Idaho's recently adopted law
provides for reciprocity with contiguous states
(but not entry by "Ieap-frogging"). Washington's
legislation will allow entry through acquisition of
banks at least three years old by any out-of-state
bank or bank holding company regardless of location, but only on a reciprocal basis. Non-reciprocal legislation passed in Arizona will allow entry
through merger or acquisition by any out-of-state
bank in 1986, and entry de novo in 1992.
Finally, California is considering various proposals, including one embracing nationwide
reciprocity. The California Bankers Association
favors an initial regional approach similar to
Oregon's, but most large banks in the Association
apparently believe that there is little to be gained
by regional or reciprocal arrangements and consequently favor nationwide interstate banking. The
spokesman for one large bank recently stated:
"There are not many reciprocal markets (in the
West) that really turn us on."
Legalities
The growing popularity of these regional banking
compacts was the subject of an important legal
challenge mounted by Northeast Bancorp, Inc.
and Citicorp. They challenged the constitutionality of legislation in Massachusetts and Connecticutthat permitted New England-based bank holding companies, but not those from New Y()fk or
other states outside the region, to acquire' local
banks. By selectively denying entry from some
states, such legislation has the effect of denying
interstate banking by the nation's largest banking
organizations. The legal opposition was based on
the overall argument that states cannot choose to
allow entry by banking organizations from some
states and not others. In other words, that the
Douglas Amendment authorizes only an all-ornothing approach.
In addition, Northeast Bancorp Inc. and Citicorp
claimed that selective interstate banking violated
the Equal Protection Clause of the U.S. Constitution. They also argued that interstate agreements
amount to compacts that infringe on the sovereignty of federal and other state governm~nts in
violation of the Compact Clause, which stipulates
that "no state shall, without the consent of the
Congress ... enter into any agreement or compact
with another state ..." Finally, they claimed that
regional compacts violated the Commerce Clause
of the Constitution by impeding the free flow of
trade among states.
On June 10, the Supreme Court unanimously
upheld the val idity of the New England agreement. The Court stated that the Douglas Amendment did not limit states to an all-or-nothing
choice, but gave them flexibility in controlling
interstate banking. Moreover, it stressed that the
legislative history of the Douglas Amendment
gave ample indication of Congress' intentto retain
local, community-based control over banking.
On the basis of these findings, the Court wrote that
the New England agreement did not violate the
Equal Protection Clause because Congress had
demonstrated that banking is of "profound local
concern." It stated that the regional agreement
was not a compact because there was not joint
organization to regulate banking. Finally, the
Court found that "When Congress so chooses,
state actions which it plainly authorizes are invulnerable to constitutional attack under the Commerce Clause."
The issue of concentration
The legal arguments for and against regional interstate banking are symptoms of major economic
and political tussles. Specifically, there is considerable controversy over the effects of interstate
banking on the concentration of market and
political power. In the five years from 1978
through 1983, the share of domestic bank assets
controlled by the top 100 banking organizations
increased from 49 to 54 percent.
In late April, Federal Reserve Chairman Volcker
testified before the House Banking Committee on
interstate banking and his concern over excessive
concentration. He recommended that acquisitions between the 25 largest banks be prohibited,
that no bank be allowed to accumulate more than
15-20 percent of the banking assets in other than
its home state, and that an upper limit (unspecified) be placed on anyone bank's share of banking
assets nationally. Similar provisions are in Congressman St Germain's (D-RI), "Depository Institutions Acquisition Act" (HR 2707).
Despite these kinds of restrictions on the interstate
expansion of large banking organizations, interstate banking per se probably will increase the
competition faced by small, local banks and
almost certainly reduce the overall number of
banks. Nonetheless, a well-run community bank
taking full advantage of franchise and vendor services and its local roots will most likely survive
and prosper, as they have in the shadow of giants
in California. Some are concerned that even the
out-of-state competition presented by large
money center banks may encourage regional banks
to merge to compete effectively, but there is no
solid evidence to suggest that economies of scale
exist in banking beyond a relatively small size.
Impact of Supreme Court decision.
It may be too soon to gauge the precise impact of
the Supreme Court's approval of selective regional
interstate banking on federal interstate banking
legislation. However, one can conclude that it has
stolen some fire from national legislative attempts
and that it clearly has shifted the emphasis of
interstate banking legislation to regional arrangements. Future national legislation, if any, probably
would evolve from the regional model.
Many of the interstate banking bills now pending
before Congress already approach nationwide
banking from this perspective. Congressman St
Germain's bill, for example, initially allows
"certain interstate acqu isitions of depository
institutions," but also provides a "trigger" to
require all states that enter reciprocal compacts at
least two years before Ju Iy 1990 to open their
doors to all banks by 1990. However, opposition
to any form of national "trigger" is strong.
A proposal of the Association of Bank Holding
Companies (BHCs), which generally represents
the large banks, also would open the way to
nationwide banking. It would do this by first
permitting BHCs, after two years, to acquire a
bank in any contiguous state within the Feder.al
Reserve District of the acquiring entity, and then
by repealing the Douglas Amendment within four
years.
Chairman Volcker also has recommended the
adoption of federal legislation endorsing regional
banking compacts on an "interim basis," with a
specific "trigger" that would require that after
three years, banks located in a state that is a member of one regional compact be allowed to acqu ire
banks in states that are part of another regional
compact. At the same time, and out of deference
to "states' rights," he argued that federallegislation should recognize the right of any state to opt
out of interstate banking by not entering into a
regional compact. In this respect, his proposal
differs from Congressman St Germain's. As a
transitional, or perhaps minimum, step to interstate banking, he also suggested that branching be
authorized within the 35 metropolitan areas
(natural and contiguous markets) and extend
across state lines.
Conclusion
Regional interstate banking initiated on the state
level is likely to have a lasting impact on the
structure of the banking industry. But how quickly
full interstate banking on the national level comes
about is still very much open to question. Next
week's Letter add resses someof the pol itical issues
that remain to be resolved before full interstate
banking will become a reality. Verle B. Johnston
Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San
Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor (Gregory Tong) or to the author .... Free copies of Federal Reserve publications
can be obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco
94120. Phone (415) 974-2246.
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BANKING DATA-TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)
Selected Assets and Liabilities
Large Commercial Banks
Loans, Leases and Investments' 2
Loans and Leases1 6
Commercial and Industrial
Real estate
Loans to Individuals
Leases
U.S. Treasury and Agency Securities 2
Other Secu rities 2
Total Deposits
Demand Deposits
Demand Deposits Adjusted 3
Other Trans'action Balances 4
Total Non-Transaction Balances 6
Money Market Deposit
Accounts-Total
Time Deposits in Amounts of
$100,000 or more
Other Liabilities for Borrowed MoneyS
Two Week Averages
of Daily Figures
Reserve Position, All Reporting Banks
Excess Reserves (+ )/Deficiency (- l
Borrowings
Net free reserves (+ l/Net borrowed(-)
Change from 7/04/84
Dollar
Percent!
Amount
Outstanding
Change
from
7/03/85
193,186
174,423
51,511
63,391
34,780
5,396
11,957
6,807
201,794
50,643
31,395
14,188
136,962
6/26/85
1,435
1,059
273
31
238
16
498
- 121
6,644
5,337
1,701
1,054
252
10,198
10,596
1,119
2,819
6,209
358
206
190
7,610
537
2,510
1,393
5,678
5.5
6.4
2.2
4.6
21.7
7.1
1.6
- 2.7
3.9
1.0
8.6
10.8
4.3
44,655
437
6,030
15.6
37,981
22,717
- 418
-
328
Period ended
Period ended
6/01/85
6/17/85
21
91
69
76
11
65
1,504
2,363
1 Includes loss reserves, unearned income, excludes interbank loans
Excludes trading account securities
Excludes U.s. government and depository institution deposits and cash items
ATS, NOW, Super NOW and savings accounts with telephone transfers
Includes borrowing via FRB, TI&L notes, Fed Funds, RPs and other sources
6 Includes items not shown separately
7 Annualized percent change
2
3
4
5
-
3.8
11.6
@FedFRASER