The interstate branching provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 ('94 Act) are becoming well known to bankers. However, a barely known provision of the '94 Act will prove to be valuable to both community banking organizations and larger institutions.
This provision, section 101(d) of the '94 Act, is known as the "affiliates" provision.
For almost 70 years, federal law has barred banks from branching interstate. Bank holding companies (BHCs) operating on a multistate basis have been able to do so only by establishing a separate legal entity in each state.
Prohibiting banks from operating as integrated entities across state lines or even within states has impaired banking efficiency. To a considerable degree, this adverse impact has been mitigated by the integration of affiliated banks' back-office operations. However, front- office operations - such as deposit-taking and lending - generally have not been similarly unified.
The '94 Act will facilitate the unification of both back-office and front-office operations through the conversion of a multibank interstate BHC system into a single branched bank. In general, the '94 Act will not permit such conversions until June 1, 1997. The '94 Act dictates that these conversions must be accomplished through mergers, which will require the prior approval of a federal regulator. (A state can permit such conversions at an earlier date. Prior to June 1, 1997, a state also can opt out of interstate branching, although the affiliates provision may make such opt-outs a waste of legislative effort.)
The affiliates provision in the '94 Act will become effective on Sept. 29 of this year, almost two years before interstate branching becomes effective. This provision will permit a bank to act as the agent of an affiliated depository institution - located in the same or another state - for specified activities without being considered a branch of the affiliated depository institution. By not being a branch, an agent bank located in another state will avoid the long-standing prohibition on interstate branching as well as the new procedural requirements for it.
The affiliates provision builds on a series of OCC "no-objection" letters issued beginning in the fall of 1992. In these letters, the OCC ruled that a national bank can take various actions as the agent of an affiliated bank, including accepting deposits, without being considered a branch of the affiliated bank. The letters indicated that the activities of the agent bank would be subject to certain policies and procedures intended to ensure its safe and sound operation.
The OCC letters were responses to requests to establish intra-state affiliate operations. As indicated by such requests, the establishment of such operations can be valuable not only on an intrastate basis, but also interstate. Hence community-sized BHCs everywhere, and not just near state lines, will be able to utilize the affiliates provision, unless state law bars its use on an intrastate basis.
Although the affiliates provision has not yet attracted much attention in the banking community, it significantly alters existing law since the affiliates provision now makes available to all banks, on an "off the rack" basis, a regulatory product that was previously available only from the OCC on an individually tailored basis.
Under the affiliates provision, the activities that a bank can engage in as agent for an affiliated depository institution include, among others:
* Accepting deposits for crediting to existing accounts.
* Renewing time deposits.
* Servicing loans, such as providing loan applications, assembling documents, providing a location for returning documents necessary for making a loan, and providing loan account information.
* Receiving loan payments.
This provision does not permit agent (or affiliate) banks to establish new deposit accounts, make credit decisions, or disburse loan funds. Given the modest nature of these restrictions, BHCs will be able to use the affiliates provision to achieve nearly the same front-office integration offered by interstate branching.
The affiliates provision does not affect any other provision of law determining whether an agent bank should be considered a branch of the affiliated depository institution. Therefore, state laws contrary to the affiliates provision could negate its impact unless amended to conform with it, but only with regard to intrastate relationships between affiliates. State legislatures will not be able to restrict the interstate operation of the affiliates provision in the '94 Act.
From the standpoint of a community-sized banking company, affiliate banking will offer significant potential benefits. These benefits potentially will be greater for smaller BHCs than for larger ones, since smaller institutions should be able to implement affiliate banking more swiftly and to realize relatively greater efficiency gains.
Additionally, two unrelated community banks, one on each side of a state line, could join together to form a BHC that would then utilize the affiliates provision to operate the two banks as if they were one.
Critical to the rapid implementation of affiliate banking is the fact that it will not be subject to prior regulatory approval. This contrasts sharply with the regulatory prior approval process mandated by the '94 Act with respect to interstate branching.
Except in emergency situations, the '94 Act requires interstate branching applications to take numerous factors into account, including CRA compliance, specified deposit-concentration caps, and capital and management adequacy. Moreover, affiliate banking can be implemented even if one or both states involved opt out of interstate branching.
In addition, while yielding substantially the same efficiency gains as a merger of two or more affiliated banks, affiliate banking has certain otherwise unavailable advantages.
For example, the merger of separately chartered affiliated banks into a single branched bank will reduce deposit insurance coverage for individual depositors. Today, a depositor with accounts in two affiliated banks now enjoys two deposit insurance limits. That customer will lose one of these limits approximately six months after the consolidation of the two banks.
Affiliate banking will avoid this problem by maintaining the separately chartered status and deposit insurance limits of the affiliated institutions. Preserving several deposit insurance limits may be the affiliates provision's greatest benefit for smaller BHCs.
Also, the merger of several banks into one bank will erase the local identity of each (or all but one) consolidating bank. This will not be the case with affiliate banking.
Further, the implementation of affiliate banking leaves the door open for branching at a later date. However, once affiliate banking has been implemented, the banks involved may conclude that moving on to branching will afford little additional benefit.
Indeed, some BHCs may want to convert existing branches of a single bank into separately chartered banks that are linked in an affiliate-banking relationship. Such a BHC would lose little in terms of the integration of its front-office operations. At the same time, the BHC would gain increased aggregate deposit insurance coverage for its larger depositors and increased local identity for each of the new banks. Also, some BHCs with substantial Oakar deposits may find the affiliates provision a useful way to minimize the growth in their SAIF assessments.
Community-sized BHCs that are establishing affiliate banking must address several implementation issues. For example, they will have to develop, implement, and monitor policies and procedures for ensuring the safety and soundness of the arrangement. These procedures should be spelled out in a formal contractual agreement between the affiliated banks.
The no-objection letters referred to above give some guidance as to what these policies and procedures will involve. For example, the participating banks should:
* Clarify the legal relationship over such matters as which bank bears the risk of loss with respect to items in transit and when transactions will be posted to depositor accounts.
* Establish appropriate procedures for identifying, segregating, and properly recording items received by one bank on behalf of an affiliate.
* Develop policies with respect to record keeping, reporting, and customer disclosure to ensure compliance with applicable legal and prudential requirements, including any relevant laws regarding financial privacy.
* Establish procedures for explaining the affiliate-banking relationship to customers, including informing customers of any changes in the arrangement and making clear that the participating banks are separate legal entities.
* Allocate costs among the affiliates on an arms-length basis.
* Establish procedures for resolving disputes among the participating banks.
The most important aspect of the safety-and-soundness requirements for affiliate banking is that they will be no more onerous than the safety-and- soundness requirements applicable to branched banks.
The affiliates provision of the '94 Act has received relatively little notice thus far. It is significant, however, because it permits the achievement of almost as much front-office integration as will be possible under interstate and intrastate branching while also permitting the realization of certain additional benefits.
Further, the costs of implementing affiliate banking will not be burdensome, and may be much lower in the aggregate than the costs of implementing branching. Community banking organizations considering how to apply the '94 Act should therefore give immediate consideration to the affiliates provision.
Mr. Mann is a partner in the Washington, D.C., office of the law firm McDermott, Will & Emery. Mr. Ely is the principal in Ely & Co., a financial institutions consulting firm based in Alexandria, Va.