WASHINGTON - A federal appeals court ruling this week appears to be a mixed blessing for the industry's efforts to retain its insurance powers.

On the one hand, the decision could help salvage insurance powers for banks in small towns. But is also threatens other activities, like the sale of annuities.

The decision Monday in New York by the U.S. Court of Appeals for the Second Circuit upheld the validity of a 1916 law that permits banks to sell insurance in towns of fewer than 5,000 persons.

A federal appeals court in Washington ruled last month that Congress had inadvertently repealed the small-town exemption in 1918. After that ruling, prospects for review by the Supreme Court appeared dim, because the appellate panel was nearly unanimous in refusing to rehear the case.

"Now there's a clear split among the districts," said Michael F. Crotty, who oversees litigation for the American Bankers Association. "That almost guarantees a Supreme Court decision."

But the court's decision also signaled growing judicial support for the notion that the small-town exemption was intended to limit, rather than expand, insurance powers for national banks.

As a result, other insurance powers approved as "incidental to banking" including the sale of annuities and credit life insurance, could be nullified by the courts.

"Clearly, if the courts continue on that theory - that banks can only exercise insurance powers in small towns - that could happen" said Alan Schott, a former general counsel to the comptroller of the currency.

The trend is worrisome to many industry analysts.

"The preservation of incidental powers is one of the most important issues for the banking industry." said Karen Shaw, president of the Institute for Strategy Development.

The issue is already being raised in a case pending in the U.S. Court of Appeals for the Fifth Circuit that attacks annuity powers by arguing that Congress intended to limit bank activities in 1916.

"The passage of section 92 means that Congress did not intend for national banks to have additional insurance powers," said Jonathan Sallet, a lawyer who represents the Independent Insurance Agents of America. The small-town exemption is contained in section 92 of the federal statute.

"It means we will win on annuities, too," he added.

In its ruling, the court in New York said the legislative record "provides evidence that Congress intended to withhold from national banks, located in towns with over 5,000 inhabitants, the authority to sell insurance."

The court cited a 1968 case, decided in the same circuit that is hearing the annuities suit, that said the comptroller of the currency erred in concluding that the sale of auto, home, property, and casualty insurance is incidental to banking.

The 1968 case also relied on the notion that Congress had intended to limit bank insurance powers in passing the small-town exemption.

As a result, the insurance agents believe they may be able to have the best of both worlds. Mr. Sallet argues that the courts, after concluding that Congress intended in 1916 to limit bank insurance activities to small towns only, could then decide that even that grant of authority is no longer valid.

Bank lawyers also hope to have it both ways. They are hopeful that the Supreme Court will agree as a result of Monday's decision to hear arguments on the small-town exemption.

And they believe that insurance powers approved as incidental to banking will be permitted to stand.

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