The McFadden Act of 1927 was once thought of as an insurmountable barrier to interstate branching by national banks. The courts had construed the law strictly to prohibit branching across state lines.

National banks could not operate interstate offices that carried on the business of banking by accepting deposits or making loans.

Some have argued that these court decisions have resulted in market inefficiencies, placing banks at a competitive disadvantage against nonbanks that have no geographic constraints.

Although states have entered into regional, and in some cases national, compacts to permit interstate banking through subsidiaries of holding companies, the McFadden Act effectively blocked national banks, until recently, from full interstate branching.

Barriers Crumble

In recent years, courts have upheld decisions by the Office of the Comptroller of the Currency, with some exceptions, that break down these barriers to branching.

The McFadden Act has become so riddled with exceptions that it is no longer an effective barrier to interstate branching.

In the next several years, it is likely that the act will be further interpreted by regulators and courts to permit full interstate branching. Congress may accelerate the process by passing an interstate banking law.

These developments will certainly benefit large money-center and regional companies, such as NationsBank. The implications for community banks are less clear, but community banks, on their own or through networking arrangements (much like ATM alliances) with other banks, might also find advantages in interstate banking.

Gradual Changes

The process has been evolutionary, not revolutionary. In the 1960s, the OCC allowed a national bank to move its main office to a location where it could not have a branch under state law and establish a branch office at the old location.

In the 1970s, the OCC permitted national banks to establish loan production offices anywhere in the country, provided that they did not accept deposits or make loans at those offices.

At about the same time, banks were establishing automated teller machines where they could not have branches.

Although the courts held that these terminals met the definition of branches, and were therefore subject to the McFadden Act, they also held that if the terminals were owned or leased by a third party, including another bank, they were not branches.

Brokerage offices

Thus we have ATMs that for all intents and purposes function as nationwide bank branch networks.

Several years ago, the Supreme Court ruled that national banks could operate securities brokerage offices anywhere in the country, because they did not constitute a "core banking function."

Meanwhile, the courts were upholding the Comptroller's decisions permitting national banks to branch within a state anywhere that thrifts could branch, even though state banks were not permitted to establish branches at these locations.

The office of Thrift Supervision has permitted federally chartered thrifts to establish interstate branches. The 1982 Garn-St Germain Depository Institutions Act permitted national banks to acquire failed or failing thrifts and retain their interstate branches.

Under certain circumstances, the 1991 FDIC Improvement Act authorized national banks to acquire the branch networks of healthy thrifts.

New York and Utah have enacted laws permitting reciprocal interstate branching. Several other states have passed laws allowing state banks to merge with banks located in other states and then allowing the resulting bank to operate these offices as interstate branches.

The OCC has recently allowed a state bank with interstate branches to convert to a national bank and to retain its interstate branches, then for the national bank to merge with another national bank in another state and for the resulting bank to retain the branches of both of the banks.

Finally, last October, the OCC issued an interpretive letter that allowed a national bank in Illinois to use banking offices of affiliate banks of its holding company in Illinois to provide accommodation services. Those included depositing and withdrawing funds, even though under the McFadden Act it could be argued that the national bank was improperly operating branches in these affiliate bank locations.

A Sturdy Precedent

There will be further McFadden Act developments. The OCC seems likely to follow the Illinois ruling and permit accommodation services among affiliate banks of a holding company to take place interstate as well as intrastate. Such a ruling would, in effect, permit interstate offices of a holding company system to operate as branches.

Under the reasoning of the Illinois decision, there is also no legal impediment to allowing accommodation services among nonaffiliated banks, much like ATM network arrangements.

The bottom line is that brick-and-mortar offices of banks are no different in law than offices of other businesses or than other forms of modern communications, such as computer networks. The McFadden Act is dead; it has just not been buried.

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