Flaws Abound in Interstate Branching Bill

It has become a virtual cliche to talk about how interstate banking has finally become a reality in the United States. Yet, as anyone involved in the banking industry is acutely aware, there is a vast difference between the interstate ownership of individual banks and interstate branching by individual banks.

As interstate ownership of banks inches forward, through progressive efforts of individual states, Congress did its best to avoid the issue. Now, however, at the prodding of the Treasury Department and various industry groups, Congress appears on the verge of seriously considering major reform to permit interstate branching for national banks.

Such a move would undoubtedly encourage the states to do likewise, for state-chartered banks. Once the threshold issue - interstate branching capability for national banks - is crossed, however, Congress must address the much trickier question: how and by whom those branches would be regulated.

The Treasury report on modernizing the financial system addresses this issue, albeit in limited form, with respect to state-chartered banks. The report recommends that activities of a national bank would continue to be defined by federal law, regardless of the location of its branches.

Possible End to Incentive

Both the report and Treasury bill recommend a different approach when a state bank, permitted to engage in one set of activities in its home state, branches into a host state that permits a different set of activities: The host state's laws should apply to those branches.

This approach would eliminate any regulatory incentive to charter a bank in the state with the most liberal activities rules, then branch into all the other states. In theory, Congress could draft legislation that treats national banks in the same manner.

The Treasury report and bill, however, raise more questions than they can answer, since they address only the powers available to out-of-state branches.

In the absence of a cooperative agreement between two states, the Treasury bill would permit the host state to examine a branch only to determine compliance with host-state law regarding permissible activities, and to ensure that those activities are conducted in a sound manner.

The bill would permit the host state to take any enforcement actions permitted under host-state law - as if the branch were deemed to be a bank chartered by that host state. But the bill does not appear to authorize enforcement action against the bank itself.

Focus on |Powers' Question

Nor does it authorize the host state to examine a branch or take enforcement action under circumstances unrelated to the "powers" question. Presumably, although unstated in the Treasury bill, that supervision will be left to the home state.

Thus, Treasury's bill will impose a multiplicity of regulators on state banks branching into other states.

In the context of national banks, (and outside the context of the Treasury report) more structures are available:

* The powers and activities of out-of-state branches of national banks could continue to be defined by federal law, and such branches could continue to be regulated and supervised by the Office of the Comptroller of the Currency.

* The powers and activities of out-of-state branches of national banks could continue to be defined by federal law, but such branches could be regulated and supervised by the host-state regulator.

* The powers and activities of out-of-state branches of national banks could be defined by the law of the state in which they were located, but regulation and supervision of the branches could remain with the OCC.

* The powers and activities of out-of-state branches of national banks could be defined by the law of the state in which the branch is located, and such branches could be regulated and supervised by the host-state regulator.

* Finally, regardless of where the powers of the out-of-state branches of national banks derive, the branches could be regulated and supervised in a joint capacity, by both the OCC and the host state.

Radical by U.S. Standards

As noted in the Treasury Department's report, full home-state regulation for state banks, based on the European Community model, is a concept too radical to gain much acceptance in the United States.

Nevertheless, that is precisely the type of system that has always been in place for national banks. Some proponents, however, support the concept of host state regulation for out-of-state branches of national banks, along the lines of the so-called Wilmarth proposal.

That proposal would essentially "Douglasize" the McFadden Act. States would be permitted to require conditions, limitations, and restrictions on the entry of interstate branches of national banks, to the same extent as the Douglas amendment permits for interstate acquisitions by bank holding companies.

Additionally, national banks would be able to branch interstate only to the same extent as state banks located in the same state.

Reality Tests for Branching

Allowing state regulation and supervision of a national bank's out-of-state branches can have significant - and almost universally adverse - implications for the individual bank as well as for the reality of interstate branching.

Two issues are critical: the derivation of powers for out-of-state branches of national banks and regulation and supervision of such branches.

On the powers question, the problems are both practical and political. Congress, over the objection of the OCC, is not likely to enact legislation providing powers for out-of-state branches of national banks that are greater than those available under the National Bank Act.

Thus, to the extent legislation authorized state law to control the activities of out-of-state branches, it would be only in a limiting, not expansionary, fashion.

Bankwide Products Unlikely

Bankwide products, services, lending policies, and the like would not be possible. Indeed, except for the consolidation of certain back-office operations and the elimination of multiple boards and executive structures, the branches in each non-home state would have to be operated essentially as separate banks in order to ensure compliance with each state's requirements

The disruption in day-to-day operations of an individual bank that would be caused by differing banking authorities is only part of the problem, however. Regulation and supervision of branches of national banks, either solely by state agencies or jointly by both state agencies and the OCC, creates at least as many - if not more - problems.

If sole regulatory and supervisory authority were to rest with the state authorities, a single bank would have as many regulators and supervisory agencies to deal with as the number of states into which it has branched.

Furthermore, it is unlikely that a state regulator could conduct a competent examination of the branches of an out-of-state national bank within its state without access to at least some of the books and records of the bank as a whole. This would subject a national bank, with branches in 10 states in addition to its home state, to examination requests of varying degrees from 10 different state regulators as well as the OCC.

50 Separate Interpretations

If the derivation-of-powers question were to be settled in favor of federal law, host-state regulation would require 50 state regulatory bodies to interpret and applying federal banking law as it related to out-of-state branches.

Notwithstanding the long history of interpretations and decisions from the OCC, it would be naive to expect consistency from 50 different regulators. National banks headquartered in a particular state would operate under different rules than those applicable to out-of-state branches of national banks; and both would likely be different than the rules applicable to state-chartered banks in that same state.

Such a structure has the potential to replace the traditional dual-banking system with a dual-banking system for individual national banks and a triple-banking system for the industry as a whole.

Proponents of the Wilmarth proposal point out that state control over bank geographic location has a long history. Such continued control, it is argued, is necessary to protect consumers dealing with banks; to ensure that banks operate within the laws; and that, in case of a failure, both customers and creditors are treated fairly with minimal impact on the local economy.

Truth of National Banking

Those premises, however, ignore national banking reality. While states can prevent bank holding companies from entering their borders via a national bank acquisition or establishment, they can only do so if the holding company owns a bank in another state.

States can restrict branching by national banks, but only by restricting the branching powers of their own state-chartered banks. Beyond that, the states have no authority to prevent the Comptroller of the Currency from chartering a national bank in any location within their borders.

That authority has rested exclusively with the OCC for over a century. If a state permits its banks to branch within the state, it cannot prevent the OCC from authorizing a national bank to branch in any location within that state's borders.

Chartering Objections

Host-state proponents do not object to the OCC's long-standing authority to charter a national bank at any location within a state. Rather, they object to allowing the OCC to charter a national bank branch at the same location.

State bank regulators do have legitimate cause for concern over full interstate branching by national banks. Once national banks gain full interstate branching power, some state banks will inevitably switch charters.

State banks wishing to branch interstate, to any significant degree, will be caught in the fractured regulatory structure already described. Any significant switching of charters will mean reduced power for state banking departments, as well as reduced revenues from chartering, examination, and similar fees.

To prevent such charter switching, proponents of host-state regulation seek to impose the same fractured regulatory structure on national banks.

Congress, as noted, is unlikely to grant powers to out-of-state branches of national banks in excess of their powers under the National Bank Act and other federal laws. Nor is Congress likely to strip the OCC of its regulatory and oversight responsibilities over national bank branches - wherever located.

Answer in State Hands

Is there a solution for the concerns of state bank regulators, short of a convoluted system that would impose at least two supervisory bodies on each out-of-state branch of a national bank and up to 50 on the bank as a whole?

The answer lies squarely in the hands of the states and their state bank supervisors.

Treasury's proposal maintains the right of each state to determine whether to authorize interstate branching powers for its own state banks. Treasury explicitly recognized, though, granting such authority to national banks would obviously increase competitive pressure to do so. But the competitive pressure for states to act should not stop at that threshold.

To maintain and enhance the value of a state bank charter, the states must work together to develop cooperative agreements. Such development would lessen the burdens imposed on state banks branching into other states.

Alleviating Some Burdens

Even on a regional basis, agreements between the states -- analogous to the interstate banking compacts entered into by various states during the 1980s - would go a long way toward alleviating some of the burdens that will be faced by interstate branches of state banks.

Arizona and Utah, for example, have worked out an agreement for regulating a Utah branch of an Arizona-chartered bank. This agreement resulted from a transaction in 1990 by the Resolution Trust Corp. In this case, an out-of-state bank holding company acquired a failed thrift in Arizona, then converted it to a state-chartered bank. The agreement embodies the host-state concept, under which Utah will be primarily responsible for examining the branch.

Ultimately, the only comprehensive answer will be development - among the states - of uniform regulatory and examination standards for the treatment of interstate branches of state banks. The Conference of State Bank Supervisors is uniquely situated to begin work on such a project.

With an appropriate framework designed to minimize the regulatory burden on out-of-state branches, the value of a state bank charter will not only be preserved, it will be enhanced.

Mr. Patrick S. Antrim is an attorney with the Washington office of Pillsbury Madison & Sutro, specializing in financial institution matters.

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