As smaller banks start looking at ways to add low-cost deposits, thrifts in New York could benefit from an effort in the state legislature that would let them expand their municipal banking business.

But not if the state's banking lobby has something to say about it.

The New York Bankers Association and the Independent Bankers Association of New York State are opposing a bill in the state Senate that would lift New York's ban on municipal deposits at thrifts — potentially benefiting several of their member banks. Their opposition stems from a provision in the bill that would also let credit unions accept public funds.

The groups argue that their stance is necessary to protect the industry against competition from credit unions, even if it creates problems for thrifts, representatives for the groups said.

"We really have to defend ourselves against what credit unions are trying to do, to expand into the community banking territories, geographically and businesswise," said John Witkowski, president and chief executive of the Independent Bankers Association of New York State.

Commenting on the reaction of thrifts in his organization, Witkowski said it is his job to do what's best for the majority of his group's members. "You can't please everybody," he said.

"Our argument is very simply that public deposits are taxpayer dollars, and in some cases are taxpayer dollars of banking institutions," said Michael Smith, president and chief executive of the New York Bankers Association. "We think it's unfair that credit unions should receive this authority" given their tax-exempt status.

The New York Bankers Association "strongly supports thrift institutions," and would back the bill if credit unions were excluded, Smith said.

Tension over municipal deposits has been brewing in the state in recent years. The issue most recently made headlines in 2010, when Michael Bloomberg, who was then mayor of New York City, lobbied the state legislature to lift the deposit ban.

The effort was part of broader effort by the mayor's office to expand financial services in low-income communities. Allowing savings banks and credit unions to accept municipal deposits would "increase the number of loans they issue to low-income families and small neighborhood businesses across the city," Bloomberg said in a 2010 statement.

The banking groups opposed the 2010 effort because of the potential benefits for credit unions.

"The credit union tax exemption provides credit unions with a dramatic competitive advantage over tax-paying commercial banks and thrift institutions," the New York Bankers Association wrote in a position paper at that time.

Because of the New York law, commercial banks control the state market for municipal deposits, which have been growing as more cities rebound from the financial crisis.

Public deposits accounted for $24.5 billion, or 4%, all deposits at New York banks at Dec. 31, rising 85% since 2010, according to data from the Federal Deposit Insurance Corp. The agency's database does not differentiate between state and municipal deposits.

The bill, as introduced in the New York Senate, would give savings banks, savings and loan associations, federal savings associations and credit unions the authority to hold up to $1 million in deposits from local governments.

Several of state's largest financial institutions have savings institution charters, including the $44 billion-asset New York Community Bancorp in Westbury and the $15 billion-asset Astoria Financial in Lake Success. Neither bank responded to a request for comment.

"Municipal deposits could allow credit unions and savings banks to increase their deposit base, and greatly scale up the offering of affordable products to serve New Yorkers with low incomes," according to a memo introduced alongside the bill, which was sponsored by Sen. James Sanders, a Democrat from New York City.

In response to the ban, some New York thrifts have used a legal workaround to get into municipal banking. Since the passage of the Gramm-Leach-Bliley Act in 1999, the state's thrifts have been able to establish commercial units to accept public deposits, said Tom Schneider, the president and chief executive of Pathfinder Bank in Oswego, N.Y.

Pathfinder formed a commercial unit in 2002, after it bought municipal deposits through a branch deal with the First Niagara Financial Group in Buffalo, N.Y., Schneider said. The $561 million-asset thrift has separate internal systems to accommodate both charters — a process that can be "cumbersome and inefficient," he added.

"From a compliance perspective, regulatory costs are higher" Schneider said.

Pathfinder's commercial bank has $63 million in municipal deposits, compared to $428 million in deposits under its primary charter, according to FDIC data. In total, thrifts throughout New York hold roughly $1.4 billion, or 5%, of the state's public deposits.

Though Pathfinder could benefit from the bill, Schneider backs the New York Bankers Association's position — mostly because it blocks credit unions from entering municipal banking.

"We are very firm in our stance that the power not be extended to credit unions," Schneider said. "Why should they gain the advantage of serving the same municipalities that they are denying?"

The bill has received the backing of New York Credit Union Association, a state trade group representing credit unions. The NYCUA would prefer, however, that lawmakers consider a bill that does not contain a cap on public deposits, said Michael Lanotte, the association's general counsel.

"We are aware of Sen. Sanders' bill and applaud [his] effort to provide municipalities with access to all financial institutions," Lanotte said.

With only three months left in the state legislative session, it's unclear whether the bill has the momentum necessary to pass both chambers. The New York legislature wraps up its current session at the end of June.

"You just never know what's going to happen," Witkowski said, noting that it's hard to make predictions about New York politics.

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