Verle B. Johnston.

English

Research Papers in Economics

FRBSF WEEKLY LETTER
July 26, 1985
The joy of Interstate Banking: II
Last week's Letter provided an overview ofthe
current dimensions and nature of interstate bank-
ing, including legislation designed to facilitate its
development at the regional level. As that Letter
pointed out, interstate banking already exists in
the form ofnonbankorganizations that provide
banking services on a nationwide basis. Whether
banks perse will be allowed to conduct business
on a nationwide basis, however, depends on the
resolution ofseveral thorny and related policy
issues. These include "nonbank banks," expan-
sion ofasset and liabilitypowersforbanks, deposit
insurance reform, and regulatory restructuring.
This Letter reviews these issues and developments
that may variously act as catalysts orobstacles in
influencingthe pace ofthe move towards inter-
state banking legislation on the national level.
Views from Capitol Hill
One ofthe issues that some members ofCongress
insist must be addressed in conjunction with any
discussion of interstate banking is the nonbank
bank movement. This movement presents a par-
ticularly difficult policy problem because many
nonbank banks are notowned by banking organi-
zations and therefore run counter to the long held
view that banking and commerce ought to be
separate. Moreover, since nonbank banks do not
offer both demand deposits and commercial loans,
they are not banks in the technical sense and are
able to skirt restrictions on interstate branching
directed at banks. In response, legislation has
been passed by the House Banking Committee
(Chairman St Germain's HR 20, the "Financial
Institutions Equ ityAct")orwill be re-introduced in
the Senate to plug the nonbank loophole by
broadeningthe definition ofabankto includeany
institution insured by the FDIC.
Completelypluggingthe nonbankbank loophole,
however, may prove difficult. A numberof large
commercial banks already view nonbankbanks as
a means ofextending their operations across state
lines. A while back, Senate Banking Committee
Staff Director DannyWall commented that "as
every day goes by there is more and more opposi-
tion to closing the loopholes," and especially to
imposingthe July 1, 1983 grandfathering date.
Both theChairmen ofthe Houseand Senate Bank-
ing Committees had originally insisted upon that
date. Even now, HR 20 sets agrandfathering date
at May 9, 1984 for nonbank banks established
priorto thatdate.
Federal Reserve Board Chairman Volckerrecently
noted that savings banks and unitary S&Ls should
not be excluded in any amendments to banking
legislation because that would leave a potential
loophole for nonbank banking through the acqui-
sition ofsuch thrifts by commercial and industrial
entities. HR 20 addresses this consideration by
exempting only "qualified" thrifts-thosethat
have 65 percent oftheir assets in residential mort-
gages and related investments. The Independent
Bankers have also pointed outthatnonbankbanks
may be acquired through state charter, as Sears
did in Delaware. To date, only some seven states
have passed legislation specifically prohibiting
nonbank banks.
Recently, there has been renewed interestIn
authorizing so-called "consumer banks." The
Chairman ofSears Roebuck, in asking for Con-
gressional authorization, called them "family
banks" thatwould take deposits (withoutcharge
oraminimum balance requirementand pay inter-
est) and make loanstofamilies and small business;
theywould operate in conjunction with Sears',real
estate, insurance and brokerage business.
Chairman Volcker strongly opposes consumer
banks on the grounds thatthey are simply a
specialized nonbankbank. The "familybank," an
unhappy Independent Bankers Association of
America (IBAA, which represents mainly smaller
banks) recently noted, is "skillfullywrapped in
God, motherhood and country...but is nothing
more than a nonbank bank in drag."
The fierce intra- as well as inter-industry debate
these developments have caused is reverberating
in Congress. Senate Banking Committee Chairman
Jake Garn (R-UT), forexample, has tied anyclosing
ofthe nonbank bank loopholeto other issues
involving competitive equity and the financial
structure. These include expanded lending and
investment authority and the issue of interstate
banking. In contrast, House Banking CommitteeFRBSF
Chairman St Germain (D-RI) clings tenaciously to
the viewthatthe questionofexpanded powersfor
banks should be addressed only after (1) closing
the nonbankbank loopholeand (2) addressing the
issues ofdeposit insurance and the safety and
soundness ofthefinancial system. The latter issue,
he notes, is underscored bythe recentContinental
Illinois crisis and by the rising numberofbanks
and savings and loans (S&Ls) on regulators'
" problem" lists.
Vox populi: gopher prairie and central city
In the meantime, back in the trenches, the
American Bankers Association (ABA) and the
Association of Bank HoldingCompanies (ABHC)
are in an ongoing dispute with the IBAA over the
interstate banking issue.
In February, the ABA endorsed proposals that the
nonbank bank loophole be closed (with the July
1983 grandfather date) but only on two condi-
tions. One is thatCongress specifically authorize
regional banking compacts with atrigger requir-
ing fuII interstate banking afterfive years for those
states thatenactregional legislation in the interim.
The other condition is that the powers of BHCs
(and their subsidiaries) be broadened to include
the underwritingofmunicipal revenue bonds,
mortgage-backed securities and commercial
paper, plus authority to offer money market
mutual funds (which the Federal Reserve Board
also supports) andengage in real estate investment
developmentand brokerageand insurance under-
writing and brokerage.
For its part, the ABHC also opposes pluggingthe
nonbankbank loopholewithoutgeographical and
productderegulation, noting that the large money
center banks hold 31 percent ofbank assets but
only 15 percentofrelatively stable consumer
deposits. Itthus envisions the elimination or mod-
ification ofcurrent geographical and product
restrictions as a means of reducing the risks
inherent in the asymmetrical structure ofthe
money center banks' assets and liabilities-
Continental Illinois representing a case in point.
Predictably, theABAand ABHCproposals elicited
outrage from the 8,000 member IBAA, which
called the conditional, or "linkage", approach
"rotten" and claimed thatthisapproach is precisely
what forestalled loophole plugging efforts in the
House last year. The IBAA's Executive Director
recently noted thatwhile 90 percent ofhis organ-
ization's members oppose interstate banking per
se, some would rather see interstate restrictions
Iifted altogetherthan gothe routeofregional com-
pacts. Nationwidebankingofcourse would increase
the numberofpotential buyers of local banks.
The stance ofthe securities and insurance indus-
tries mayfurther complicate the efforts to plug the
nonbank bank loophole. Those industries seem
certain to continueto oppose any significant
broadeningofbankpowers, and theirtrack record
in Congress thus far has been fairly good.
Vox magistratis
In February, the u.s. DistrictCourt, in response to
a suit filed by the Florida Bankers Association and
the IBAA, issued apreliminary injunction restrain-
ingthe Comptrollerfrom grantingfinal approval to
chartersfor nonbankbanks. Itdid so on the grounds
that the Comptroller's authority only covered the
chartering ofbanks, and that Congress did not
intend to remove nonbank banks from the provi-
sions ofthe Bank HoldingCompany Act. In ApriI,
the u.s. Appeals Court in Atlanta, in a different
case, ru led that itwas notCongress' intenttoallow
banks to use nonbank banks as a guise for collect-
ing deposits across state lines.
However, lastSeptember, the U.S. CircuitCourt in
Denver, in asuitbroughtbythe Dimension Finan-
cial CorporationofKansas City(which is planning
to operate thirty-one nonbank banks in twenty-five
states), ruled that in 1982 and 1983 the Fed
exceeded its authority in an initial attempttoclose
the nonbank bank loophole. The Fed had expanded
its definition ofdemanddeposits to include NOW
accounts and its definition ofcommercial loansto
include virtually all loans other than personal
loans. The Courtsaid thatthe Fed's action "simply
was adevice to accomplish an end-a change in
the Board's jurisdiction."
Recently, the Supreme Courtagreed to hear the
Denver case on appeal bythe Board ofGovernors,
with the IBAA appearing in its support. It is the
view at the Board that the CircuitCourt "misread
or ignored the relevant legislative history" and
Congressional intent governing the Board's res-
ponsibilities under the Bank HoldingCompany
Act. These responsibilities include maintaining
the separation ofbanking and commerce. (In addi-
tion, The MonetaryControl Actof1980specifically
groups NOWaccounts with demand deposits in
its definition of "transactions accounts.")Regulatory reform
Still another potentially importantcatalyst for
change is the Bush Task Group proposals for re-
form ofthe bank regulatory structure, which have
been formalized and recently submitted to Con-
gress. In the view ofmany in Congress, a restruc-
turing ofthe bank regulatory apparatus notonly is
essential to restoring confidence in the safety and
soundness ofdepository institutions (their primary
concern), but also to ensuring that future financial
developmentwill occur in a mannerthat allows
institutions to compete on an equitable basis.
Whether implementation ofthe Bush proposals
would in fact achieve this is a matterofsome
dispute, butapriori, many in Congress believe
that regulatory reform should precede, or at least
accompany, further moves to deregulate geo-
graphical and product markets.
In this connection, one ofthe Bush recommenda-
tions would place responsibility for merger and
acquisition analyses solely in the hands ofthe
Justice Department rather than (as at present) in
the three separate federal banking agencies. This
means that the Justice Department will be respon-
sible for developingappropriate measures for
assessing regional and/ornational "concentration"
and foranswering such presumably relevantques-
tions as "atwhatpointdoes size (or as somewould
argue, "success") becomesociallyunacceptable?"
and (with an eyetothejointventures and franchis-
ingarrangements thatprobablywiII be essential to
the survival ofthe"Iittleguys'') "exactlywhere are
the dividing lines between competition, coopera-
tion and collusion?"
Deposit insurance reform
Closely related to both the matter of regulatory
reform and the "safety and soundness" ofdeposi-
tory institutions is reform ofthe deposit insurance
system. Underlyingthis issue is the broaderoneof
theextenttowhich thefederal "safetynet" should
(as itclearly has done in some cases) blunt market
discipline as ameans ofenforcingbetterdecision-
making on the partof institution managers, stock-
holders and depositors alike. Inevitably, these
considerations are bound to the question of
expanded powers and geographical deregulation,
and to the potential increases in concentration
and increases (ordecreases) in risk thatwill result.
By definition, the larger an institution the greater
the potential risk to the insurance fund especially
if, as in theContinental Illinoiscase, publicpolicy
decides that considerations ofsafety and sound-
ness require thatall depositors be protected
regardless ofthe sizeoftheirdeposits. Conversely,
while geographic and at least a modest degree of
productderegulation conceivably should work in
the direction of reducing market risk, risk actually
could be increased to the extent that market
opportunities rather than the "safety net" are
allowed greater latitudeto influencethe decisions
of institutional managers and their customers.
March oftechnology
The continuing "marchoftechnology" and related
courtdecisions also will ensure that deposit and
payments services are available to households and
businesses on a nationwide basis.
For example, in February, the Appeals Court in
New York (in Independent Bankers ofNew York
vs. MarineMidland) reversed a District Court and
upheld a ruling ofthe Comptrollerthat an auto-
mated teller machine (ATM) used but notowned
byabank (in this case, oneowned byagrocergnd
leased by a bank) is not a branch ofthe bank. The
lowercourt had interpreted the MacFadden Act,
which definesabranch as any national bankfacil-
ityatwhichdeposits are received and checks paid
or money lent, to include ATMs used but not
owned by a national bank. However, the Appeals
Court stated that the language ofMacFadden was
notdeterminative and that a rigid application ofa
lawwritten in 1927 to newtechnology fails to
confronteconomic realities and would lead to
anomalous results.
The significance ofthe Appeals Court ruling (if it
stands) is that currently some 16,000ATMs are
tied to 200 networks processing 60 million trans-
actions a month, and about 100 ofthese networks
operate on an interstate basis. Significantly, tne
Appeals Court also noted that ATMs are noteven
the cutting edge ofthe newtechnology, and that
the wave ofthe future involves point-of-sale and
home banking systems, which is precisely what
some (including in the Fed) were arguing many
years ago. In any case, the court noted that it
simplywould "defycommon sense" to considera
home computer as a branch ofa bank,
The remaining question, therefore, seems to be
whether such banking services will be provided
by traditional banking organizations. The answer
lies intheresolution ofthenonbankbankissue, as
well as in theoutcomeofvarious regulatoryreform
proposals now before Congress.
Verle B. Johnston
Opinionsexpressed in this newsletterdo not necessarily reflect theviews of the managementofthe Federal Reserve Bank ofSan
Francisco,orofthe Board ofGovernorsofthe Federal Reserve System.
Editorialcommentsmay beaddressedtotheeditor(GregoryTong) ortotheauthor....Freecopiesof Federal Reserve publications
can beobtainedfrom the Public Information Department, Federal Reserve BankofSan Francisco, P.O. Box 7702, San Francisco
94120. Phone (415) 974-2246.uo~6U!4S0m 4o~n uo6~JO 0po,,~U
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BANKING DATA-TWELFTH FEDERAL RESERVE DISTRICT
(Dollaramounts in millions)
Selected Assets and Liabilities
Large Commercial Banks·
Amount
Outstanding
7/10/85
Change
from
7/3/85
Change from 7/11/84
Dollar PercenF
Loans, Leases and Investments1 2 192,733 - 434 11,005 6.0
Loans and Leases1 6 173,797 - 604 11,045 6.7
Commercial and Industrial 51,402 - 117 1,355 2.7
Real estate 63,498 109 2,892 4.7
Loans to Individuals 34,732 44 6,116 21.3
Leases 5,432 33 392 7.7
U. S. Treasury and Agency Securities2 12,124 165 129 1.0
OtherSecurities2 6,813 6 - 167 - 2.3
Total Deposits 197,974 -3,597 8,182 4.3
Demand Deposits 47,278 -3,141 1,476 3.2
Demand Deposits Adjusted3 31,831 777 1,212 3.9
OtherTransaction Balances4 13,967 - 221 1,517 12.1
Total Non-Transaction Balances6 136,729 - 234 5,188 3.9
MoneyMarket Deposit
Accounts-Total 44,699 44 6,273 16.3
Time Deposits in Amounts of
$100,000 or more 37,711 - 280 - 2,166 - 5.4
Other Liabilities for Borrowed MoneyS 22,818 - 54 3,912 20.6
Two WeekAverages
of Daily Figures
Reserve Position, All Reporting Banks
Excess Reserves (+)/Deficiency(-)
Borrowings
Netfree reserves (+)/Netborrowed(-)
Penodended
7/1/85
21
91
69
Period ended
6/17/85
76
11
65
1 Includes loss reserves, unearned income, excludes interbank loans
2 Excludes trading account securities
3 Excludes U.5. government and depository institution deposits and cash items
4 ATS, NOW, Super NOWand savings accounts with telephone transfers
S Includes borroWing via FRB, TI&L notes, Fed Funds, RPs and other sources
6 Includes items notshown separately
7 Annualized percent change

The joy of interstate banking: II

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The joy of interstate banking: II

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