CHAPTER SIX

BANKING REGULATION

Regulation of American commercial banking is intricate, labyrinthine, baffling, and remarkable. It is divided not only between the States and the Federal Government but also, within the Federal Government, among three autonomous regulatory agencies. Its roots go back as far as 1864, which makes it older than railroad regulation, frequently cited as the oldest form of economic regulation in this country. Its statutory authority, on the Federal level alone, is divided among seven major enactments. Undeniably, it contains the seeds of a significant amount of overlap, duplication, and inconsistency. In fact ". [t]he most serious obstacle to improving the regulation and supervision of banking is the structure of the regulatory apparatus.'

The two salient features of the structure of banking regulation today are (1) a dual system under which both States and the Federal Government may charter and supervise commercial banks and (2) a threepart system of Federal regulation for National and insured State banks. The Congress has determined that both stability of the Nation's banks and competition among them are the preeminent goals of bank regulation. This chapter reviews the creation of the current system, its structure and examines organizational alternatives.

Before a commercial bank may open its doors to the public, it must receive a charter or, simply, a license to do business. Once chartered, it is subject to primary supervision by one of the three Federal agencies and, if chartered by a State, to supervision by its own State banking authority as well. Commercial banks may, in effect, select their Federal regulator by changing either their charter status-State versus National or their membership in the Federal Reserve System.*

The Comptroller of the Currency charters and supervises national banks. Of the 14,657 commercial banks in the United States today, 4,748 of them are national banks falling within the Comptroller's jurisdiction. These banks hold 57 percent of the Nation's banking assets. Where permitted by State law, the Comptroller may authorize domestic branches of a national bank. He must approve all mergers between banks where the surviving bank is a national bank.

The Federal Deposit Insurance Corporation insures all National banks and all State banks that are members of the Federal Reserve System. A State bank that chooses not to be a member of the Federal

1 Hackley. Howard H. "Our Baffling Banking System." Virginia Law Review, v. 52, May 1966: 597–632.

2 Golembe. Carter H. "Our Remarkable Banking System." Virginia Law Review, v. 53, June 1967: 1091-1113.

3 Speech by Arthur F. Burns, Chairman of the Federal Reserve Board, before the American Bankers Association, October 21, 1974.

That is, a State chartered bank may elect to become a member of the FRS. In that case, its primary Federal regulator becomes the Fed. If it chooses not to belong to the Fed but seeks FDIC insurance, its primary regulator is the FDIC.

Reserve System may also obtain FDIC insurance. It is called an insured State nonmember bank and is supervised by the FDIC.

The FDIC supervises 8.590 insured nonmember banks which account for 22 percent of the country's banking assets. As an insurer, the FDIC also enters into the disposition of assets of failed banks, regardless of their primary affiliation or that of the banks acquiring such assets. The Corporation also must approve all mergers where the surviving bank is an insured State nonmember bank.

The Federal Reserve System consists of 12 regional banks, governed by a Board of Governors. The Fed supervises all State banks which are members of the system, approves and issues regulations covering foreign branches of member banks-both State and National-and approves merger applications where the surviving bank will be a State member bank. There are 1,030 State member banks today with 19 percent of the total banking assets. All national banks must belong to the Federal Reserve System although the Comptroller remains their primary regulator. In its capacity as the Nation's central bank, the Fed exercises considerable influence over all commercial banks through its control over monetary policy and in its role as a lender of last resort. The Board of the Federal Reserve System regulates all bank holding companies, including their nonbanking activities. It must approve all formations and all acquisitions. It does not, however, directly regulate the bank or banks controlled by the holding company. However, through its ability to withhold approvals of bank holding company applications, it exerts a very definite and potentially very conflicting influence over subsidiary banks, often when it does not have primary responsibility over the subsidiary banks. That is, of the 1.800 registered bank holding companies 5 which control 4.700 commercial banks, nearly 2,000 are national banks and therefore subject to primary regulation by the Comptroller. Several hundred others are nonmember State banks and therefore subject to primary Federal regulation by the FDIC.

Finally, each State has its own banking authority which charters, approves branches and supervises its banks.

The structure of banking regulation is unique. In no other situation does a regulated industry have an opportunity to choose its regulatory agency. This ability to select a regulator through switching charters, joining the Federal Reserve System, or applying for Federal deposit insurance has led to forum-shopping among the banks. That is to say, banks can and do select a Federal regulator which best suits their needs. In turn, forum-shopping has led to competition among the three agencies to attract members. The existence of three Federal bank regulatory agencies has led to inconsistent and often inefficient regulation. In this chapter we examine inconsistencies in the three most significant areas of bank regulation-(1) examination standards, (2) merger policy and (3) bank holding company policy.

The present three-part Federal agency structure was not developed as part of an overall plan. Nevertheless, the divided agency structure

Chase, Samuel B., Jr.. "The Structure of Federal Regulation of Depository Institutions." U.S. Congress. House Committee on Banking. Currency, and Housing. Financial Institutions and the Nation's Economy: Compendium of papers prepared for the FINE Study (Committee print) Washington, D.C. U.S. Government Printing Office. Book I, pp. 145-172. • These 4.700 commercial banks hold two-thirds of the total assets of U.S. commercial banks.

does reflect an historical "abhorrence of the concentration of banking power in either public or private hands."?

Thus, there is not only a scattered and diverse network of banks, but also an equally diffuse filigree of banking regulation. For example, various statutes have carefully defined the limits of mergers between banks both within a single State and across State lines. Efforts to establish a single central bank of the United States failed twice in the 19th century. The sanctity of the dual Federal-State system persisted through the bank failures of the 1930's and is acknowledged today in legislation under consideration by the Congress-S. 684-to unify the Federal banking authorities. The decision to have 12 Federal Reserve banks instead of one also reflects this desire to provide a regional system of banking services.

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The present system also reflects a determination to protect the public's deposits. In practice, this is accomplished both through statutorily authorized examinations which seek to uncover unsound or unsafe banking practices and through the insurance of the public's deposits.

The well-documented bank failures of the 1920's and 1930's resulted in much closer Federal supervision of banks and in Federal insurance of deposits. Regulation and supervision between 1945 and 1961 "can probably best be characterized as one of caution. . ." 10 since business conditions in the postwar period were fostering expanding bank lending portfolios. It was only after a dramatic decline in the number of bank failures and a significant upturn in national prosperity that bank expansion and a resulting concern for competition in the industry returned to prominence. Congress reflected this concern in legislation to control bank mergers and the expansion of bank holding companies.

There is to some extent conflict between maintaining a safe and sound banking system and permitting banks to engage in risks in order to foster competition. The job of an effective system of banking regulation is to balance these goals.

A. BACKGROUND

The State system of bank chartering and supervision dates back to 1838 with New York State's Free Banking Act which permitted an administrator rather than the legislature to issue bank charters. Today, two-thirds of American banks are State chartered. They are subject to regulation and supervision by both State banking authorities and in almost every case 11 by one of the three Federal agencies.

With the establishment of the National Currency Act in 1863 and the National Bank Act of 1864, the Office of the Comptroller of the Currency was established with the power to charter and supervise national banks. This was the beginning of the dual system of banking a bank could then be chartered by either the Federal Government or its own State government.

7 Golembe. p. 1097.

* See 12 U.S.C. 36; 12 U.S.C. 1828; 12 U.S.C. 1842.

*See 12 U.S.C. 481; 12 U.S.C. 1819: 12 U.S.C. 248: 12 U.S.C. 483.

10 Leavitt. Brenton C. The Philosophy of Financial Regulation. Banking Law Journal, August 1973: p. 646.

State banks which are not insured are not regulated by any Federal authority.

The first incursion of Federal bank regulation into the affairs of State chartered banks began with the Federal Reserve Act of 1913. The act created the Federal Reserve System and required all national banks to become members. Congressional respect for the dual banking system was reflected in the act since it did not require State banks to become members, although they were permitted to do so if they wished and if they met the requirements. It also represented the first division of Federal authority over banks, sharing, as it did, its supervisory and regulatory responsibilities over American commercial banks with the Comptroller of the Currency.

Further congressional concern for maintaining State banks was expressed in the McFadden Act of 1927 which required national banks to conform with State branching laws. Today, as a result of the McFadden Act, there is a general prohibition of interstate banking. The Federal Deposit Insurance Corporation was created in 1933 as an amendment to the Federal Reserve Act.12 Before 1933, national banks were required to be members of the Federal Reserve System. State banks, until that time, had an option to join the Fed. After passage of the act, though, all banks that were federally insured were required to be members of the Federal Reserve System. This provision was repealed in 1939 and insured State banks were given an option once again to join the Fed. The FDIC, however, assumed the responsibility for supervising insured nonmember State banks. The present three-part system of Federal regulation therefore dates back

to 1939.

The responsibilities of the Federal Reserve Board were substantially increased in 1956 with the passage of the Bank Holding Company Act. Supervision of bank holding companies was placed with the Fed. Supervision of subsidiary banks, however, remained the responsibility of the primary regulators.

Therefore, a national bank in a bank holding company continued to be regulated by the Comptroller even though the holding company was regulated by the Fed. The 1956 act did not apply to companies holding only one bank ("two or more"). As a result there was a proliferation in the 1960's of one-bank holding companies, free to acquire nonbanking subsidiaries and unregulated by the Fed. In 1970 this situation was rectified and the Fed was assigned responsibility for regulating one-bank holding companies.13 But even with this problem corrected, there remains enormous potential, much of it unresolved, for uncoordinated regulation of a large number of banks. As mentioned on page 198. the Fed has in fact used its power to withhold approval of bank holding company applications in order to exert some control over subsidiary banks. These banks, if they are national banks or nonmember State banks, would not otherwise be subject to regulation by the FRB. We will examine this area in more detail shortly.14

The final chapter in the legislative history of banking, the Bank Merger Act of 1960,15 was passed as a response to a growing trend

12 It was removed from the Federal Reserve Act in 1950 and made a separate Act to be known as the Federal Deposit Insurance Act. Public Law 86-230; see 12 U.S.C. 1811. 13 Public Law 91-607.

14 See pp. 215–222.

15 Public Law 86-463.

toward mergers. An absence of serious bank failures and a healthy economy had combined to spur banks to merge. With the 1960 act and its 1966 amendments, the antitrust language of section 7 of the Clayton Act and section 1 of the Sherman Act was applied to bank mergers. Under the 1960 act, the Federal agency having primary responsibility over the surviving bank is assigned the responsibility of approving the merger. The responsible agency is required, except under extradordinary circumstances that is, imminent bank failure— to request reports on the competitive factors involved from the Attorney General and the two sister banking agencies. Once approval is granted, the agency must notify the Attorney General who, if he disagrees with the decision, may then take action under appropriate antitrust laws.

Prior to the 1960 act, Federal approval was generally necessary only when the surplus and capital of the combined banks would have been reduced and then it was the responsibility of the Comptroller. The 1966 amendments attempted to make the standards employed by each regulatory agency more uniform and to introduce "need" and "convenience" as considerations that could outweigh the prospective anticompetitive effects of the proposed merger.16

The remainder of this chapter will look in greater detail at the areas of overlapping jurisdictions created by tradition and statute and consider proposals which would unify Federal bank regulation.

B. SUPERVISION AND CHARTERING UNDER THE PRESENT REGULATORY SYSTEM

1. Bank examination

The primary activity of bank regulatory agencies is supervision of banking activities. The fundamental method of supervision is bank examinations. State banking authorities and Federal banking authorities devote considerable effort to examining those banks for which they are responsible. Bank examination is the most frequently cited area of functional overlap in the industry.

On paper, a national bank finds itself subject to a welter of supervisory authorities. It is subject to supervision by the Comptroller of the Currency because of its national charter. It is subject to supervision by the Fed, because by law it must belong to the Federal Reserve System. It is subject to supervision by the FDIC, because of FDIC authority as the insurer.

A State member bank too finds itself answerable to multiple authorities. It is subject to supervision by State banking authorities, as a State chartered bank. It is further subject to Fed supervision, as a member of the FRS. And it is, because Fed membership carries with it the requirement of FDIC insurance, also subject to FDIC supervision.

Generally, "this unworkability does not usually materialize since over the years the three Federal banking agencies have devised (an)... arrangement for exercising Federal supervision." 17 This arrangement calls for each of the three Federal agencies to be a "pri

18 Eisenbeis. Robert. Differences in Federal Regulatory Agencies' Bank Merger Policies. Journal of Money. Credit & Banking. Vol. VII, February 1975: 93–104.

17 Golembe, p. 1093.