What Is Interstate Banking?

Interstate banking refers to the expansion of banks across state lines. This phenomenon became widespread in the mid-1980s when state legislatures passed bills allowing bank holding companies to acquire out-of-state banks on a reciprocal basis with other states. Interstate banking has led to the rise of both regional and national banking chains.

Key Takeaways

  • Interstate banking refers to a bank holding company that is permitted to own and operate banks in more than one state.
  • In the mid-1980s, state legislatures passed bills allowing states to rule whether banks from anywhere in the country could establish or acquire a bank inside their borders.
  • By the 1990s, more freedom was granted via The Riegle-Neal Act, a piece of federal legislation sanctioning the establishment of nationwide banks.
  • The Riegle-Neal Act repealed both the Douglas Amendment and the McFadden Act.

Understanding Interstate Banking

Lawmakers were initially against interstate banking by nationally chartered banks. The National Bank Act of 1863, and later the McFadden Act of 1927, strictly forbade banks being owned and operated across state lines

Regulations were eventually loosened after it became apparent that restrictions on interstate banking limited banks to regional expansion and left them vulnerable to local economic crises. The rising number of Americans traveling or relocating across the country also contributed to a rethink of the old rules, as mobile citizens found it difficult to gain access to banking services outside the local region in which they lived.

It was also discovered that many bank holding companies were getting around the prohibitions of the McFadden Act by acquiring subsidiary banks in other states and then operating them in the same manner as they would normal branches.

History of Interstate Banking

The Douglas Amendment

More leeway was granted by the Douglas Amendment to the Bank Holding Company Act of 1956. This particular legislation, introduced in the mid-1980s, allowed states to rule whether out-of-state bank holding companies would be permitted to establish, operate, and own banks within their borders. The 1985 court case Northeast Bancorp v. Board of Governors upheld this right.

Interstate banking grew in three separate phases, starting in the 1980s with regional banks. These companies are limited to a specific region, such as the Northeast or Southeast, and were formed when smaller, independent banks merged to create larger banks. In the 1980s, six states in New England passed legislation allowing for the formation of regional banks, followed shortly after by banks in the Southeast and Midwest.

Eventually, 35 states agreed to enable banks from anywhere in the country to establish or acquire a bank inside their borders. Meanwhile, 14 states and Washington D.C. chose to allow only regional banking, while only one state, Hawaii, failed to pass neither regional nor national interstate banking legislation.

The Riegle-Neal Act

By the 1990s, federal legislation was passed that sanctioned the establishment of nationwide banks, effectively giving the country's financial institution (FIs) even more freedom to expand. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 permitted banks that met capitalization requirements to acquire other banks in any other state after Oct. 1, 1995.

The Riegle-Neal Act permitted truly nationwide interstate banking for the first time, allowing well-managed, well-capitalized banks to acquire banks in other states, regional or not, after Sept. 29, 1995.

The Riegle-Neal Act further gave banks in different states permission to merge into nationwide branch networks after June 1, 1997. There were stipulations, though: Under the act, no bank holding company can control more than 10% of the total assets on deposit in the United States, nor can it control more than 30% of any single state's total deposited assets unless a specific state had established a deposit cap of its own.

Individual states were allowed to opt-out of the branching provisions of the Riegle-Neal Act. Initially, Texas and Montana chose to take this route, before changing their mind and embracing interstate branching. The Riegle-Neal Act repealed both the Douglas Amendment and the McFadden Act.

Criticism of Interstate Banking

Interstate banking paved the way for banks to become much larger in size. Nationwide banking has its benefits, though not everyone agrees that the creation of mega-banks has been for the greater good.

Banking behemoths have been accused of lacking efficiency, being impersonal, displaying sluggish characteristics, and struggling to adapt quickly enough to market trends. Some economists argue that banks with more than a few billion dollars in assets often tend to fall into this trap.