Fordham Law Review Volume 58 Issue 6 Article 1 1990 The Expansion of State Bank Powers, the Federal Response, and the Case for Preserving the Dual Banking System Arthur E. Wilmarth, Jr. Follow this and additional works at: https://ir.lawnet.fordham.edu/flr Part of the Law Commons Recommended Citation Arthur E. Wilmarth, Jr., The Expansion of State Bank Powers, the Federal Response, and the Case for Preserving the Dual Banking System, 58 Fordham L. Rev. 1133 (1990). Available at: https://ir.lawnet.fordham.edu/flr/vol58/iss6/1 This Article is brought to you for free and open access by FLASH: The Fordham Law Archive of Scholarship and History. It has been accepted for inclusion in Fordham Law Review by an authorized editor of FLASH: The Fordham Law Archive of Scholarship and History. For more information, please contact [email protected]. The Expansion of State Bank Powers, the Federal Response, and the Case for Preserving the Dual Banking System Cover Page Footnote Associate Professor of Law, George Washington University National Law Center. B.A. 1972, Yale University; J.D. 1975, Harvard University. The author wishes to thank the National Law Center, Dean Jack Friedenthal and former Dean Jerome Barron for summer research grants that assisted him in preparing this Article. The author also wishes to thank Jim Bell, Barkley Clark, Tamar Frankel, Helen Garten, Kenneth Scott, Andy Spanogle and Luize Zubrow for their helpful comments, and Brian Ashe for his able research assistance, on a preliminary draft of this Article. This Article includes developments through June 15, 1990. This article is available in Fordham Law Review: https://ir.lawnet.fordham.edu/flr/vol58/iss6/1 THE EXPANSION OF STATE BANK POWERS, THE FEDERAL RESPONSE, AND THE CASE FOR PRESERVING THE DUAL BANKING SYSTEM ARTHUR E. WILMARTIH, JR. * Introduction ................................................... 1135 I. The Transformation of the Competitive Environment for the Banking Industry ..................................... 1139 A. TraditionalRegulation of the Banking Industry ........ 1139 B. Changes in the FinancialMarketplace Since 1975 and the Growth of Nonbank Competitors ................... 1141 C. The Removal of Barriersto Bank Expansion and Increased Competition from Foreign Banks ............ 1144 D. The Decline in Bank Profitability and the Increase in Bank Failures........................................ 1147 E. The Debate Over Expanded Bank Powers .............. 1149 II. The Dual Banking System and Legislative Actions of Congress and the States with Respect to New Bank Powers ................................................... 1152 A. Federaland State Regulation of Banks Under the Dual Banking System ...................................... 1153 1. Historical Background of the Dual Banking System ........................................... 1153 2. The Dual Banking System's Record of Innovation . 1155 3. The Current Regulatory Structure ................. 1159 B. Federal Restrictions on Banking Powers ................ 1161 1. Federal Restrictions on Bank Involvement in Securities Underwriting ........................... 1161 2. Federal Restrictions on Bank Involvement in Insurance Activities ............................... 1166 3. Federal Constraints on Bank Involvement in Real Estate Investment or Development ................ 1169 C. The Failure of Congress to Expand Banking Powers .... 1171 D. State Initiatives to Expand State Bank Powers ......... 1177 • Associate Professor of Law, George Washington University National Law Center. B.A. 1972, Yale University; J.D. 1975, Harvard University. The author wishes to thank the National Law Center, Dean Jack Friedenthal and former Dean Jerome Bar- ron for summer research grants that assisted him in preparing this Article. The author also wishes to thank Jim Bell, Barkley Clark, Tamar Frankel, Helen Garten, Kenneth Scott, Andy Spanogle and Luize Zubrow for their helpful comments, and Brian Ashe for his able research assistance, on a preliminary draft of this Article. This Article includes developments through June 15, 1990. 1133 1134 FORDHAM LAW REVIEW [Vol. 58 III. The Response of the Federal Agencies and Congress to the Expansion of State Bank Powers .......................... 1181 A. The Responses of the FRB and the FDIC to the Expansion of State Bank Powers ...................... 1181 1. The Response of the FRB ......................... 1181 2. The Response of the FDIC ....................... 1184 B. The Response of Congress to Expanded State Bank Powers ............................................... 1185 IV. The Limited Authority of the Federal Reserve Board and the FDIC to Restrict the Powers of State Banks ........... 1189 A. Standardsfor Reviewing Claims of Statutory Authority By the FRB and the FDIC............................ 1189 B. Limitations on the Authority of the FRB and the FDIC to Regulate the Activities of State Banks ............... 1191 1. The FRB's Authority to Place Conditions on the Entry of State Banks into the Federal Reserve System ........................................... 1191 2. The FDIC's Authority to Review the Powers of State Nonmember Banks Applying for Deposit Insurance ......................................... 1195 3. The FDIC's Authority to Terminate Deposit Insurance and to Issue Regulations to Protect the Deposit Insurance Fund .......................... 1196 4. The Authority of the FRB and the FDIC to Require State Banks to Terminate Unsafe or Unsound Activities ............................... 1200 a. Statutory Provisions of Section 8(b) of the FDI A ct ........................................... 1200 b. JudicialInterpretations of Section 8(b) .......... 1204 c. Legislative History of Section 8(b) .............. 1207 5. The FRB's Authority to Regulate Bank Transactions with Affiliates ....................... 1209 6. The Authority of the FRB and the FDIC to Adopt Capital Adequacy Requirements ................... 1211 C. The Absence of Authority under the BHC Act for FRB Regulation of the Activities of Holding Company-Owned State Banks and Their Operations Subsidiaries ......... 1213 1. The Statutory Provisions .......................... 1214 a. Section 3 of the BHC Act ...................... 1214 b. Section 4 of the BHC Act ...................... 1217 i. Application of Section 4(a) to Holding Company-Owned Banks .................... 1218 ii. Application of Section 4(a) to Operations Subsidiaries of Holding Company-Owned Banks ..................................... 1219 2. The Legislative History of the BHC Act ........... 1227 1990] STATE BANK POWERS 1135 a. The OriginalBHC Act of 1956 ................. 1227 b. The 1966 Amendments ........................ 1229 c. The 1970 Amendments ......................... 1231 d. The 1982 Amendments ........................ 1233 e. Unsuccessful Efforts Since 1982 to Restrict the Powers of Holding Company-Owned State Banks and Their Subsidiaries ......................... 1235 3. Judicial Constructions of Section 4 ................ 1237 V. Critiques of State Authority to Determine the Powers of State Banks Under the Dual Banking System .............. 1239 A. The "Competition in Laxity" Critique ................. 1241 B. The "Myth of Competition" Critique................... 1250 Conclusion ..................................................... 1255 INTRODUCTION p E banking industry in the United States presently confronts its X eatest challenge since the Depression. This Article describes the factors that have combined to erode the profitability and long-term via- bility of the banking industry in its present highly regulated form. The Article considers the restraints currently imposed on bank operations by federal law, and it then examines the initiatives taken by a number of states to expand the powers of state banks. In light of the present eco- nomic vulnerability of the banking industry and the ongoing debate con- cerning the ability of banks to use expanded powers safely, this Article argues that state experimentation with broader bank powers can provide a critically needed testing ground for the industry. An experimental role for the states with regard to the desirability and safety of new bank pow- ers would be consistent with the history of our nation's dual banking system. Under that system, the federal and state regulatory components have each played a creative role in helping the banking industry to adapt to changing competitive conditions. As explained in Part I of this Article, the banking industry's current predicament is the result of several related developments in the financial markets that have increased competitive pressures on banks and reduced their profit-making opportunities. First, between 1980 and 1986, the fed- eral government removed its regulatory controls over the interest rates paid on bank deposits. These federal controls were lifted in response to the high inflation and volatile market interest rates of the late 1970s and early 1980s, which made it extremely difficult for banks to attract low- interest deposits from the public. The removal of these federal controls enabled banks once again to compete effectively for deposits, but banks can no longer obtain deposits at low cost.1 Second, rapid technological advances over the past two decades in data 1.For a discussion of the former federal controls on deposit interest rates and the impact of their removal, see infra notes 15 & 28-34 and accompanying text. 1136 FORDHAM LAW REVIEW [Vol. 58 processing and telecommunications have deprived banks of their