The Role that the Formation of Regional Compact and the Development of Superregional Banks Played in Breaking Down Barriers to Interstate Banking in the US

 

Commercial bank consolidation in the US has been driven by a number of factors, including:

• Deregulation. Relaxation of laws restricting interstate banking in the 1980s and 1990s which allowed banks to expand across state lines, leading to mergers and acquisitions.
• Economies of scale. Larger banks can spread their costs over a bigger customer base, making them more efficient.
• Technological advancement. Online and mobile banking have reduced the need for physical branches, making consolidation more feasible.
• Competition. Banks face competition from non-traditional financial institutions, such as fintech companies, which can put pressure on profits and encourage consolidation.
• Regulatory changes. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 imposed some restrictions on banks mergers, but also raised the threshold at which regulatory scrutiny is triggered, making it easier for some large banks to merge. 

Let’s explore regulation that imposed restrictions on interstate banking and branching and the role that the formation of reciprocal regional compact and the development of superregional banks played in reducing the effectiveness of branching restrictions in the US.

Early Phase of Bank Consolidation During the 1970-1980

As previously mentioned, the banking industry in the U.S. is a complex ecosystem composed of various types of financial institutions, each serving distinct roles and catering to different customer needs. Among these institutions, community banks, regional banks, and money center banks stand out due to their unique characteristics and operational scopes.  When comparing the size distribution of the banking system that prevails in the U.S. with regard to other countries such as Canada, England and India reveal that the United States has one of the most diverse banking sectors in the world. As of the first quarter of 2024, there were 4,012 commercial banks, with total assets amounting to approximately $22,754.0 billion.

The McFadden Act of 1927 and the Douglas Amendment: Shaping the Landscape of U.S. Banking

The McFadden Act of 1927 and the Douglas Amendment to the Bank Holding Company Act of 1956[1] were pivotal pieces of legislation that significantly influenced the structure and operations of the U.S. banking industry. These laws, imposed restrictions on interstate banking and branching, leading to a fragmented banking system with numerous small, state-bound banks.

The McFadden Act of 1927

The McFadden Act was enacted to address the competitive disparities between national and state-chartered banks. Prior to this act, national banks were restricted to operating within a single building, while state banks in some states were allowed to operate multiple branches. This created an uneven playing field, disadvantaging national banks.

The McFadden Act allowed national banks to establish branches within their home state, but it prohibited interstate branching. This meant that national banks could only open branches to the extent permitted by state law. The act aimed to create parity between national and state banks, but it also reinforced the fragmentation of the banking industry by preventing the formation of larger, interstate banking institutions.

The Douglas Amendment to the Bank Holding Company Act of 1956

The Douglas Amendment further restricted interstate banking by targeting the activities of bank holding companies. It prohibited bank holding companies from acquiring banks in other states unless the state explicitly allowed it. This amendment reinforced the limitations on interstate banking and branching, leading to a proliferation of small, state-bound banks.

The Douglas Amendment gave individual states the authority to regulate interstate acquisitions, resulting in a patchwork of regulations across the country. This further entrenched the fragmentation of the banking industry and limited the growth of larger, interstate banking institutions.

Impact on the Banking Industry

The McFadden Act of 1927 and the Douglas Amendment to the Bank Holding Company Act of 1956 played crucial roles in shaping the U.S. banking landscape. By imposing restrictions on interstate banking and branching, these laws contributed to the fragmentation of the banking industry and limited the growth of larger, interstate banking institutions.

The Decline in the Number of Commercial Bank Since the 1980

The landscape of the U.S. banking sector has undergone a dramatic transformation since the 1980s, marked by a significant decline in the number of commercial banks.  In the early 1980s, the United States boasted a robust banking sector with approximately 14,496 commercial banks. However, by the end of 2020, this number had plummeted to around 4,3771. This represents a staggering 70% decrease over nearly four decades. The trend continued, and by the end of 2023, the number of commercial banks further declined to 4,036.

Bank Failures Played a Significant Role but Not Predominant

Bank failures have played a significant role in the decline of the number of commercial banks in the U.S., particularly during periods of economic instability. Here are some key points:

• 1980s and 1990s Banking Crises: During the 1980s and early 1990s, the U.S. experienced a series of banking crises. More than 4,000 banks closed between 1980 and 1994. These failures were driven by high interest rates, insufficient oversight, and deregulation, which led to financial instability.
• 2008 Financial Crisis: The financial crisis of 2008 resulted in numerous bank failures. The collapse of major financial institutions and the subsequent economic downturn exposed vulnerabilities in the banking system, leading to stricter regulatory oversight and further consolidation.

While bank failures have contributed to the decline in the number of commercial banks, the impact has been compounded by other factors such as mergers and acquisitions. Even after periods of financial instability, the number of banks continued to decline due to the increasingly common practice of bank mergers. 

The Formation of Reciprocal Regional Compacts in U.S. Banking Paved a Way for Interstate Banking

The formation of reciprocal regional compacts in U.S. banking was a significant development that paved the way for interstate banking and ultimately led to the consolidation of the banking industry. These compacts emerged as a response to the restrictive regulations imposed by the McFadden Act of 1927 and the Douglas Amendment to the Bank Holding Company Act of 1956, which limited banks' ability to operate across state lines.

Emergence of Reciprocal Regional Compacts

In the late 1970s and early 1980s, banks began to lobby state governments to enact regional reciprocal interstate banking agreements. These agreements allowed banks in partnering states to acquire and establish branches across state lines, circumventing the federal restrictions imposed by the McFadden Act and the Douglas Amendment. The formation of these compacts was driven by the need for banks to achieve economies of scale, enhance competitiveness, and better serve their customers.

Several factors contributed to the formation of reciprocal regional compacts:

1. Economic Pressures: Banks faced increasing competition and economic pressures, which necessitated expansion beyond state borders to achieve economies of scale and improve efficiency.
2. Technological Advancements: Advances in technology made it easier for banks to manage operations across multiple states, facilitating the formation of regional compacts.
3. State-Level Lobbying: Banks lobbied state governments to pass legislation allowing interstate banking within specific regions. Southern regional banks, such as Barnett Banks of Florida and North Carolina National Bank (NCNB), played a leading role in these efforts.

One notable example of a regional compact was the Southern Common Market, which deregulated interstate banking within the Southern states between 1984 and 1985. This compact allowed banks in participating states to acquire and establish branches across state lines, setting a precedent for other regions to follow.

Challenges Faced During the Implementation of Regional Reciprocal Agreements in Banking

The implementation of regional reciprocal agreements in banking, which allowed banks in one state to own banks in other states, was a significant step towards interstate banking. However, this process was not without its challenges. Here are some of the key difficulties encountered:

Regulatory Compliance

One of the primary challenges was navigating the complex web of state and federal regulations. Each state had its own set of banking laws and regulations, which banks had to comply with when expanding across state lines. This required significant legal and administrative resources to ensure compliance with varying regulatory requirements.

Cultural Integration

Merging banks from different states often meant integrating different corporate cultures. This could lead to conflicts and inefficiencies if not managed properly. Differences in management styles, employee expectations, and corporate values needed to be harmonized to create a cohesive organization.

Operational Integration

Combining different banking systems, technologies, and processes was another major challenge. Ensuring seamless integration without disrupting services required careful planning and execution. Banks had to invest in technology and infrastructure to support the expanded operations, which could be costly and time-consuming.

Market Share Limitations

The regional reciprocal agreements, imposed limitations on market share to prevent excessive consolidation and maintain competition. This sometimes restricted the ability of banks to merge or acquire other institutions, limiting their growth potential.

Customer Retention

Maintaining customer loyalty during and after a merger was crucial. Differences in service quality, product offerings, and customer experience could lead to customer attrition. Banks had to ensure that the expanded operations did not negatively impact the customer experience.

Geographic and Economic Differences

Banks had to adapt to different economic conditions and customer preferences in various states. This required tailored strategies to effectively serve diverse markets. Understanding and responding to local market dynamics was essential for the success of interstate banking operations.

Despite these challenges, many banks successfully navigated the complexities of regional reciprocal agreements, leading to a more integrated and competitive banking industry. 

Market Dynamics

The early phase of bank consolidation was characterized by a series of high-profile mergers and acquisitions. The loosening of restrictions on interstate banking in the United States marked a significant turning point in the banking industry. This regulatory shift facilitated the development of superregional banks—bank holding companies that began to rival money center banks in size and influence, despite being headquartered outside traditional financial hubs like New York City.  Regional and super-regional banks were particularly active in acquiring smaller institutions to expand their geographic footprint and enhance their competitive positioning. 

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[1] The term “bank holding company” (BHC) holds significant importance. A bank holding company is a corporate entity that owns a controlling interest in one or more banks but does not itself offer banking services. This structure allows the holding company to manage and oversee the operations of its subsidiary banks, providing strategic direction and support without engaging in the day-to-day banking activities.