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Public Hearing on Preemption Petition

Testimony of John S. Allison
Commissioner of Banking & Consumer Finance
State of Mississippi & Chairman, Conference of State Bank Supervisors
Before the Federal Deposit Insurance Corporation Board of Directors
May 24, 2005

Good morning, Chairman Powell, other members of the FDIC Board and senior staff. I am John Allison, Commissioner of Banking and Consumer Finance for the State of Mississippi. I currently serve as chairman of the Conference of State Bank Supervisors (CSBS), the professional organization for the 54 state bank supervisors, and the only national organization dedicated to protecting and advancing the state banking system. I am very pleased to represent CSBS and my colleagues at today's hearing, and I appreciate this opportunity to express our views.

CSBS commends you for holding today's hearing. The issue is of great interest to those of us who oversee the financial services industry at the state level. As you know, we are the chartering agencies for nearly 75 percent of the banks in the country who have chosen the state bank charter.

We also would like to thank The Financial Services Roundtable for highlighting a problem in the dual banking system and for seeking the FDIC Board's views on the many important policy issues raised by recent federal preemption rulings.

We cannot overstate the importance of today's topic. The OCC's recent preemption rules have already significantly altered the financial regulatory system, and threaten the future of our nation's dual banking system. How we and, ultimately, the Congress address these issues and the policy questions involved will have long-term, systemic ramifications for banks, their customers, and our economy. We are sympathetic to the needs of multi-state institutions for consistency. However, we must be mindful of how we accomplish this.

As of year end 2004, 48 of the largest 100 commercial banks are state-chartered. Using FDIC data, we calculate that 224 state-chartered banks currently operate branches across state lines. While that number is a relatively small percentage of state-chartered banks, they hold the vast majority of assets in our system. Additionally, many other state chartered banks have customers in states other than their own because they operate near state lines, provide credit cards nationwide, or are involved in Internet banking. Even those banks that do not operate across state lines can feel the impact of these sweeping preemption decisions. Accordingly, a sizable portion of the state banking system is impacted by these issues.

The OCC's February 2004 preemption rulings present grave concerns to me and my colleagues. We believe that the OCC has exceeded its authority provided by Congress and the National Bank Act in these instances. We believe that the OCC erred in extending the definition of "national bank" to cover subsidiaries, and that the OCC also erred in overriding the provisions of the Riegle-Neal Act that ensure states' rights to protect their consumers. These preemption decisions have created a major regulatory imbalance in the system, and need to be reexamined before irreparable damage is done.

We welcome and encourage the FDIC's thoughtful consideration of this issue. As primary federal regulator of approximately two-thirds of all state-chartered banks, the FDIC plays a crucial role in the interstate supervision of these institutions. These OCC preemptions are changing that role, and shifting the balance among the federal banking agencies. This is the nature of our dual banking system; periodic shifts are healthy, and to be expected. But the FDIC has an important policy role to play in this dynamic, and cannot sit idly on the sidelines of this debate.

Because of the many complex issues presented in the Roundtable's petition, CSBS cannot either support or oppose the proposal in its entirety. Within CSBS, the state bank supervisors have serious disagreement on how we, the FDIC or the Federal Reserve should respond to the OCC's preemptive actions. Speaking for CSBS and for the state of Mississippi, I appreciate the divergent views on this topic and am happy to see individual states will be presenting testimony to the FDIC to illustrate the diversity of views within the state chartering system. This should convey the importance of these issues to all of us, and the need to continue this discussion. However, CSBS feels strongly that the federal banking agencies and Congress need to open these questions to real public debate, as current law requires.

CSBS does agree with the need to codify existing FDIC General Counsel opinions 10 and 11 for banks, and on the need to highlight current applicable law found in Riegle Neal II for interstate branches of state banks.

We must address the needs of the 21st century financial marketplace together, weighing the appropriate roles of federal and state policy. These issues are too important to be left to a single agency that is not held accountable for its actions.

Historical Background
Dual chartering and supervision have been essential elements of the American banking system since the 1860s. The ability to make a meaningful choice between regulatory systems has encouraged competition, innovation, and the identification of best practices not only for financial institutions, but also among the regulatory agencies. The healthy tension that has traditionally characterized our dual banking system has created a banking system envied and imitated around the world.

Federal preemption has always been part of this dynamic. It has often been helpful and necessary for the system as a whole and, at these times, CSBS has supported preemption. Most recently, CSBS endorsed the federal Fair Credit Reporting Act, which included preemptions that provided consumers and financial institutions with consistency and certainty.

Our federal system of government, however, demands that preemption take place only after Congress has fully aired and reviewed the issues at hand, and has explicitly authorized preemption. This is the basis of our legal system, and this was reaffirmed again in the Riegle-Neal Interstate Banking and Branching Efficiency Act.

State bank supervisors' goals have been consistent since the first adoption of interstate banking laws – at the state level, I might add. We want a safe, sound and efficient banking system that does not disadvantage state-chartered banks or smaller institutions simply because of their choice of charter or structure.

Historically, the CSBS Board has adopted policies to address the needs of state chartered banks. As far back as 1994, we have board policy stating that interstate branches of state chartered banks should not be disadvantaged in an interstate branching supervisory environment.

Two years later, the CSBS Board voted to pursue amendments to Riegle-Neal to clarify that host state law applies to branches of out-of-state, state-chartered banks only to the extent that it applies to branches of out-of-state national banks; and to ensure that host state branches of state-chartered banks maintain at least equal powers to national banks, if their home states authorize the activity.

That same year, the CSBS Board unanimously endorsed the Nationwide Cooperative Agreement and Nationwide State-Federal Agreement for the coordinated supervision of multi-state, state-chartered banks. As recently as this past June, CSBS worked with our federal counterparts, the FDIC and Federal Reserve, to develop and announce an agreement which updated these documents with a set of 12 recommended practices designed to achieve a more coordinated approach to the supervision of state-chartered banks, including those with interstate operations. Each agency at the state and federal level continue to ensure these coordination documents remain dynamic and active.

In 1998, our board voted again to support competitive equality for state-chartered banks with all federal financial institutions. Specifically, we prefer an approach that increases powers for all financial institutions rather than one that curtails the powers of a given class of institution.

We have reiterated and refined this policy again and again over the past several years. State bank supervisors understand that if our system is to survive, it must accommodate the needs of multi-state banking operations and the interstate business plans of well-capitalized state banks.

Congress has endorsed this point of view whenever it has had the opportunity to do so. Riegle-Neal specified that interstate branching was meant to preserve the existing balance between state and national chartering systems. The Riegle-Neal Amendments of 1997 laid out specific procedures for preemption, designed to protect this balance.

Despite this explicitly-stated Congressional intent, however, the OCC and the OTS have waged a campaign of dueling preemption that has brought us before you here today.

The Office of Thrift Supervision began this drive, with its sweeping "field preemption" of any state law that the agency considered to interfere with the operations of a federal savings association. Following the OTS's example, the OCC has exempted national banks from intrastate branching limitations; from licensing requirements for non-banking subsidiaries of national banks; and, ultimately, from any state law that would affect – not interfere with, but merely "condition" – the activities of a national bank or its operating subsidiaries.

The lengths of the OTS's and the OCC's preemption determinations continue to grow well beyond the national banks and federal thrifts these agencies were created to supervise. Late in 2004, the OCC opined that the preemptions contained in the National Bank Act would apply to an operating subsidiary where a national bank's total ownership of that operating subsidiary was only 10%. Based on the OCC's Interpretive Letter on this issue, it would appear that a national bank could own as little as 1% of a "subsidiary", and the preemption would still flow to that entity.

The OTS recently issued an opinion letter that extends federal preemption to include non-bank sales agents of a federally-chartered thrift, shielding these agents from state licensing and examination requirements that ensure professional conduct and consumer protection.

Unfortunately, these are just further examples of the wholesale preemption of state laws and regulations on the part of the OTS and the OCC that threatens to undermine the integrity of the dual banking system in this country.

CSBS has challenged these actions before the courts at every turn. CSBS has been involved as amicus in court cases brought against the state banking commissioners in Michigan, Connecticut and Maryland by national banks and their subsidiaries seeking to take advantage of the expansive preemptive interpretations by the Comptroller of the Currency. I would like to reiterate that the Comptroller has not only attempted to preempt the vast majority of state consumer protection laws, but has extended these preemptions to state chartered corporations that are subsidiaries of national banks. In addition, the Comptroller has tried to keep state officials from investigating and enforcing any applicable laws against national banks and their subsidiaries. These opinions by the Comptroller undermine the principles of federalism that are the cornerstones of our systems of financial regulation and corporate governance.

While the courts grant the Comptroller great deference in interpreting the National Bank Act, it should be clear that operating subsidiaries do not qualify as "national banks" under the National Bank Act. Operating subsidiaries are chartered as nonbank corporations under state law. They do not receive a federal charter to conduct the "business of banking," and they cannot become members of the Federal Reserve System. Accordingly, operating subsidiaries should not be entitled to any immunity from state supervision that "national banks" may enjoy.

The Supreme Court has affirmed that each state "is legitimately concerned with safeguarding the interests of its own people in business dealings with corporations not of its own chartering but who do business within its borders." (Union Brokerage Co. v. Jensen, 322 U.S. 202, 208 (1944).) Each state may therefore require foreign corporations to comply with nondiscriminatory licensing and reporting requirements and other regulations enacted for the purpose of "assuring responsibility and fair dealing on the part of foreign corporations coming into a State." (Id. at 210-11 (quote at 210).

In Barnett v. Nelson (517 US 25 (1996)), the Supreme Court stated:

"In defining the pre-emptive scope of statutes and regulations granting a power to national banks, these cases take the view that normally Congress would not want States to forbid, or to impair significantly, the exercise of a power that Congress explicitly granted. To say this is not to deprive States of the power to regulate national banks, where (unlike here) doing so does not prevent or significantly interfere with the national bank's exercise of its powers."

The Comptroller's opinions have turned federalism on its head and have undermined the importance of the states police powers in protecting their own citizens. While the current cases have gone against the states in District Court, they are all currently being appealed and will most likely be appealed to the Supreme Court.

These preemptive actions have had a significant effect on the balance of our dual banking system. Although the state system retains 75% of the bank charters, as of year end 2004 national banks now hold more than two-thirds of the total assets in our banking system, leaving the state system with approximately 33 percent. Compare that to 2003, when state banks' share of total assets was around 45 percent. Much of the decrease in asset share can be attributed to 2-3 large charter conversions that occurred in 2004, after the Office of the Comptroller of the Currency issued its preemption rules.

CSBS believes that last year's federal preemption rule by OCC, as well as similar actions by OTS, have upset the regulatory balance in the dual banking system and threaten the future viability of the state system.

I would like to highlight that this is not merely a 'turf battle' between the state and federal chartering agencies. There are real potential consequences for chartering and supervising community banks and, accordingly, to our local economies. In testimony before the Senate Banking Committee, Federal Reserve Chairman Greenspan referred to the American dual banking system and its support of community banks as a "jewel" of our economy. State bank supervisors see the value of this jewel every day. The preservation of a state bank chartering and regulatory system sets the United States' financial system apart from every other developed nation, and is a primary contributor to our nation's diverse, vibrant, resilient and responsive economy.

Community banking is the cornerstone of this system. Let me be clear. Diversity in our financial system is not inevitable. Community banking is not inevitable. They are the product of a consciously developed state-federal system. At the state level, we know that a responsive and innovative state banking system that encourages community banking is essential to creating diverse local economic opportunities. The state charter has been and continues to be the charter of choice for community-based institutions, because the supervisory environment – locally-oriented, hands-on, and flexible – matches the way these banks do business. Our goal is a safe and sound financial system that meets the needs of all our communities. This goal requires that we find a balance between encouraging economic opportunity and protecting our citizens.

A bank's ability to choose its charter encourages regulators to operate more efficiently, more effectively, and in a more measured fashion. A monolithic regulatory regime would have no incentive to efficiency. It is easy to imagine how fast its authority and its costs might grow if left unchecked. Our founding fathers knew that federalism was the best check on this government overgrowth, and therefore left control of financial regulation in the hands of the states. The emergence of a nationwide financial market made it necessary to create a federal regulatory structure, but the state system remains as a structural curb on excessive federal regulatory burden and a means of promoting a wide diversity of financial institutions.

Elements of a Successful Banking System
Our dual banking system, unique in the world, has survived for 140 years for three fundamental reasons: accountability, creativity, and effectiveness.

Accountability. American government is built upon the concept of checks and balances. Regulatory agencies at both the state and federal levels implement the laws passed by legislatures and the policies established by the elected executives, subject to judicial review in the courts.

What makes the American banking system unique even among our own regulatory agencies, however, is the breadth of this accountability. The federal banking agencies are accountable not only to Congress, and not only to the President, but to each other, to the state agencies, to the industry, and directly to consumers. The existence of multiple agencies makes it extremely difficult for any one regulator to become a "rogue," and requires the development of consensus on best practices and emerging risks.

Likewise, the state agencies work directly with the FDIC and the Federal Reserve to supervise the institutions under their authority, and work with all of the federal banking agencies through the State Liaison Committee of the Federal Financial Institutions Examination Council (FFIEC). The FFIEC is a forum for developing uniform approaches to regulatory and supervisory issues.

The existence of a banking department in each state provides immediate accountability for consumers, who can usually make a local call to ask a question or voice a complaint. In addition, state bank commissioners are accountable to their governors, legislatures, and so forth. Eliminating all state authority over national banks eliminates this accountability, as well.

Creativity. The existence of separate chartering systems means that a bank can choose the charter that best conforms to its business plan.

States have served as the incubators for almost every major change in the banking industry over the past 100 years. It is usually easier to pass a law at the state level than at the federal level, and individual states have been able to experiment with bank products and services before they were ready for the national market. Branching, adjustable-rate mortgages, automated teller machines, and interest-bearing checking accounts are just a few of the services that were originally authorized at the state level. Congress has often looked to the states for help in determining when the national market is truly ready for major changes in the industry, such as nationwide branching or expanded powers for banks.

Most recently, states have been the innovators in developing new methods for consumer protection. We can look to the Georgia legislature for an excellent example for the state "laboratory". When the industry strongly objected to the initial predatory lending law in Georgia, the state legislature was able to act quickly to modify its law to better balance consumer protection with industry burden. Now, Georgia and North Carolina, among other states, have formed the models for discussions of a national anti-predatory lending policy. My colleague from North Carolina is testifying today on Capitol Hill as to the findings of various studies on the North Carolina predatory lending law.

Effectiveness. The U.S. banking system serves as a model of efficiency, integrity and prosperity around the world. American banks foster a unique culture of entrepreneurship, and back one of the world's highest rates of homeownership. The number of "problem institutions" within the industry stands just over 1%.

The system was tested and reformed in the late 1980s and early 1990s, when hundreds of institutions failed and Congress intervened to grant more powers to the federal regulatory agencies. Within the commercial banking system, however, the regulatory system and the FDIC's insurance fund performed exactly as they were designed to, preventing widespread economic instability and collapse.

Conflict between state and federal regulators, and occasionally among the federal regulators, is not only the nature of the dual banking system, but the source of many of its benefits. This conflict produces consensus on best practices and new activities, and serves to keep any one element of the system from overpowering the others. Overreaching actions by any one federal agency stifles this dynamic tension. Left unchecked, this concentration of power threatens to eliminate many of the benefits of the dual banking system.

The Financial Services Roundtable Petition
The Financial Services Roundtable's petition and today's hearing have spurred CSBS to pursue a position that respects the states in fulfilling their law-given role while not disadvantaging interstate banks that operate under the state charter.

To that end, CSBS has held numerous meetings, and the subject has been on the agenda of every Board meeting since the OCC's proposal first came forward. We have also held a series of conference calls with the state banking departments over the past month to discuss the ideas raised in the Roundtable petition.

As you can imagine, with 50 states – all with different legal and legislative pressures – it is nearly impossible to reach unanimous agreement. Dissenting views on this particular issue are very strong and well-reasoned. On many of the issues raised in the Roundtable petition, I can honestly say our members are evenly split.

We did, however, reach consensus on the need to codify existing FDIC General Counsel opinions 10 and 11 for banks, and on the need to highlight current applicable law found in Riegle Neal II for interstate branches of state banks.

State banking supervisors understand that if the current OCC preemption is allowed to remain, major state-chartered interstate banks will likely migrate to a national charter. We are hearing from some of the largest state-chartered banks that the OCC's unilateral action to preempt state laws and authority is putting them at a significant competitive disadvantage relative to national banks. They are telling us that if this imbalance in the system is not addressed, the state charter may no longer be an option. I remind you, 48 of the 100 largest commercial banks are state-chartered. If this imbalance caused all 100 of the largest banks to become nationally chartered, the state system would supervise only 17% of U.S. commercial banking assets, and the damage to the dual banking system would be immeasurable. The states will be left with intrastate community banks and very few large state-chartered interstate banks that operate on a wholesale basis or strictly through a branching network. It is not clear that such a system would be sustainable.

Given time, we believe that we can resolve most, if not all, of the issues. However, time is not on our side.

We hesitate to turn such decision-making authority over to one federal banking agency. Ideally, Congress would enact legislation to rationalize applicable law, and would reassert its role in determining the appropriate balance of state and federal law, supervision and enforcement. We strongly urge the FDIC and other federal banking regulators to work with CSBS in requesting that Congress address and debate these issues to clarify its vision of the dual banking system.

In the absence of Congressional action, however, CSBS seeks to cooperate with the industry, other federal banking regulators, and other interested parties to find a workable solution that will meet the needs of banks with interstate operations regardless of charter type.

These are the policy questions that face us:

  • Is it good for the industry to have only one viable charter alternative for banks that operate in numerous states? We say no.
  • Is it good public policy to have the largest banks subject to supervision by a single chartering authority? We say no.
  • Will the state banking system, which has served this country so well throughout our history, retain its relevance and political significance if it charters only 17 percent of the nation's banking assets? We say no.
  • Is it good to lose the FDIC and the Federal Reserve's current roles in regulating and supervising these large, interstate banks? We say no.

These are serious public policy questions for the state banking regulators, the FDIC and Federal Reserve System, the banking industry, and the general public. Ultimately, it is the Congress who must address these questions.

States must be part of the discussion. As our founding fathers recognized, we need federalism, not just federal in our banking system. A realistic choice in chartering for all institutions is essential to maintain the preeminent banking system in the world. We urge the FDIC in its leadership role to ensure this debate continues past this hearing.

CSBS commends the FDIC for beginning this debate about real concerns in the dual banking system. We look forward to participating in this discussion as it continues, and we thank you for this opportunity to comment.

Last Updated 05/24/2005

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