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4000 - Advisory Opinions

Insured State Nonmember Banks May Enter Into Contract Branching Agreements With Other Banks Located Within Same State Without Prior FDIC Approval


August 12, 1993

Alfred J. T. Byrne, General Counsel

This is in response to your April 29, 1993 inquiry whether affiliated insured state nonmember banks may provide certain services to one another's customers pursuant to a recently enacted Minnesota statute, without filing branch applications with the Federal Deposit Insurance Corporation ("FDIC") and receiving the FDIC's prior written consent.

The FDIC has received numerous inquiries from insured state nonmember banks concerning such arrangements whereby banks (affiliated or nonaffiliated) within the same state agree to provide certain banking services to one another's customers.

Generally, the banks involved enter into a contract whereby each bank agrees to act as agent for the other bank in providing specifically enumerated banking services. Examples would include an agent bank accepting deposits, cashing checks and receiving loan payments for customers of the other bank. These arrangements commonly are referred to as "contract branching," "accommodation branching" or "facility banking."

The primary legal question such arrangements pose is whether the agent bank providing the accommodation service ("service bank") becomes a "domestic branch" of the customer's bank ("customer bank") as that term is defined in section 3(o) of the Federal Deposit Insurance Act ("FDI Act").

This question has been addressed previously in two published FDIC Legal Division staff advisory opinions. FDIC 88-69 (October 28, 1988); FDIC 91-34 (April 23, 1991). In both opinions, Legal Division staff opined that a service bank would be considered a domestic branch of a customer bank. Accordingly, the filing of a branch application pursuant to section 303.2 of the FDIC's rules and regulations would be required. In view of the substantial interest in this question and the FDIC's desire to facilitate the provision of safe, sound and efficient banking services to consumers and minimize the administrative burden on insured state nonmember banks, the Legal Division decided to re-examine the issue.

Section 3(o) of the FDI Act defines a domestic branch as "any branch bank, branch office, branch agency, additional office, or any branch place of business located in any State. . .at which deposits are received or checks paid or money lent." The scope of this definition is unclear and the definition has never been interpreted by a court of competent jurisdiction.

However, section 36(f) of the National Bank Act ("NBA") contains a definition of "branch" which is virtually identical to section 3(o) of the FDI Act, and which has been interpreted by the Supreme Court and several courts of appeals.1 First National Bank in Plant City v. Dickinson, 396 U.S. 122 (1969) ("Plant City"); Independent Bankers Association v. Smith, 534 F.2d. 921 (D.C. Cir. 1976), cert. denied, 429 U.S. 862 (1976) ("Smith"); Independent Bankers Association v. Marine Midland, 757 F.2d. 453 (2d. Cir. 1986), cert. denied, 476 U.S. 1186 (1986) ("Marine").

In Smith, the court was presented with the question whether an automated teller machine ("ATM") owned and operated by a bank was a branch of that bank pursuant to section 36(f). The ATM in question dispensed cash, accepted deposits and allowed customers to transfer funds between accounts. The Office of the Comptroller of the Currency ("OCC") had issued an interpretive ruling to the effect that such ATM's were not branches under the NBA. Central to its analysis, the OCC analogized the functions performed by the ATM to banking-by-mail and banking-by-telephone.

The court rejected the analogy, because "in the case of a mailbox or a telephone, no place or facility established (i.e., owned or rented) by a bank is involved. Mailboxes and telephones are not facilities supplied by banks for the added convenience of their customers and designed to retain and attract patronage." Smith at 941. This analysis formed the basis for the court's holding that:

[A]ny facility that performs the traditional bank functions of receiving or disbursing funds is a "branch" of a national bank within the meaning of section 36(f) if (1) the facility is established (i.e., owned or rented) by the national bank, and (2) it offers the bank's customers a convenience that gives the bank a competitive advantage over other banks (national or state) that do not operate similar facilities.

Id. at 951-952. (Emphasis added)

In Marine, the Second Circuit Court of Appeals was presented with the same branching question that faced the Smith court, except that the ATM in Marine was owned by a grocery store. The bank had entered into an agreement with the store which allowed its account holders to use the ATM to make deposits, cash withdrawals, transfer funds between accounts and obtain account balance information. Each time a bank customer used the ATM, the bank would pay a transaction fee to the grocery store. Early in its decision, the court in Marine quoted with approval the Smith test.

The court discussed in some detail the legislative history of section 36(f), the need for the court to apply a measure of common sense, and the well-recognized rule of giving appropriate deference to the executive agency charged with a statute's enforcement when attempting to apply it to new technology or circumstances. It observed that:

Congress in 1927 could not possibly have foreseen the current revolution in banking practices. The McFadden Act pre-dated the invention of computers as well as their application to banking through electronic funds transfer systems. Banking is no longer confined to physical transactions. A rigid application of the language of 1927 to the new technology fails to confront the economic realities facing a court, and leads to anomalous results.

Marine at 459. Explicitly adopting the Smith test, the court held that the ATM in question was not a branch of the bank because the bank neither owned nor rented it. Id. at 463.

Both of the previously published FDIC Legal Division staff advisory opinions, especially FDIC 91-34, expressed the opinion that Smith was not controlling in cases involving contract branching arrangements, because Smith (a) interpreted section 36(f) of the NBA, not section 3(o) of the FDI Act, and (b) involved ATMs, not brick and mortar branches. Upon further review and reflection, however, the Legal Division believes the better view is that the Smith test should be applied in the cases involving contract branching.

At a time when new banking services and products rapidly are being developed, one of the FDIC's primary functions is to "[f]ashion policies in response to events that were unforeseeable when the legislation was written." Id. at 461.2 We therefore conclude that insured state nonmember banks which enter into agreements to have other banks (affiliated or nonaffiliated) within the same state provide certain banking services to their customers will not be required to apply to the FDIC for permission to establish and operate a new branch pursuant to section 303.2 of the FDIC's regulations.3 Of course, insured state nonmember banks must comply with the state statutes and regulations concerning branching.4

In the interest of safe and sound banking practices, the FDIC expects any insured state nonmember bank which engages in contract branching to enter into an arms-length written agreement with the other bank(s) involved that adequately addresses the nature of the services to be provided and the rights and responsibilities of each of the parties.

Moreover, the Legal Division is of the opinion that the range of permissible activities which can be offered by a service bank to customers of other banks is limited to those activities which are virtually identical to activities which can be conducted at an ATM or a teller window of the customer bank. Thus, service banks may not originate loans or issue letters of credit on behalf of the customer bank. Your incoming inquiry represents that the activities permitted by the Minnesota statute are limited to routine services such as accepting deposits, paying withdrawals, issuing money orders, travelers' checks or similar instruments, cashing checks, receiving loan payments and disbursing loan proceeds.

Finally, I should also note that it is the Legal Division's opinion that, for federal deposit insurance purposes, deposits made with a service bank will be treated as deposits made directly with the customer bank in the event that either institution fails prior to the actual transfer of funds.

I trust this letter is fully responsive to your inquiry. If you have further questions, please to not hesitate to contact me or Alan J. Kaplan (202-898-3734) or Jeffrey M. Kopchik (202-898-3872) of the Legal Division.

1The operative phrase "at which deposits are received or checks paid or money lent" was inserted in the Banking Act of 1935. It is interesting to note that identical language was included in the National Bank Act in 1927. The legislative history of the Banking Act of 1935, however, gives no indication whether Congress consciously intended to copy the National Bank Act language, but the timing and the fact that the language is identical suggests that possibility. Go back to Text

2To the extent that the FDIC Legal Division staff advisory opinions 88-69 and 91-34 are inconsistent with the views expressed in this letter, this letter shall control. Go back to Text

3The Chief Counsel of the OCC recently issued an opinion letter expressing a similar view that national banks which engage in contract branching shall not be considered to be branches of the bank with which they contract. See October 8, 1992 letter from William P. Bowden, Jr., Chief Counsel. Moreover, the OCC also recently issued a revised Interpretative Ruling applying the Smith test in cases involving the use of messenger services by national banks. See 12 C.F.R. 7.7490; 58 Fed. Reg. 4070 (January 13, 1993). Go back to Text

4FDIC Legal Division staff advisory opinions 88-69 and 91-34, as well as the OCC Chief Counsel's recent opinion, were prompted by state statutes explicitly permitting contract branching and providing that banks which enter into such arrangements are not establishing additional branches and need not file branch applications with the state banking department. Go back to Text

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