FDIC Preemption of State Law

FDIC Chairman Don Powell dropped a strong hint on June 3 that the FDIC is strongly considering the possibility of "leveling the playing field" for national and state banks. In a speech to the Conference of State Bank Supervisers in San Antonio, Texas, Chairman Powell addressed a petition filed recently with the FDIC by the Financial Services Roundtable that asked the FDIC to determine that state banks operating across state lines enjoy the same preemption of host state laws as if they were a national bank. "In other words," Chairman Powell stated, "a state bank would be allowed to operate nationwide under the laws and regulations of its home state, to the same extent a national bank could operate nationwide under the laws and regulations applicable to national banks."

Powell acknowledged that critics of such a federal preemption ruling have valid concerns. Foremost among these is the concern that there will be a "race to the bottom" by states, who will compete to attract state banks to locate in (and relocate to) their state by enacting lax regulatory regimes. Other commentators worry that the preemption rule would be a death knell for the sometimes aggressive "experimentation" in consumer protection that is often fostered in state "laboratories."

Nevertheless, Powell stated the obvious: "More broadly, I think it is hard to dispute that state banks that wish to do business interstate are not now operating on a level playing field with federally chartered institutions. Current regulatory arrangements and laws appear fundamentally tilted in favor of a federal charter, and some very thoughtful people have questioned whether this lack of parity between the state and federal charters is consistent with Congressional intent to preserve a strong dual banking system."

Powell has asked FDIC staff to bring the preemption issue to the FDIC's Board for consideration. His concluding remarks signal the clear direction in which the FDIC appears to be headed:

"It is premature to speculate what the outcome of the Board's deliberations will be. What is clear, however, is that the state banking system is at an important fork in the road.

"One possibility is that states will retain their unchallenged regulatory sovereignty—but only over the dwindling fraction of banking activity that is not conducted through federally chartered institutions. It is ironic that if this path is followed in the name of consumer protection, most consumers will end up doing business with federally chartered institutions, and the states' role in consumer protection will have been diminished.

"Another possibility might be that the share of assets in the state system will stabilize or be reversed. This result, however, seems unlikely unless each state, somehow, relinquishes some regulatory control in the interests of a more uniform and competitive playing field for state banks. None of us knows today how or if this can occur, and many do not agree that it should occur. But as a number of witnesses at our hearing said, inaction is a choice—and most likely, a choice to relegate the dual banking system to the history books."

I believe that the impact of an FDIC preemption ruling could be huge. I have seen a number of acquirers of existing banks and founders of new banks, choose the national bank charter (or, in some cases, the national thrift charter) for two primary reasons: federal preemption of state laws (which substantially reduces the regulatory burden, operational and financial, of conducting business on an interstate basis) and the ease of interestate branching (particularly with the federal thrift charter). On the other hand, the OCC and the OTS, while aggressive proponents of federal preemption, have proved to be strict regulators, or, at least, more strict than many state banking regulators. I can think of a number of clients who, if they were offered the opportunity to switch to a state charter without giving up federal preemption, would "flip" to a state charter without hesitation. There already exist state regulators who are more "reasonable" (in the minds of these bankers, at any rate) than the federal regulators with whom they must deal.

Of course, the devil is in the details. We'll need to see how extensive such a preemption ruling might be, and what kinds of legal roadblocks might be thrown in its way. Nevertheless, the potential impact on the banking industry, and the future of state banks, is profound.
---Kevin Funnell