Supreme Court Ruling Gives Major Boost to ‘Non-Bank’ Banking

WASHINGTON —  The Supreme Court on Wednesday swept aside a major obstacle to the rapid spread of “non-bank banks,” ruling that the Federal Reserve Board lacks authority to regulate the newly created, limited-service financial institutions.

In a decision widely awaited in the financial industry, the court held 8 to 0 that provisions of the federal Bank Holding Company Act were intended by Congress to exempt limited-service institutions from regulation by the board, even though they effectively provide many of the same services as ordinary commercial banks.

“Without doubt, there is much to be said for regulating financial institutions that are the functional equivalent of banks,” Chief Justice Warren E. Burger wrote for the court. “The statute may be imperfect, but the board has no power to correct flaws that it perceives in the statute.”

Problem for Congress

If the law fails to protect the public, Burger said, “that is a problem for Congress, and not the board or the courts, to address.”

The limited-service banking concept emerged as a means of avoiding Bank Holding Company Act provisions that substantially restrict interstate banking. Under the act, a “bank” is a financial institution that both accepts deposits that the depositor has a legal right to withdraw on demand and offers commercial loans. Non-bank banks sidestep the law by providing--at least technically--either service but not both.

The court’s ruling represents an important victory for the brokerage firms, retailers and other companies that recently have entered the limited-service banking field.

Preliminary applications for more than 300 limited-service banks, most from bank holding companies, have been approved by the Comptroller of the Currency, but final approval has been blocked by an injunction pending resolution of a federal court suit in Florida challenging such institutions.

A lesser but undetermined number of non-bank banks, most established by non-banking firms that have purchased state-chartered banks, now operate in the country, a spokesman for the comptroller’s office said.

Some large commercial banks favor establishing non-bank banks because, in the absence of interstate banking, these quasi-banks give institutions a chance to establish networks in other states--thereby improving profitability, reducing dependence on regional economies and allowing banks to better compete with other financial-services firms.

Smaller banks generally have opposed non-bank banks because they would present still more competition in their areas from both large banks and financial-services companies.

The battle over non-bank banks appears far from finished, and legislation that would extend the Federal Reserve Board’s authority over such institutions has been introduced in Congress. The measure has won approval of the House Banking Committee, whose chairman, Fernand J. St Germain (D-R.I.), on Wednesday called for its passage.

Other Actions Pending

“If we don’t do anything in the Congress, we will have a plethora of who knows what kinds of financial institutions which will be very hard to regulate,” he said.

Other legal actions that challenge the validity of non-bank banks on other grounds are pending in lower courts.

The decision Wednesday came against a backdrop of widespread change in the banking industry. Firms like Merrill Lynch, Sears and J. C. Penney have begun to offer banking services in competition with regular banks. Banks, in turn, have entered securities, insurance and other fields of business and have sought to expand into new geographical areas.

In 1984, the Federal Reserve Board, concerned over the spread of non-bank banks, decided to revise its regulations to bring limited-service institutions within its authority. Changes were necessary, the board said, because non-bank banks were enjoying a significant competitive advantage over regular banks, posing a threat to the traditional separation of banking and commercial enterprises and undermining longstanding restrictions on interstate banking without state approval.

The board amended its definition of “demand deposits” to include so-called NOW accounts, which function much like regular checking accounts, and broadened its definition of “commercial loans” to include purchases of certificates of deposit, some money-market transactions and other services.

Kansas Institution

The case before the court arose when Dimension Financial Corp., a unit of Valley Federal Savings & Loan Assn. of Hutchinson, Kan., sought to establish 31 non-bank banks in 25 states. The company proposed to provide checking accounts and to issue consumer but not commercial loans.

The board attempted to invoke its new regulations to bring such limited-service banks within its control, but a federal appeals court in Denver ruled that the board had exceeded its authority. The board appealed the ruling but, in a rare split, the Justice and Treasury departments opposed the board, saying that its new regulations contradicted the intent of Congress.

In Wednesday’s ruling (Board of Governors vs. Dimension, 84-1274), the justices affirmed the lower court ruling without dissent.

Burger wrote that the Fed’s broadened definition of “demand deposits” was “not an accurate or reasonable” interpretation of the law. Nor, he said, was the Fed’s new definition of commercial loans permissible under the act.

The court further rejected the Fed’s claim that its regulations conformed with the “plain purpose” of the act to include within board authority those institutions that were “functionally equivalent” to banks.

Jeffrey Davidson, the attorney who represented Dimension in the case, praised the court’s ruling as a “healthy development” that would bring more competition to banking.

Large Banks Pleased

A spokesman for the Federal Reserve Board declined to comment on the ruling except to say that it now “will be up to Congress” to decide whether to change the law to broaden board authority over such institutions.

Several large commercial banks hailed the decision as a step in the right direction.

“We really welcome this decision,” said Michael Capatides, a vice president and attorney for New York-based Chemical Bank. “Chemical Bank’s policy has been all along that we support interstate banking,” he said. “We feel that increased competition ultimately benefits consumers.”

Chemical Bank has 14 applications for limited-service banks pending.

Helmut Loring, a Bank of America senior vice president, said he hopes the court will take a similar stand in other suits that challenge the right of bank holding companies to own limited-service banks.

Times staff writer Nancy Rivera, in Los Angeles, contributed to this story.