What Is Interstate Banking?

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Interstate banking describes the ability of a bank to expand beyond its home-state borders to own and operate banks in other states.

Interstate banking describes the ability of a bank to expand beyond its home-state borders to own and operate banks in other states. Interstate banking restrictions have been in place since the Civil War, although they consistently change.

Learn how interstate banking works and the ways in which you can benefit as a consumer.

Definition and Example of Interstate Banking

Interstate banking is when a bank that has a home base in one U.S. state expands across state lines to own and operate banks in one or more other states. Historically, the banking industry in the United States has had heavy regulation. Those regulations typically include things such as the prices banks can charge, minimum capital requirements, and consumer protections. Some of the rules also involved consumer access to credit, as well as geographic restrictions on bank operations, such as limiting bank branches. However, many of these restrictions have gradually relaxed over time.

In banking terms, “geography” refers to the location where banking activities may take place. Interstate banking refers to a financial institution’s ability to offer banking services across state lines. The term is often confused with intrastate banking (multiple locations in the same state) and interstate branching (one or more branches in other states).

An example of interstate banking would be if a bank located in Indiana wanted to acquire a branch of a bank located in Illinois.

How Does Interstate Banking Work?

Generally, state laws have always determined whether chartered or non-chartered banks could establish additional subsidiaries and branches.

During most of the 20th century, state and federal laws made it practically impossible for banks to have branches in more than one state. One reason was to protect local banks from interstate and intrastate competition. Another reason was the concern that national banks would become too powerful and harm local economies.

However, during the 1980s, most states began to relax laws. They began allowing some form of interstate banking within their borders either on a reciprocal or non-reciprocal basis. The interstate banking process started with the formation of regional banks (when smaller banks were combined to create larger institutions).

The Interstate Banking and Branching Efficiency Act of 1994 allowed insured banks to merge with different home states regardless of state law.

History of Interstate Banking

Interstate banking restrictions have ebbed and flowed since the Civil War. The McFadden Act of 1927 clarified how much control states had over the branching of national banks within their borders. Regulators eliminated some restrictions in the 1930s; however, many states enforced regulations until the 1970s.

The relaxing of interstate banking and branching restrictions typically involved a two-step process. First, states permitted multibank holding companies to convert subsidiary banks into branches. This meant that banks could expand across state lines by acquiring out-of-state banks and converting them into an already existing subsidiary branch. Second, states began allowing what’s known as “de novo” branching, which meant they could open new branches anywhere within the state’s borders.

By 1992, all states except Hawaii had passed reciprocity laws. These laws permitted out-of-state banks to acquire banks in a home state only if the home state was also allowed to acquire banks in their states.

Most banks in the United States are owned by bank holding companies (BHCs). The Federal Reserve supervises these companies whether the bank subsidiary is a state member, national bank, or nonmember.

The Douglas Amendment

Typically, most legislation related to interstate banking occurs at the state rather than the federal level. The Bank Holding Company Act of 1956 was enacted to limit the growth of the banking companies. The act included the Douglas Amendment, which authorized takeovers when they are authorized by the state of the target bank. In other words, it was up to the state to decide if interstate banking would be allowed within its borders.

Riegle-Neal Act

In 1994, President Clinton signed the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. This passage of this law essentially eliminated any remaining federal restrictions against interstate banking expansion. However, it still allowed states significant leeway to govern when deciding on the entry of out-of-state branches.

On June 1, 1997, the interstate branching laws of the Riegle-Neal Act became fully effective.

After the Riegle-Neal Act was passed, the banking industry in the U.S. went from a system of locally operated banks to a system that has become nationally integrated. However, making the U.S. banking system more economically competitive was not the sole reason the Riegle-Neal Act was passed. It was believed that interstate banking would make the banking industry more diversified, less risky, and more efficient. Congress also thought this legislation would provide more convenience and choices for consumers.

Notable Happenings

After the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 removed federal restrictions on interstate banking, larger banks swallowed up smaller banks in an attempt to gain market share.

Since large banks controlled most of the banking-industry assets, the federal government was forced to bail them out during the 2008 financial crisis. At the time, the government believed that the economy would collapse if the big banks failed.

What Does Interstate Banking Mean for Individual Consumers?

Interstate banking benefits consumers as well as large banks. One advantage is that bank customers have more options by being able to visit a bank’s branch outside of the banking organization’s home state.

Also, increased competition means better prices on banking products and services, and better convenience. Interstate banking has also led to considerable improvements in the efficiency of banks. Studies have shown that interstate banking led to a decline in loan losses for banks. So, consumers benefit by receiving lower prices on loans.

Plus, having access to larger banks provides consumers with a wider array of products and services that smaller banks might not offer.

Key Takeaways

  • Interstate banking is the ability for banks to expand across state lines.
  • Out-of-state banks acquisitions are primarily controlled by the target state.
  • The Interstate Banking and Branching Efficiency Act of 1994 removed restrictions on interstate banking.
  • Consumers benefit from interstate banking when increased competition lowers the cost of banking services and products.

Article Sources

  1. Board of Governors of the Federal Reserve System. “The Effect of Removing Geographic Restrictions on Banking in the United States: Lessons for Europe.” Accessed Feb. 4, 2022.

  2. Federal Reserve Bank of St. Louis. “Going Interstate: A New Dawn for U.S. Banking.” Accessed Feb. 4, 2022.

  3. Federal Reserve Bank of Chicago. “Accessing a Decade of Interstate Bank Branching,” Pages 5, 9-10, 13. Click “Download Entire Publication.” Accessed Feb. 4, 2022.

  4. Federal Reserve System. “Bank Holding Companies and Financial Holding Companies.” Accessed Feb. 4, 2022.

  5. Federal Reserve Bank of Chicago. “Accessing a Decade of Interstate Bank Branching,” Page 9. Click “Download Entire Publication.” Accessed Feb. 4, 2022.

  6. Federal Reserve Bank of Chicago. “Accessing a Decade of Interstate Bank Branching,” Page 2. Click “Download Entire Publication.” Accessed Feb. 4, 2022.

  7. Federal Deposit Insurance Corporation. “General Counsel’s Opinion No. 11, Interest Charges by Interstate State Banks.” Accessed Feb. 4, 2022.

  8. Journal of Legislation. “The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994: Responding to Global Competition,” Pages 268-269. Accessed Feb. 4, 2022.

  9. Federal Deposit Insurance Corporation. “The $700 Billion Bailout: A Public-Choice Interpretation.” Accessed Feb. 4, 2022.