McFadden Act Regulates Branch Banking

The McFadden Act granted national banks in the United States the right to open branches in their head-office cities in order to reduce the comparative disadvantages they had suffered and to retain government control over banking and monetary policies.

Summary of Event

The main provisions of the McFadden Act, which became law on February 25, 1927, permitted branch banking by federally chartered banks (national banks) that were located in states in which laws granted such authority to state-chartered banks (state banks). The act was intended to remove some of the handicaps under which national banks had been competing with state banks. [kw]McFadden Act Regulates Branch Banking (Feb. 25, 1927)
[kw]Act Regulates Branch Banking, McFadden (Feb. 25, 1927)
[kw]Branch Banking, McFadden Act Regulates (Feb. 25, 1927)
[kw]Banking, McFadden Act Regulates Branch (Feb. 25, 1927)
McFadden Act (1927)[Macfadden Act (1927)]
Branch banking
[g]United States;Feb. 25, 1927: McFadden Act Regulates Branch Banking[06850]
[c]Banking and finance;Feb. 25, 1927: McFadden Act Regulates Branch Banking[06850]
[c]Laws, acts, and legal history;Feb. 25, 1927: McFadden Act Regulates Branch Banking[06850]
McFadden, Louis Thomas
Crissinger, Daniel Richard
Hoover, Herbert

The Federal Reserve Act of 1913 Federal Reserve Act (1913) prohibited national banks from branching; each could operate from only one full-service office. State banks, however, were often allowed to branch within their head-office cities or counties, or even statewide. The purpose of this differential regulation was to protect small (state) banks from competition from branches of large (national) banks. This disadvantage to national banks in competing with state banks caused many banks to convert to state charters. During the 1920’s, 127 large national banks (with total assets of five million dollars or more at that time) converted to state charters.

Unlike national banks, state banks were not required to be members of the Federal Reserve system Federal Reserve system and were not subject to the reserve requirements set by the Federal Reserve, under which banks had to keep certain percentages of deposits available as reserves to meet demands for withdrawals. Therefore, the Federal Reserve’s ability to maintain direct control over banking policies and the money supply was weakened as national banks converted to state charters.

To alleviate this problem, Daniel Richard Crissinger, chairman of the Office of the Comptroller of the Currency, in 1921 authorized national banks (in states that permitted state banks to branch) to open teller windows that would accept only deposits and cash checks. These acted as limited-service branches. The problem of conversion to state charters nevertheless continued. Between 1924 and 1927, the issue of branch banking was extensively debated in the banking industry, in state governments, and in Congress.

The McFadden Act allowed national banks to open full-service branches. Under the McFadden Act, national banks were allowed to branch within the cities or towns in which they were located, provided that state banks had the same privilege. State banks were permitted to retain all branches established prior to the McFadden Act but were forbidden to establish new branches outside their head-office cities.

The purpose of the McFadden Act was to reduce the comparative disadvantage suffered by national banks thereby reducing the incentive to abandon federal charters in favor of state charters. The bill was designed to slow defections from the national banking system. The disadvantage to national banks remained, however, in states in which state banks had already established branches outside their head-office cities, because the branching of national banks was limited to the cities in which they were located.

According to Louis Thomas McFadden, it was not the purpose of his act to encourage branch banking in the broadest sense. The act was in fact an “anti-branch banking bill” that cut the number of bank branches per capita by about half between 1920 and 1930. The reduction came about because of the restrictions on branching by state banks.

On June 16, 1933, the Glass-Steagall Act Glass-Steagall Act (1933)[Glass Steagall Act (1933)] was passed, amending the McFadden Act by extending the branching privilege of national banks to outside their head-office cities if state law permitted state banks this freedom. Under this bill, national banks and state banks had the same branching rights. Branching authority for both national and state banks was subject to state branching laws. Bank branching can be classified into three categories. First, unit-banking states permitted only single-office banks. Second, limited-branching states allowed state banks to branch within a city, county, or portion of the state. Third, statewide-branching states allowed banks to open branches anywhere within the state.

Branch banking began on a large scale after passage of the Glass-Steagall Act. National banks took advantage of the right to branch outside their head-office cities. For example, the number of branches of Bank of America Bank of America increased to five hundred by 1946 and to more than a thousand by 1976, with at least one branch in every county in California. During the period from 1933 to 1951, three-fourths of new branches created were outside head-office cities.

Although banks were granted more freedom to branch intrastate, neither national nor state banks were allowed to branch across state lines. The purpose of this interstate branching restriction was to prevent monopolistic tendencies in the banking system. That is, the restriction was intended to prevent development of a monopolistic bank that would have control over loan and deposit markets in the entire nation. In addition, the interstate branching restriction was believed to prevent banks from draining funds from one state to lend in another state. Local banks were believed to be more likely to commit to serving local businesses and investments within the state. In supporting this argument, President Herbert Hoover stated in 1929 that the American credit system should be subject to the restraint of local interest.

Some banks were interested in branching beyond their intrastate branching rights. These banks evaded the interstate branching restriction by setting up holding company organizations to acquire banks in other states. Up until the 1950’s, the multibank holding company was frequently used as a mechanism to expand across state lines. Forty-seven bank holding companies existed in 1960.

This loophole in the McFadden Act was closed on May 9, 1956, by the Douglas Amendment to the Bank Holding Company Act, Bank Holding Company Act (1956) which prohibited bank holding companies from acquiring banks in other states. Those bank holding companies that had already acquired bank subsidiaries in other states were allowed to keep them and operate them. The Douglas Amendment effectively prohibited banks from branching across state lines unless specifically authorized to do so by state authorities.

The Bank Holding Company Act of 1956 was amended in 1970 to define a bank as an institution that accepts deposits that can be withdrawn on demand and also makes commercial loans. A branch office that did not provide one of these services would not satisfy the definition of a full-service bank. These branch offices were called “nonbank banks” Nonbank banks and were not regulated by the Federal Reserve system. Some banks evaded the interstate branching restriction by opening nonbank banks in other states as a way to expand across state lines. The Competitive Banking Equality Act of 1987 closed this loophole by defining a bank as any institution insured by the Federal Deposit Insurance Corporation (FDIC), but it exempted nonbank banks established before March 5, 1986.

Branch liberalization within states (intrastate branching) continued as more and more states converted from unit banking to statewide banking. For example, New Jersey and New York converted to statewide branching in 1973 and 1975, respectively. Florida converted from unit banking to countywide branching in 1977, and then to statewide branching in 1980. By the end of 1990, forty-two states had statewide branching, and Colorado was the only unit-banking state in the nation.


More important than allowing national banks to branch within their head-office cities, the McFadden Act imposed interstate branching restrictions for both national and state banks, one of the most important restrictions on the nation’s banking industry. All banks were prohibited from branching across state lines in order to prevent monopolistic tendencies in the banking system. This interstate branching law had an unintended effect. In addition to tampering with the degree of competition in the banking industry, the law imposed restrictions on banks’ ability to diversify geographically, as banks were not able to open branches in other states to diversify their loan and investment portfolios.

The limitation on geographic diversification increased bank risks. An economic downturn in a state could have a disastrous effect on banks with business concentrated in the state and cause a chain of bank failures in that state. For example, First Republic Bank of Texas, the fourteenth largest bank in the nation at the time, went bankrupt in the late 1980’s, as did several other Texas banks. Problems in the oil industry and real estate in Texas caused the failures, which used up a large part of the FDIC insurance fund.

As the number of bank failures increased dramatically in the 1980’s, the FDIC attempted to minimize depositor losses and resulting communitywide or nationwide disruption by arranging for troubled banks to be merged with healthy ones, with FDIC financial assistance. This policy was applied particularly to large banks, which regulators considered to be too big to be allowed to fail because of the disruptions that would result from failure. The FDIC sometimes had a difficult time finding a healthy bank within the same state to acquire a troubled bank, as problems in a state tended to affect all the state’s banks.

The Garn-St. Germain Depository Institutions Act was passed on October 15, 1982, to affirm the power of the FDIC to arrange interstate mergers if an acquirer from the same state was not found. For example, First Republic Bank of Texas was acquired by the North Carolina National Bank (NCNB) in July, 1988, under an FDIC emergency rescue program. The FDIC emergency rescue program helped to promote nationwide banking and improve geographic diversification in the U.S. banking system.

In addition, starting in the early 1980’s, states began to pass laws that would allow out-of-state banks to enter under specified circumstances. Some states required a reciprocal arrangement that allowed banks and bank holding companies from other states to enter by acquiring existing banks within their borders only if the home state of an entering bank granted similar privileges to banks headquartered in the state being entered. By the end of 1992, the only four states that did not allow out-of-state banks to enter were Hawaii, Kansas, Montana, and North Dakota. The trend appeared to be toward nationwide banking, which would help to reduce banks’ vulnerability to regional economic downturns.

Aside from the issue of geographic diversification, it has also been argued that the interstate branching restriction imposed by the McFadden Act reduced cost efficiencies in the banking system. Small banks are generally likely to be handicapped by higher costs relative to large banks. Banks could obtain economics of scale by expanding nationwide. Some analysts argued that banks did not necessarily have to expand across state lines to be large enough to realize economies of scale. Whether U.S. banks could become more efficient by branching across state lines remains an issue that will have to be decided by experience. Cost efficiency studies for commercial banks have provided mixed results. The fact that branching was being allowed on a larger scale showed that regulators were swayed by cost considerations and were less concerned with potential monopoly power.

Nationwide banking as opposed to branching has also been a topic for debate since the late 1980’s. Under state branching laws, such as reciprocal arrangements, and the FDIC emergency rescue program under the Garn-St. Germain Depository Institutions Act, banks are allowed to acquire existing banks in other states and operate them as bank subsidiaries. This improves the geographic diversification of bank holding companies, but it may not significantly reduce the rate of bank failures if profits and losses are not pooled among bank subsidiaries. That is, diversified bank holding companies may choose to let their troubled bank subsidiaries fail and continue to impose potential liabilities on the FDIC insurance fund. In 1994, passage of the Riegle-Neal Interstate Banking and Branching Efficiency Act gave banks much greater ability to operate interstate branches. The impacts of this change in banking law are still being debated. McFadden Act (1927)[Macfadden Act (1927)]
Branch banking

Further Reading

  • Burns, Helen M. The American Banking Community and New Deal Banking Reforms, 1933-1935. Westport, Conn.: Greenwood Press, 1974. Discusses the development of banking reforms and presents interesting statistics on bank branching by both state and national banks during the period 1900-1935. Unlike many books on regulatory reforms in the 1930’s era, this one was written long after the events, allowing the author to relate important issues in the 1930’s to more recent regulatory development.
  • Calomiris, Charles W. U.S. Bank Deregulation in Historical Perspective. New York: Cambridge University Press, 2000. Offers historical background on U.S. banking laws to explain the changes in the banking industry in the last two decades of the twentieth century. Briefly discusses the McFadden Act.
  • Chapman, John M., and Ray Westerfield. Branch Banking. New York: Harper & Brothers, 1942. Useful for information on the history and theory of branch banking, both in the United States and abroad. Provides statistics about branch banking.
  • Frieder, Larry A. Commercial Banking and Interstate Expansion: Issues, Prospects, and Strategies. Ann Arbor, Mich.: UMI Research Press, 1985. Provides detailed arguments for and against interstate banking. Discusses issues such as geographic diversification, cost efficiency, effects on competition, and the safety and soundness of the banking system. Examines Florida’s regulation of interstate banking in detail. Well written, but perhaps too technical for readers with no special background in finance or economics.
  • Johnson, Richard B., ed. The Bank Holding Company, 1973. Dallas: Southern Methodist University Press, 1973. Collection of conference papers devoted to issues related to bank holding companies, with a focus on regulatory issues. Intended for readers with background in banking and finance.
  • Klebaner, Benjamin J. American Commercial Banking: A History. Boston: Twayne, 1990. Well organized history, easy to understand even for readers without background in finance and economics. Provides a chronology of important events from 1781 to 1989.
  • Matasar, Ann B., and Joseph N. Heiney. The Impact of Geographic Deregulation on the American Banking Industry. Westport, Conn.: Quorum Books, 2002. Addresses the changes in American banking since the passage of the Glass-Steagall Act in 1933. Intended for readers with some background in banking and finance. Includes an appendix containing the text of the McFadden Act, bibliography, and index.
  • Ostrolenk, Bernhard. The Economics of Branch Banking. New York: Harper & Brothers, 1930. Discusses the development of and reasons for branch and chain banking. Chapters 8-10 examine the history of branch banking in the United Kingdom, Canada, and California.

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