Regional and interstate bank mergers will reshape the industry and significantly enhance economic growth, according to the top executives of three major Washington-area banks.

"Historically, we have had artificial barriers dividing up a very natural marketplace," said Charles W. Cole Jr., president and chief executive officer of Baltimore's First Maryland Bancorp, parent of the state's second-largest bank. "As these artificial barriers are removed through the interstate compacts, then mergers can evolve with the benefit being larger capital positions by institutions, economies of scope and economies of scale. . . ."

Cole -- along with Daniel J. Callahan III, chairman and chief executive officer of American Security Corp., and C. A. Cutchins III, chairman and chief executive officer of Sovran Financial Corp. -- discussed the pros and cons of interstate banking recently, on the heels of the District's decision to participate in regional banking. The sharp increase in bank mergers in the region over the last few months makes their comments even more timely.

"You'll get more crossover in the investment of funds and loans into the other parts of the region," Callahan said when asked about the positive aspects of regional banking. His bank, American Security, is the city's second-largest.

Cutchins said that "banking in the metropolitan area can achieve both operation efficiencies and some cost reduction benefits through affiliation." Sovran is Virginia's largest bank-holding company.

The flurry of area bank mergers was hastened by a Supreme Court decision in June that upheld the right of states to enter into regional reciprocal banking pacts. Such pacts, which originated in New England, were challenged unsuccessfully by New York's giant bank-holding companies as protectionist schemes devised to avoid competition.

Under a reciprocal banking agreement, the District, for example, would permit bank-holding companies from other states to purchase D.C. banks if the other states allowed D.C. holding companies to buy their banks.

By voting to override Mayor Marion Barry's veto of a regional banking bill earlier this month, the D.C. City Council cleared the way for D.C. banks to merge with institutions in Maryland, Virginia and 11 southeastern states. Although the interstate banking laws of those states differ in some details, they are very similar.

Maryland's reciprocal banking law, which its General Assembly approved in the last session, will proceed in two stages. The first phase, which became effective this past July, authorizes regional banking pacts with the District, Delaware, Virginia and West Virginia. Beginning July 1, 1987, reciprocal banking agreements with 11 southeastern states will go into effect.

Maryland also passed a companion banking measure last spring giving out-of-state banks that currently have limited-service banking offices in Maryland permission to offer full-service banking beginning July 1, 1986. Before those institutions can begin full-service operations, however, they must agree to invest a minimum of $25 million in facilities in Maryland and employ at least 1,000 residents, mostly in areas of the state with high unemployment. Moreover, a limited-service bank must have been in existence for two years before converting to a full-service institution.

Virginia's General Assembly approved its regional interstate banking bill in February. Under that law, which became effective in July, Virginia may enter into reciprocal agreements with 13 southeastern states and the District.

In just over six months, 10 bank companies in the District, Maryland and Virginia have signed agreements that, if approved, would result in six mergers across state lines. Two of those agreements involve Sovran, which has assets of $8.7 billion. Sovran has agreed to acquire D.C. National Bancorp, holding company for D.C. National, the District's seventh-largest bank, and Suburban Bancorp, parent of Suburban, Maryland's fourth-largest bank.

Neither American Security nor First Maryland has announced plans to merge with another institution.

Q: At this time, which is preferable: regional interstate banking or national interstate banking?

Callahan: I personally have always been a proponent of national interstate banking. However, that is not currently in the cards. Congress has not seen fit to pass any such legislation. The banking industry and the related industries have never agreed on a common ground on that issue.

I personally believe it will probably be some time before we get to full interstate banking, and it will be at the congressional level when it comes.

In the meantime, the concept of regional banking has come to the fore. Since that appears to be the only game in town, I would think that it's the proper approach for our region and our institution. We have been locked into the confines of Washington, D.C., right from the beginning. We now have an opportunity to participate in the region.

Cutchins: Sovran has always supported the concept of regional interstate banking which was passed by the Virginia legislature and upheld in a Supreme Court ruling.

It provides an orderly approach, allowing banks to expand initially into natural markets, the geographic extensions of current markets.

Regional expansion affords regional financial institutions, such as Sovran, the opportunity to achieve the size necessary to compete effectively with the money-center banks and other financial service companies such as Sears and Shearson American Express.

This strategy of regional interstate banking is the most beneficial to local communities. It preserves a degree of local ownership, local involvement and reinvestment back into the community not usually provided by distant money-center banks.

Cole: First Maryland Bancorp has felt for a long time that regional reciprocal banking is the logical step to national banking. We think that this gives the regional institutions a fair period of time to consolidate and carefully prepare for national banking.

Q: How will banks in Maryland, Virginia and the District benefit from mergers under regional interstate banking laws?

Callahan: The banks that are able to merge or acquire each other can work together in ways to consolidate operational and other expenses.

I hope that the larger institutions will be able to acquire money and the deposits at more favorable rates. It would make more sense probably to have a bigger institution that can get into other areas of financial services that maybe one institution on its own would not be able to do.

I guess I'm philosophically opposed to a trigger because it seems to me we're just getting into this regional activity and it should be given some time to see how it works out. If another law is needed to go to wider ranging interstate activity, then it should be put in at that time.

I just don't believe in tying yourself down to doing something at a set point in time in the future when you're not even sure today how the current activity will progress. On the other hand, I said that I'm in favor of national interstate banking if everybody went the same way and the same day.

Cutchins: Banking in the metropolitan area can achieve both operational efficiencies and some cost reduction benefits through affiliation. The combination of duplicate functions is an obvious benefit. On the cost reduction side, advertising dollars spent come immediately to mind.

Sovran, for instance, has a strong presence in the Northern Virginia market and advertises in regional publications and broadcast media that includes coverage in both D.C. and Maryland. A regional organization would more effectively utilize advertising expenditures. In addition, regional partnerships will allow banks to diversify their portfolios, balancing inequities that can occur with too great a concentration in one line of business. Through orderly growth and geographic spread, banks can reduce risks by serving a broader and wider economic base.

Cole: Historically, as you know, we have had artificial barriers dividing up a very natural marketplace. As these artificial barriers are removed through the interstate compacts, then mergers can evolve with the benefit being larger capital positions by institutions, economies of scope and economies of scale will follow and the net result will be that corporations, and the consumer, will benefit in the marketplace.

Q: How will consumers benefit from interstate mergers?

Callahan: I think we'll be able to provide a wider array of products and services. To give you an example, there are some activities that we're not doing on our own but we might like to if we had a bigger base to operate from. If we can keep control of operating expenses, we'll be able to provide consumers with highest rates for their deposits and lower and competitive rates for their borrowing needs. I believe the bigger the institution, probably the better everyone is going to be able to accomplish that.

Cutchins: Combined regional institutions have greater resources for research and development, thus providing the consumer expanded and more sophisticated services. The economies of scale that can be achieved should improve the delivery of services without increasing their cost. In addition, the consumer will be afforded more convenient access to his financial services provider.

Also to be considered is the fact that size and diversity play a major role in balancing the inequities of the marketplace. There is greater stability and security provided with regional combined institutions and therefore the assurance to the consumer of the availability of a full spectrum of financial services.

Cole: As financial institutions are combined and their capital positions are enhanced, then through economies of scale and economies of scope, those institutions can provide a wider range of services, such as in the cash management area, and through a broader spectrum of services the consumer will benefit and there should be improvement through the price mechanism.

Q: How will the region's economy be helped by interstate banking?

Callahan: I think you'll get more crossover in the investment of funds and loans into the other parts of the region. Take our region as an example. The two Virginia banks that have already announced merger activities with two D.C. banks are larger and stronger than the D.C. banks. I believe that their impact in our community will prove to be very favorable. I think that as we expand outside the region the same thing will be true there.

Cutchins: Combined regional banks will be able to better meet the credit needs of this market and to service large business concerns.

Banks themselves are active in economic development and a critical size is necessary to attract large business and industry to an area.

Cole: As larger financial institutions evolve in a natural marketplace, this means that there will be larger legal lending limits for corporations. There will be a wider range of services that can be offered both the consumer and the corporate client base. And the number of institutions will be more fully integrated, and full-service banking institutions are catering to the retail, commercial, trust, international and real estate arenas. Therefore, corporations and consumers will benefit.

Q: Is national interstate banking inevitable, and when would be the right time to begin the process?

Callahan: I'm not so sure it is inevitable. I think there's an awful lot of states' rights issues and different views coming up from around the region and the country and I don't necessarily think it is inevitable. The larger the banks become in various other parts of the country, the less likelihood of that taking place.

The big money-center banks are already all across the country. So are finance companies with mortgage companies, leasing operations, credit cards, consumer mailings, etc.

Other than taking deposits they are able to do just about everything else they want to. It's the accumulation of deposits from other parts of the country that they're not able to do right now. I think as the regional banks get stronger and spread their wings, maybe there never will be any national interstate banking. I wouldn't want to bet on it.

Cutchins: At some point in time we will experience nationwide interstate banking. Banks should be allowed to expand their geographic reach to compete with other financial service organizations.

Banks are heavily regulated and subject to so many restrictions that national interstate banking is, realistically, a long way off. It is not a high priority with either the Congress or many banks.

Cole: In many ways, national interstate banking is here through holding companies and through loan production offices in the banks and through Edge Act corporations. What is missing at the present time is national deposit-taking capabilities for the banking industry. In my opinion it is inevitable. It's being demanded by consumers and corporations, and a natural time frame for it to fully evolve would be between three to five years.

Q: How large do regional banks need to be to compete effectively in their traditional markets with the money-center banks?

Callahan: I guess everybody's got their own idea on that, I would think that if a regional bank had assets of $15 billion, that that is going to be large enough to be competitive for the next 10 years or so. Looking beyond that I don't know. But I do believe we will have a whole host of banks $15 billion to $30 billion in size.

Cutchins: The size of an organization is relative to the markets it serves. First you have to be able to compete effectively in your markets with your peers, which, for Sovran, are other expanding regional banking companies. It is necessary to achieve a critical size in order to properly service your markets -- both in extension of credit and quality of services effectively delivered.

Once the time is afforded to establish regional banks in a market, they can then compete more effectively with other giant financial services institutions -- including money-center banks.

Cole: Community banks, in my opinion, will be able to survive for some time to come in a very profitable mode. Certain financial institutions of a larger size that are catering to certain niches in the market should be able to survive in a profitable mode for many years to come, as long as they continue to fine-tune their skills. In the broader scale of banking, when you get into integrated institutions that are catering to the marketplace in total, then size becomes very important in capital strength, economies of scale. Economies of scope become critical ingredients to success.

Therefore, I would say in another five- to 10-year period those institutions should be somewhere in the $15 to $20 billion range. In terms of $15 to $20 billion, I'm referencing asset size.

Q: How would the presence of money-center banks in Maryland and the District affect competition among other banks in the region?

Callahan: So far the money-center banks have been able to move into certain states because of problems existing in those states, with the exception of Delaware. Delaware passed laws to attract banks and somewhat restricted their activities. The money-center banks have gone into other states to save or rescue troubled institutions.

In most cases, it's been thrifts that have been in trouble, and the money-center banks have gone in and taken those thrifts over so there have been benefits to the state, to the depositors and those institutions by letting the money-center banks do that. They've been willing to pay that price of admission just to get themselves ensconced around the country. We do not have that need in Washington, D.C. We don't have any of our banks that are in trouble or any that need to have that sort of situation take place. We have a finite market that we're talking about here in terms of deposit base.

Cutchins: On entering a market, it is anticipated that a money-center bank would position its services in a loss-leader approach in order to gain market share and a foothold. We think they would initially conduct expensive marketing and promotional campaigns to attract consumer deposits at higher rates.

Of course, regional banks would have the option of bearing the additional expense to match their initial offerings or could simply wait until the market was stabilized and rates returned to realistic levels. We know our markets, are comfortable in our own turf, and feel that any negative or draining effect would be relatively short term.

Cole: As you know, at the present time a money-center bank can have a limited-service bank in Maryland. It certainly appears in the very near future that that will change in Maryland and money-center banks will be operating here. Community banks, I think, will not be adversely affected because they will continue to cater to the consumers and companies in their own townships.

Very little will change for larger institutions such as First Maryland, which has been active for years in competing in the retail, in the commercial, in the international, in the real estate and in the trust arenas. We have been competing against the money-center banks literally for decades. Clearly we will all have to continue to fine-tune our skills and our services to the public, but we welcome the competition and look forward to the challenge.

Q: Do you favor a trigger that establishes a certain date, and when should the area be open to national interstate banking?

Callahan: I am not in favor of a trigger. I think that that's bad legislation. You don't create legislation to do something at a point in time in the future when you do not know how your current legislation is going to work out. Unless Congress does something on an overall basis, then I would be against setting a certain date and time for a trigger. Now that's my personal view on it. There will obviously be some give and take on that issue.

Cutchins: We do not favor a trigger. We think that banks should expand their geographic markets in an orderly manner in areas they know best and are therefore the most capable of serving.

Cole: First Maryland would be very much in favor of a trigger. It gives a time certain in the future, therefore we're able to plan carefully for when national banking will arrive and, as I've mentioned earlier during our interview, First Maryland is very much in favor of national banking. We think it is inevitable, it is happening gradually in the country and we think that the sooner that the playing field is level in all states, then the banking and the public will benefit.

Q: So far, all the merger announcements involving banks in this area are based on agreements among institutions in D.C., Maryland and Virginia. Are we likely to see bank companies in this area merge any time soon with institutions from other states in the Southeast region?

Callahan: I don't know how soon that might take place, but I think the likelihood down the road is there. The larger institutions in the Southeast and the states that have already passed such legislation -- Virginia, North Carolina, South Carolina, Georgia, Florida -- have already announced various mergers and acquisitions, and I would think that they have their plates fairly full for the next few months, absorbing those activities before they reach further and try to broaden their base. But eventually I think it will probably happen.

Cutchins: The dynamics of the region have already attracted several banks, as evidenced by the number and variety that previously applied for nonbank bank status. The Virginia-D.C.-Maryland area is a natural market with a rich and a stable economy. We believe many financial insitutions from various areas will attempt to enter this market.

Cole: As you know, under Maryland registration we are restricted for two years to operating on an interstate basis with Virginia, the District, West Virginia and Delaware. Assuming that there is reciprocal legislation between those political divisions after that time, those institutions in Maryland can operate in 15 states going down through Florida.

In my opinion, there will continue to be consolidations within the Virginia, Maryland and Washington area and that those institutions in turn will flow into consolidations of some very large regional banking companies that could very well end up being between $15 to $20 to $25 billion in size. We think this is a natural evolution.