The Supreme Court yesterday issued a decision that could boost interstate banking and accelerate changes in the financial-services industry, ruling that the Federal Reserve Board has no control over limited-service, or "nonbank," banks.
The 8-to-0 decision, written by Chief Justice Warren E. Burger, is a victory for major brokerage firms, department stores such as Sears, Roebuck & Co. and J. C. Penney Co. Inc., and other businesses that have entered the financial-services field to compete with banks.
It is a defeat for state banking regulators and the Fed, which had tried to rein in the diversification movement by expanding its definition of what constituted a bank under federal laws.
The ruling is also likely to spur now-stalled efforts in Congress to regulate the new institutions, which in practice function much like banks but under yesterday's decision are not covered by major banking legislation.
The law giving the Federal Reserve authority to regulate banks says a bank is a financial institution that takes in deposits and makes loans to businesses. Most nonbank banks avoid that definition by not making business loans, concentrating instead on services to individual consumers.
The Fed has argued that nonbank banks should be regulated because they put traditional banks "at a severe competitive disadvantage." The Fed said the spread of nonbank banks threatened to erase legal barriers against mixing banking with other commercial enterprises and undermined laws limiting interstate banking.
Striking down the Fed's reading of the 1956 law, Burger said "the statute may be imperfect, but the board has no power to correct flaws that it perceives in the statute it is empowered to administer."
Burger said that, if the law "falls short of providing safeguards desirable or necessary to protect the public interest, that is a problem for Congress, and not the board or the courts, to address."
Rep. Fernand St Germain (D-R.I.), chairman of the House Banking Committee and a strong opponent of nonbank banks, issued a statement shortly afterwards calling for renewed efforts to regulate the new institutions.
"This ruling opens the door for a plethora of new hybrid banking institutions that will be outside the regulations of the Bank Holding Company Act. This has the potential for a massive change in the U.S. banking system and its relationship to other areas of the economy," St Germain said, adding that it is "of paramount importance" for Congress to move quickly in light of the ruling.
But Sen. Jake Garn (R-Utah), chairman of the Senate Banking Committee, said the practical effect of the decision is "quite limited." A U.S. District Court judge in Florida has blocked the comptroller of the currency from granting any final nonbank bank charters, Garn pointed out. The most common method for large banks to establish nonbank banks was to request a national charter from the comptroller of the currency.
Many nonbank banks have been exempt from the act because, technically, their negotiable order of withdrawal (NOW) accounts are not identical to traditional checking accounts. Burger said some nonbank banks may offer conventional checking accounts but escape the regulations by "limiting their extension of commercial credit to the purchase of money market instruments such as certificates of deposit and commercial paper."
The Fed wanted to bring the nonbank banks under its authority by saying the NOW accounts were, in effect, checking accounts and the money market transactions were the same as standard commercial loans.
John D. Hawke Jr., an attorney for a nonbank bank organization, said yesterday's decision in the case -- Board of Governors of the Federal Reserve System v. Dimension Financial Corp. -- would likely overrule the 11th U.S. Circuit Court of Appeals last May, which said the Fed had a duty to stop the proliferation of nonbank banks. Hawke said the likely effect of the decision is "probably to allow bank holding companies to acquire nonbank banks."
Hawke and others said they do not expect major changes immediately as a result of the ruling. The ruling will increase pressure on Congress to act, and financial institutions are likely to wait to see what Congress will do.
Legislation has been deadlocked because the House and Senate differ on the scope of the legislation and disagree about the cutoff, or "grandfather" date, for determining which institutions can continue to exist. The House passed a banking bill last June that would stop further expansion of nonbank banks but grandfathered in 109 nonbank banks existing as of May 9, 1984.
The Senate had passed a bill in 1984 with a July 1983 cutoff date. But Garn warned yesterday that Congress will act and will not accommodate new nonbank banks organized since then.
Justice Byron R. White did not participate in yesterday's decision.
In other action yesterday, the court limited states' power over natural gas regulation. In a 5-to-4 ruling, written by Justice Harry A. Blackmun, the court struck down a Mississippi regulation requiring an interstate pipeline to buy a proportional amount of gas from all the owners of a common gas pool when the pipeline had long-term contracts with only some of them.
Blackmun said the 1938 Natural Gas Act and the Natural Gas Policy Act of 1978 banned such state regulations and that the Mississippi rule "frustrates the federal goal of ensuring low prices."
Justice William H. Rehnquist, in dissent with Justices Lewis F. Powell Jr., John Paul Stevens and Sandra Day O'Connor, said the rule was "price neutral" and consistent with congressional intent to decontrol the price of natural gas.
The case is Transcontinental Gas Pipe Line Corp. v. State Oil and Gas Board of Mississippi.