BANK OFFICER'S HANDBOOK OF COMMERCIAL BANKING LAWFifth Edition

FREDERICK K. BEUTELProfessor of Law, Enwritus, Uttiversity o f Nebraska Member of the Nebraska Bar

MILTON R. SCHROEDERProfessor of Law, Arizona State Ut~iversity Member of the Arizona Bar

WARREN, GORHAM & L A M O mUosron NCW York

PREFACE financial institutions has dictated an enlargement of the chapters dealing ) with the nature and regulation of commercial banking. These chapters, which are now Part I of the Fifth Edition, not only provide an overview of the gcneral regulatory framework but discuss important provisions of b the Depository Institutions Deregulation and Monetary Control Act of 1980, the Financial Institutions Regulatory and Interest Rate Control Act of 1978, and other recent legislation. The materials on commercial paper have been reorganized into a separate Part I1 and the chapters describing the duties of bank and customer have been reorganized as Part 111. These two parts have the greatest continuity with the Fourth Edition, but the material has been revised to focus primarily upon the Uniform Commercial Code and developme'nts under it. Increased coverage is given to credit card transactions and electronic fund transfers. ., Part IV contains an expanded discussion of the law relating to secured transactions which is now governed by Article 9 of the U.C.C. This Part provides a comprehensive outline of the methods for creating and enforcing security interests in different types of collateral. It covers the . numcrous changes effccted by the 1972 amcndmenls to Article 9 of the U.C.C, also givcs a bricf synopsis of the rcccntly cnactcd B:~nkruptcy It Reform Act. The continued growth of special regulatory law dcaling with consumcr transactions has warranted establishing a separate Part V in this edition to treat issucs rclating to such laws as thc Consumer Credit Protection Act and the Federal Trade Commission Holdcr in Due Course Rule-issues bankers must be familiar with. In preparing this Fifth Edition we are deeply indebted to Mark Sanford and Bill Richardson, students at the Arizona State University Collegc of Law, who providcd research and editorial hclp in preparing this manuscript for publication. Thcir contributions wcre invaluable. We are also grateful for the outstanding support providcd by the stall of the Arizona State University College of Law, and particularly for the efforts of Betty Andre, Dorothy Swanton, and Sandra Mitchell. Dean Alan Matheson of the College of Law has been especially supportive of this project.

1

I

SUMMARY OF CONTENTSPart I-The Nature and Regulation of Banking: An OverviewNature of Banking . . . . . . . . . . . . . . . . . . . . . . . The Federal Reserve System . . . . . . . . . . . . . . . Federal Deposit Insurance . . . . . . . . . . . . . . . . . Federal Regulation of Banks . . . . . . . . . . . . . . . Bank Competition and the Prohibition Against Dealing in Securities . . . . . . . . . . . . . . . Bank HoJding Companies . . . . . . . . . . . . . . . . . Savings Inslitutions . . . . . . . . . . . . . . . . . . . . . . . Specialized Organizations With Banking Functions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sources of Con~mcrcialBanking Law . . . . . . . .

3 ./,45

/

53

1 1 19 /1439 159 .

Part Il-CommercialCUAPTER 10. CIIAPTER I. I CHAPTER12. CHAPTER 13. CIIAPTER14. CHAPTER15. CHAPTER16. CHAPTER17. CHAPTER18.

Paper173 1 185 199 2 13 223 241

Commercial Paper and Its Transfer . . . . . . . . . . Elcnicntary Rcquircmcnts of Ncgotiablc Money Paper . . . . . . . . . . . . . . . . . . . . . . . . . . . Other Types of Negotiable Paper . . . . . . . . . . . . Forms of Indorsement and Transfer of Negotiable Paper . . . . . . . . . . . . . . . . . . . . . . . . Liability of Parties to Commercial Paper and Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . Holders in Due Course, Bona Fide Purchasers, and Defenses to Negotiable Paper . . . . . . . . . . . Negotiability of Commercial Paper With Special Contracts . . . . . . . . . . . . . . . . . . . . . . . . Interest and Usury . . . . . . . . . . . . . . . . . . . . . . . Personal Security Devices and Suretyship Defenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .v

f

263 285293

SUMMARY OF CONTENTS

Part 111-Duties

o f Bank and Customer

Bank Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . Mulunl Dutics of ihc Ilunk i~ndDcpsitor 'Collection and Payment of Instruments Presentment for Payment or Acceptance . . . . . . Protest, Notice of Dishonor, and Waiver . . . . . . Collection of Documentary Drafts ........... Bank's Liability on Its Own Instruments ...... New Payment Systems: Credit Cards and Electronic Fund Transfers ................. Transactions With Fiduciaries . . . . . . . . . . . . . .

.......Section

.....

TABLE O F CONTENTSPage

List of Tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Table of Abbreviations . . . . . . . . . . . . . . . . . . . . . . . . . .

xxivM V

Part I-The Nature and Regulation o f Banking: A n OverviewChapter 1

iC

iAPTER

Part IV--Secured Transactions and Bankruptcy1-5 1-10 1-15 1-20 1-25 1-30 1-35

NATURE OF BANKINGIntroduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Classification of Banks . . . . . . . . . . . . . . . . . . . . . . . . . . The Emergence of the National Government in Banking . . . . . . . . . . . . . . . . . . . . . . . . . State Regulation of Banks . . . . . . . . . . . . . . . . . . . . . . . . An Outline of the National Banking System . . . . . . . . . . Correspondent Banking . . . . . . . . . . . . . . . . . . . . . . . . . . Banks Changing From One System to the Other . . . . . .3 5 69 14

I,

28. The Creation and Perfection of Security Intcrests in Personal Property .............. ~ A P T E R 29. Types of Secured Transactions . . . . . . . . . . . . . 30. Priorities: Rights of Competing Creditors, Purchasers, and Transferees ................ 3 1. Default and Enforcement of Security Interests 32. Debt Adjustment and Bankruptcy . . . . . . . . . . .

..

15 17

Part V-Special Consumer Credit ReglrlatiotlsCrcdit Disclosure Regulation . . . . . . . . . . . . . . . ZHAPTER Regulation of Other Consumer Credit Practices ............................... IHAPTER 35. Preservation of Consumer Defenses and Claims: The Holder in Due Course Rule . 'ableof Cases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ndex . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .:IMPTER

Chnpter 2TIlE FEDERAL RESERVE SYSTEM

33. 34.

.

*

2-5 2-1 0 2-1 5 2-20 2-25 2-3 0 2-3 5 2-40 2-45 2-5 0 2-5 5 2-60

Thc Structure of thc Fcdernl Rcscrvc Systcm . . . . . . . . The Functions of the System . . . . . . . . . . . . . . . . . . . . . Board of Governors . . . . . . . . . . . . . . . . . . . . . . . . . . . . Orders, Regulations, and Interpretations . . . . . . . . . . . . Open Market Operations ........................ Federal Reserve Banks . . . . . . . . . . . . . . . . . . . . . . . . . . Directors of the Reserve Banks . . . . . . . . . . . . . . . . . . . Powers and Duties of Reserve Banks . . . . . . . . . . . . . . . Depository Functions of Reserve Banks . . . . . . . . . . . . . Reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Discounts and Advances . . . . . . . . . . . . . . . . . . . . . . . . . Check Collection and Fund Transfers . . . . . . . . . . . . . .vii

19

20 22 23 25 27 29 30 30 31 33 34

TABLE O F CONTENTS Federal Reserve Note Issues . . . . . . . . . . . . . . . . . . . . . . Examination of Banks .......................... Regulation of Interest and Dividends Paid by Banks . . . Credit Controls . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Relationship of the Federal Reserve System to Savings Institutions .......................... The Comptroller of the Currency . . . . . . . . . . . . . . . . . . Bank Holidays . . . . . . . . . . . . . . . . . . . . . . . .Page

ISection

TABLE OF CONTENTSPage

36 37 38 38 40 41 44

4-65 4-7 0 4-7 5 4-80

Environmental Regulation . . . . . . . . . . . . . . . . . . . . . . . Transactions Involving Securities . . . . . . . . . . . . . . . . . . American Banks Doing Foreign Business . . . . . . . . . . . Foreign-Owned Banking Corporations . . . . . . . . . . . . . .

79 79 81 82

. .... . .

Chapter 5 DANK COMPETITION A N D TIIE PROIIIBITION AGAINST DEALING IN SECURITIES Branch Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consolidations nnd Mcrgers . . . . . . . . . . . . . . . . . . . . . . lntcrlocking Dircctoratcs . . . . . . . . . . . . . . . . . . . . . . . . Prohibition of Tying Arrangements . . . . . . . . . . . . . . . . Banking and Antitrust Laws . . . . . . . . . . . . . . . . . . . . . The Prohibition Against Dealing in Securities . . . . . . . . Bank Scrvicc Corporations . . . . . . . . . . . . . . . . . . . . . . . Interstate Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Competition From Non-Bank Financial Institutions . . . Chnptcr 6 87 90 91 92 93 95 97 98 99

Chapter 3 FEDERAL DEPOSIT INSURANCE 3-5 3-10 3-1 5 3-20 3-25 3-30 3-35 Thc Federal Deposit Insurance Corporation . . . . . . . . . Insured Deposits ............................... Deposit Insurance Assessments . . . . . . . . . . . . . . . . . . . Permanent Insurance Funds . . . . . . . . . . . . . . . . . . . . . . Tcrmination of Insurance . . . . . . . . . . . . . . . . . . . . . . . . Liquidation and ~eorganizationof Insured Banks ..... Bank Regulation and Supervision . . . . . . . . . . . . . . . . . . Chapter 4 FEDERAL REGULATION O F BANKS Federal Regulatory Agencies in General . . . . . . . . . . . . Federal Bank Examination-Financial Institutions Examination Council . . . . . . . . . . . . . . . . . . . . . . . . . . . . f-15 Prevention of Unsafe and Unsound Banking Practices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . b 2 0 Suspension or Removal of Directors or Officers for Cause . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1-25 Dcrcgulation of Intercst and Dividends PaidbyBanks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4-30 Portfolio Regulation of Commercial Banks . . . . . . . . . . 35 Regulation of the Incidental Powers of National Banks ................................ -40 Loans to Bank Officers and Directors .............. 5 Loans to Bank Affiliates . . . . . . . . . . . . . . . . . . . . . . . . . -50 Financial Privacy for Bank Customers . . . . . . . . . . . . . . -55 Financial Record-Keeping and Reporting of Currency Transactions-The Bank Secrecy Act .............. 4-60 Local Credit Needs-The Community Reinvcstmcnt Act of 1977 4-5 4-10 53 54 56 45 46 48 48 49 50 51

BANK HOLDING COMPANIES Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Prohibition of Non-Bank Aclivitics-Exemptions . . . . . Activities Closely Related to Banking . . . . . . . . . . . . . . . Hearings and Judicial Review of Board Decisions Under Section 4 ( c ) (8) . . . . . . . . . . . . . . . . . . . . . . . . . Intcrstatc Activities of Bank Holding Companies . . . . . . Bank Holding Companies and the Securities Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Bank Holding Companies and Competition inBanking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chapter 7 SAVINGS INSTITUTIONS Savings Institutions Generally . . . . . . . . . . . . . . . . . . . . . Savings and Loan Associations . . . . . . . . . . . . . . . . . . . Regulation of Savings and Loan Associations . . . . . . . . 119 120 121 101 104 105

5757 59 65 66 68 69 74 77

111 113115116

.......................

viii

I

ITABLE OF CONTENTS Promise or Order .............................. Unconditional ................................. In Writing and Signed .......................... Certainty as to Sum . . . . . . . . . . . . . . . . . . . . . . . . . . . . Kinds of Money ............................... Demandpaper ................................. Determinable Future Time ....................... Order or Bearer Paper .......................... Designation of Payee Fictitious or Nonexisting Payecs ... ; Drawee Must Be Certain . . . . . . . . . . . . . . . . . . . . . . . . All Formal Requisites Must Be Met . . . . . . . . . . . . . . . . Ambiguous Terms and Rules of Construction . . . . . . . .PageSection

TABLE OF CONTENTS

........................... ..............

186 187 190 190 19 1 192 192 193 195 195 196 196 197

13-15 Kinds of Indorsements . . . . . . . . . . . . . . . . . . . . . . . . . . 13-20 Blank Indorsement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13-25 Special Indorsement . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 3-30 A Qualified Indorsement . . . . . . . . . . . . . . . . . . . . . . . . 1 3-3s Restrictive Indorsements . . . . . . . . . . . . . . . . . . . . . . . . . 13-40 Conditional Indorsements . . . . . . . . . . . . . . . . . . . . . . . . 1 3 4 5 Rights of Restrictive Indorsees . . . . . . . . . . . . . . . . . . . . 13-50 Bank's Power to Supply Missing Indorsement . . . . . . . . 13-5 5 Efiect of Restrictive Indorsements on Securities nnd Conlnlodi~yPnpcr . . . . . . . . . . . . . . . . . . . . . . . . . . Transfcr Without Indorsement . . . . . . . . . . . . . . . . . . . . Limit of Indorsees' Rights By Separate Contract . . . . . .

Page 215

215 215217

217 218 219 220 220 221 221

Chapter 12 OTHER TYPES OF NEGOTIABLE PAPEROther Types of Negotiable Paper . . . . . . . . . . . . . . . . . . Negotiability of Commodity Paper at ComrnonLaw ................................. UniformLaws ................................. Negotiability of Commodity Paper Under Commercial Code .............................. Identification of Documents of Title ............... Carrier's Liability .............................. Carrier's or Warehouseman's Lien ................. Method of Transfer of Documents of Title .......... Nature of Negotiation . . . . . . . . . . . . . . . . . . . . . . . . . . Stock Certificates .............................. Effect of Negotiation ..................... Prior Statutes Making Corporate Bonds Negotiable Investment Securities Under the Commercial Code . . . . Investment Securities Under the Commercial Code -1977 Amendments and Uncertificated Securities . . . .14-5

Chnpter 14

LIAUILITY OF PARTIES TO COMMERCIAL PAPER AND SECURITIES

14-10 14-15 14-20 14-25 14-30 14-35 14-40 14-45 14-50 14-55 14-60 14-65 14-70 14-75 14-8014-85 14-90 14-95 14-100 14-105 14-1 10

. .. . .....

Chapter 13FORMS OF INDORSEMENT AND TRANSFER OF NEGOTIABLE PAPER Typcs of Transfer .............................. 2 13 Nature of Indorscmcnt 2 14

..........................xii '

*

Thc Naturc of Commercial Paper Contracts . . . . . . . . . . Primary and Secondary Liability . . . . . . . . . . . . . . . . . . Liabili~yof Makers and Acceptors of Negotiable Money Paper . . . . . . . . . . . . . . . . . . . . . . . . Acceptance on the Instrument . . . . . . . . . . . . . . . . . . . . Acceptance by Separate Instrument . . . . . . . . . . . . . . . . Promises to Accept Nonexistent Paper . . . . . . . . . . . . . Liability Caused by Impropcr Handling . . . . . . . . . . . . KindsofAcceptances . . . . . . . . . . . . . . . . . . . . . . . . . . . QualifiedAcceptances . . . . . . . . . . . . . . . . . . . . . . . . . . . Effect of Acceptance on Liability of Othcr Partics . . . . . Liability of Issuers of Securities . . . . . . . . . . . . . . . . . . . Sccondary Liabili[y on the Papcr . . . . . . . . . . . . . . . . . . Indorser's Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Drawer's Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Warranty of Transferors of Paper . . . . . . . . . . . . . . . . . Warranties on Presentment of Negotiable Paper for Performance . . . . . . . . . . . . . . . . . . . . . . . . . . Limitations of Liability in Warranty . . . . . . . . . . . . . . . Limitation of Liability by Special Contract . . . . . . . . . . Liability of Agents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Illustrative Agency Cascs . . . . . . . . . . . . . . . . . . . . . . . . Truske'sLiability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rcprcscntntivc Capacity . . . . . . . . . . . . . . . . . . . . . . . . .

223 224 225 226 226 227 227 227 228 229 230 231 231 232 233 234 235 235 236 237 239240

... Xlll

'I'AIJI. E 01: CONTENTS Chapter 15 HOLDERS I N DUE COURSE. BONA FIDE PURCIIASERS. AND DEFENSES T O NEGOTIABLE PAPERPageSeclion

Page

16-55 16-60 16-65 16-70 241 242 243 245 247 248 250 252 254 254 255 255 256 257 258 258 259

Holders in Due Course . . . . . . . . . . . . . . . . . . . . . . . . . . Requirements of Holding in Due Course . . . . . . . . . . . . Without Notice of Defects or Dcfenses . . . . . . . . . . . . . Good Faith . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Organizations and Agcncy . . . . . . . . . . . . . . . . . . . . . . . Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Bank Credit as Value . . . . . . . . . . . . . . . . . . . . . . . . . . . Before It Was Overdue . . . . . . . . . . . . . . . . . . . . . . . . . . Purchaser of Overdue or "Stale" Negotiable Paper . . . . . Kinds of Defenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Defects in Contractual Relations . . . . . . . . . . . . . . . . . . . Other Agreements Affecting Defenses to the Instrument . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Wrongs in Contracting and Transfer ............... Illegality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Statutes Making Instruments Void Usury Statutes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capacity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Lack of Causation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Holder in Due Course-Abolition in Consumer Transactions . . . . . . . . . . . . . . . . . . . . . . . . . .

Provision for Sale or Holding of Collateral . . . . . . . . . . Indexation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Negotiability by Mere Statement . . . . . . . . . . . . . . . . . . Negotiability of Mortgages and Other Title-Retaining Contracts . . . . . . . . . . . . . . . . . . . . . . . . 16-75 Contracts in Mortgages-Effect on Negotiability and Enforceability of the Notes . . . . . . . . . . . . . . . . . . . 16-80 Negotiability of Investment Paper . . . . . . . . . . . . . . . . . 16-85 Registered Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16-90 Spccial Contracts in Bonds . . . . . . . . . . . . . . . . . . . . . . . 16-95 Negotiability and Effect of Stock Exchange Rules . . . . . 16-1 00 Negotiability by Contract . . . . . . . . . . . . . . . . . . . . . . . . 16-105 Waivers of Defenses . . . . . . . . . . . . . . . . . . . . . . . . . . . .

274 275 275 276 277 278 278 279 281 282 283

Chapter 17 INTEKEST AND USURY State Usury Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Federal Preemption of State Usury Law . . . . . . . . . . . . Rcsidcntial Real Property Loans . . . . . . . . . . . . . . . . . . Obligations of Depository Institutions . . . . . . . . . . . . . . Business and Agricultural Loans of $25.000 or More . Other Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . State Laws Overriding Federal Interest Limits . . . . . . . Most Favored Lender Doctrine . . . . . . . . . . . . . . . . . . . Interstnte Crcdit Activities of National Banks . . . . . . . . The "Prime" Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 285 286 288 288 289 289 290 290 290 291

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261262

.

Chapter 16 NEGOTIABILITY O F COMMERCIAL PAPER WITH SPECIAL CONTRACTS The Problem of Negotiable Notes . . . . . . . . . . . . . . . . . Acceleration Clauses . . . . . . . . . . . . . . . . . . . . . . . . . . . . Promises to Do Additional Acts . . . . . . . . . . . . . . . . . . . Promises to Preserve Collateral or Other Security . . . . . Acceleration on a Contingency . . . . . . . . . . . . . . . . . . . . Provisions in Mortgages . . . . . . . . . . . . . . . . . . . . . . . . . Chattel Paper . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sealed Instruments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Judgment Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Waiver of Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiv 263 264 266 266 267 268 269 27 1 272 273 Chnpler 18 PERSONAL SECURITY DEVICES AND SURETYSHIP DEFENSES Types of Security . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 293 Simple Personal Security . . . . . . . . . . . . . . . . . . . . . . . . . 294 Suretyship Defenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . 295 Discharge of Parties Primarily and Secondarily Liable on Negotiable Paper . . . . . . . . . . . . . . . . . . . . . . 296 Suretyship. Guaranty. and Accommodation Parties on Negotiable Paper . . . . . . . . . . . . . . . . . . . . . . 297 Use of Power of Attorney . . . . . . . . . . . . . . . . . . . . . . . 300

I

TABLE O F CONTENTS

TABLE OF CONTENTSSeclion

Part Ill-Duties

of Bank and CustomerChapter 19

Page

20-95BANK ACCOUNTSPage

20-100 20-105 305 307 307 309 3 12 3 12 314 3 19 321 324 20-1 10 20-1 15 20-1 20

Basic Commercial Code Definitions . . . . . . . . . . . . . . . . Definition of Bank and Branch Bank .............. Nature of Bank Accounts . . . . . . . . . . . . . . . . . . . . . . . . Kinds of Accounts ............................. Opening an Account . . . . . . . . . . . . . . . . . . . . . . . . . . . . Contracts of Adhesion or Unconscionable Agreements ................................... Forms of Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Termination of Relationship . . . . . . . . . . . . . . . . . . . . . . Non-Deposit Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . Chapter 20MUTUAL DUTIES OF TIIE BANK AND DEPOSITOR

Customer's Right to Withdraw Against Itenis Dcpositcd . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Duty of Depositor to Examine Monthly Statcnicnts . . . . Customer's Duty to Rcport Forgcrics and Altcr a t 'Ions When Checks Arc Rctaincd by the Bank . . . . . . . . . . . . Depositor's Duty of Due Care . . . . . . . . . . . . . . . . . . . . Ambiguous Instruments . . . . . . . . . . . . . . . . . . . . . . . . . Banker's Lien . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Garnishment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

356 357 360 360 361 362 364

Chapter 21COLLECTION AND PAYMENT OF INSTRUMENTS

Bank's Right to Charge Customer's Accounl . . . . . . . . . 328 Improper Payment and Bank's Rights of 328 Subrogation ................................. Liability of Bank for Refusal to Pay . . . . . . . . . . . . . . . . 329 Post-Dated Checks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 333 Stale Checks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 333 Stopping Payment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 334 Payment Stopped by Third Parties . . . . . . . . . . . . . . . . 338 Stopping Payment on Cashier's Checks. Bank Drafts. and Certified Checks ..................... 340 Identification of Payees and Indorsers .............. 341 Bearer Paper .................................. 342 Fictitious or Nonexisting Payees .................. 343 Miscredited Proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . . 347 Checks With Forged o r Unauthorized Signatures ...... 348 Alteration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 350 Altered Checks Which Were Complete When Signed ... 351 Instruments Issued With Blanks . . . . . . . . . . . . . . . . . . . 353 Obligation of Good Faith . . . . . . . . . . . . . . . . . . . . . . . . 354 J l i ~ n k 'Riglit to Revokc Crcclits to Cirstorncr's ~ Account and Charge Customer for Items Not Paid . . . . 355

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Relation of Depositor and Bank . . . . . . . . . . . . . . . . . . . Choosing the Collecting Bank . . . . . . . . . . . . . . . . . . . . Intcrmcdiary and Collccting Banks . . . . . . . . . . . . . . . . Conscqucnccs of Dclny or Othcr Failure to Act Propcrly in Collecting the ltcni . . . . . . . . . . . . . . . . . . . Sending Paper Direct to Payor . . . . . . . . . . . . . . . . . . . . Medium of Payn~entUnder Commercial Code . . . . . . . Duties of Drawee or Payor Bank . . . . . . . . . . . . . . . . . . Pnymcnt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Pnymcnt by Ncgotinblc Papcr and Its ElTcct on the Underlying Transaction . . . . . . . . . . . . . . . . . . . . . . . Payor Bank's Right to Canccl Payment and Recover Proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Direct Returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Instruments Payable At or Through Banks . . . . . . . . . . Errors in Handling Computer Encoded Chccks . . . . . . Federal Reserve Rulings. Clearinghouse Rules. and Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

365 366 368 368 370 372 373 373 374 375 377 378 379 381 383

Chapter 22PRESENTMENT FOR PAYMENT OR ACCEPTANCE

Formnli~icsto Dc Mct n t Maturity . . . . . . . . . . . . . . . . . 385 Dctcrn~inationof Maturity . . . . . . . . . . . . . . . . . . . . . . . 38Gxvii

TABLE O F CONTENTSSection

TABLE O F CONTENTSSection

22-1 5 Saturdays. Sundays. and Holidays ................. 22-20 Presentment for Payment . . . . . . . . . . . . . . . . . . . . . . . . 22-25 Formalities of Presentment . . . . . . . . . . . . . . . . . . . . . . 22-30 Placc of Prcsentmcnt . . . . . . . . . . . . . . . . . . . . . . . . . . . 22-35 Unusual Cases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22-40 When Presentment Is Not Required . . . . . . . . . . . . . . . . 22-45 Time Allowed for Payment . . . . . . . . . . . . . . . . . . . . . . . 22-50 Tenderof Payment ............................. 22-55 Dishonor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22-60 Presentment for Acceptance . . . . . . . . . . . . . . . . . . . . . . . 22-65 Presentment as It Affects the Drawer's Liability . . . . . . .

Page

24-1 5

Bank's Responsibilities for the Documents and theGoods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 415 Chnptcr 25 BANK'S LTADILITY O N ITS OWN INSTRUMENTS

Chapter 23 PROTEST. NOTICE O F DISHONOR. AND WAIVER23-5 23-10 23-15 23-20 23-25 23-30 23-35 23-40 23-45 23-50 23-55 23-60 23-65 23-70 23-75 23-80

Nature of Requirement of Formalities at Maturity . . . . Protcst . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Form of Protest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Time and Place of Protest . . . . . . . . . . . . . . . . . . . . . . . When Protest Is Unnecessary . . . . . . . . . . . . . . . . . . . . . Notice of Dishonor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Person Giving Notice . . . . . . . . . . . . . . . . . . . . . . . . . . . Persons Receiving Notice . . . . . . . . . . . . . . . . . . . . . . . . Time Within Which Notice Must Be Given . . . . . . . . . . Place for Addressing Notice of Dishonor ............ Cascs Where Notice Nccd Not Bc Givcn Prcscntmcnt of Previously Dishonorcd Cllccks Waiver . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Construction of Waivers . . . . . . . . . . . . . . . . . . . . . . . . . Agrccmcnt for Chargcback as Waivcr . . . . . . . . . . . . . . Notice of Dishonor to Drawer . . . . . . . . . . . . . . . . . . . .

............ ........

399 400 400 401 401 402 403 404 404 406 407 408 408 410 410 411

Bank's Liability on Negotiable Instruments Gencrally . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25-10 Certificates of Deposit . . . . . . . . . . . . . . . . . . . . . . . . . . 25-15 Cashiers' Checks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25-20 Money Orders and Travelers Checks . . . . . . . . . . . . . . . 25-25 Acceptance of Drafts . . . . . . . . . . . . . . . . . . . . . . . . . . . 25-30 Certifying or Accepting Forged or Altered Paper . . . . . 25-35 Mistake in Certifying . . . . . . . . . . . . . . . . . . . . . . . . . . . 25-40 Letters of Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25-45 Scope of Commercial Code Letter of Credit Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25-50 Form of Lcttcrs of Crcdit . . . . . . . . . . . . . . . . . . . . . . . 25-55 Issucr's Obligation to Its Customer . . . . . . . . . . . . . . . . 25-60 Issuer's Obligation to Pay . . . . . . . . . . . . . . . . . . . . . . . 25-65 International Letters of Credit and Uniform Customs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25-70 Rights of Remitters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chnptcr 26 NEW PAYMENT SYSTEMS: CREDIT CARDS AND ELECTRONIC FUND TRANSFERS26-5 26-10

25-5

417 418 418 419 420 422 423 423 427 427 429 430 431 432

Chapter 24 COLLECTION OF DOCUMENTARY D R A I T S24-5 124-10

I

Documentary Drafts . . . . . . . . . . . . . . . . . . . . . . . . . . . . 413 Bank's Duty to Present Draft and Notify Customer of Nonpayment . . . . . . . . . . . . . . . . . . . . . . . . 414 xviii

3..

Bnnk Credit Cards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 434 Truth-in-Lcnding Act Provisions Governing Crcdit Cards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 436 26-15 Issuing Credit Cards . . . . . . . . . . . . . . . . . . . . . . . . . . . . 437 26-20 Cardholder Liability for Unauthorized Use . . . . . . . . . . 437 26-25 Preservation of Cardholder Claims and Defenses . . . . . . 438 26-30 Prohibition Against Set Off of Credit Card Obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 440 26-35 Terms of Credit Card Plans Affecting Merchants and Other Persons Who Honor the Card . . . . . . . . . . . 441 26-40 Duty of Sellers to Notify Issuers of Returned Goods and Other Credits . . . . . . . . . . . . . . . . . . . . . . . 441

1eclion

T A B L E O F CONTENTSPage

TABLE O F CONTENTS441 443 444 445 446 448 448 449 450 450 45 1 45 1 452 453 454

6-45 50 -55 -60 -65 .6.70

I

:67516-80 !6-85 !6-90 !6-95 16-100

26-1 05 26-1 10 26-1 15

Electronic Fund Transfer Systems ................. Regulation of Electronic Fund Transfers . . . . . . . . . . . . Scope of the Electronic Fund Transfer Act . . . . . . . . . . Unauthorized Transfers . . . . . . . . . . . . . . . . . . . . . . . . . . Error Resolution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Financial Institution's Liability to Customers for Electronic Fund Transfers . . . . . . . . . . . . . . . . . . . . . . . Extcnt of Civil Liability of Institutions for Electronic Fund Transfers Prcauthorizcd Trnnsfcrs nnd Stop Pnymcnt Rigllh . . . . Suspcnsion of Obligations to Third Partics Disclosure and Notice Obligations . . . . . . . . . . . . . . . . . Administrative Enforcement . . . . . . . . . . . . . . . . . . . . . . Miscellaneous Restrictions on Electronic Fund Transfers . . . . . . . . . . . . . . . . . . . Issuing Access Cards .......................... Relation to State Law . . . . . . . . . . . . . . . . . . . . . . . . . . . Enforcement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Part I V-Secured Transactions and BankruptcyChapter 28 T H E CREATION AND PERFECTION OF SECURITY INTERESTS IN PERSONAL PROPERTY Introductinn . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Scopc of Comnlcrcinl Codc . . . . . . . . . . . . . . . . . . . . . . Lcascs and Consignments as Security Transactions . . . . The Security Agreement . . . . . . . . . . . . . . . . . . . . . . . . . Purchase Money Security Interest . . . . . . . . . . . . . . . . . . Pcrfcction of Sccurity Intcrcsts . . . . . . . . . . . . . . . . . . . . Filing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Financing Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . Termination Statements and Partial Releases of Collateral . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Assignment of Security Interests . . . . . . . . . . . . . . . . . . .Poxr

.......................

..........

. .. . . . . .. . .

473 474 476 477 479 479 480 482 484 485

Chapter 27 TRANSACTIONS WITH FIDUCIARIES Nature of Fiduciary Rclalionsllip Duties of Fiduciary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Special Duties of Fiduciaries Handling Funds or Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Duties of Third Parties Dealing With Fiduciaries . . . . . Requirements of Value to Cut Off Rights of Beneficiaries ................................ The Nature of Notice of Breach of Fiduciary Relationship . . . . . . . . . . . . . . . . . . . . . . . . . . Transfers of Negotiable Instrument by Fiduciaries Deposits of Fiduciaries and Fiduciary Funds . . . . . . . . Fiduciary Deposits Under Uniform Fiduciaries Act . . . . Deposits in Name of Two or More Trustees . . . . . . . . . . Fiduciary Deposits Under Commercial Code ......... Banks in Fiduciary Relation to Security Owners . . . . . . Uniform Act for Simplification of Fiduciary Security Transfers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Uniform Common Trust Fund Act ................. Regulation of Trust Authority of National Banks . . . . .

..................

Chapter 29455 456 457 458 459 460 461 463 465 465 466 466 467 468 469

TYPES O F SECURED TRANSACTIONS T h e Pledge ................................... 487 Field Warehouse Systems . . . . . . . . . . . . . . . . . . . . . . . . 490 Duties of a Pledgee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 491 Perfection of Security Interests by Filing . . . . . . . . . . . . 492 Security Interests in Goods and Chattels ............ 493 Consumer Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 494 Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 495 Farm Products . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 496 Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 497 Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 498 General Intangibles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 499 Instruments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 499 Chattel Paper . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500 Documents of Title . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 501 Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 501 Fixtures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 505 Motor Vehicles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 507

....

. .

xxi

TABLE OF CONTENTSSection

TABLE O F CONTENTSPogeSection

29-90 29-95

Bank Accounts Insurance Policies

................................Chapter 30

Page

..............................

507 509

32-30 32-35 32-40 32-45

Bnnkruptcy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Voluntary and Involuntary Pctitions in Bankruptcy . . . . Rights and Powers of Trustccs in Bankruptcy . . . . . . . . Sccurcd and Unsecured Creditors . . . . . . . . . . . . . . . . .

539 541 542 544

PRIORITIES: RIGHTS OF COMPETING CREDITORS. PURCIIASERS. AND TRANSFEREES 130-5 D3elo Po-15 . 30-20 30-25 ?30-30 30-35 30-40 30-45 30-50 Unperfected Security Interests . . . ; ................ Conflicts With Other Perfected Sccurity Interests Buyerof Goods ................................ Purchasers of Instruments. Chattel Paper. Documents ......................... Proceeds .......................... .......... Fixtures . . . . . . . . . . . . . . . . . . . . . . . . . . . Rights of Unpaid Sellers of Goods . . . . . . .......... Conflicts With Liens Arising Under Other aws . . . . . . Commingled or Processed Goods . . . . . . . . . . . . . . . . . Subordination Agreements . . . . . . . . . . . . . . . . . . . . . .

.....

51 1 513 515 516 517 518 520 521 522 522 33-5 33-10 33-15 33-20 33-25 33-30 33-35 33-40 3 3-45 33-50 33-55 33-60 33-65 33-70 33-75 3 3-80

Part V-Special C o n s ~ o u c r Credit RegulatiorlsChapter 33 CREDIT DISCLOSURE REGULATION Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Truth-in-Lending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Scope . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Closcd-End and Open-End Credit Arrangements . . . . . . Closcd-End Crcdit Disclosure Rcquiremcnts . . . . . . . . . Opcn-End Crcdit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consumcr Lcascs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Disclosures in Real Estate Transactions . . . . . . . . . . . . . Rcscission Rights in Real Estate Transactions . . . . . . . . Civil Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Adriiinistrativc Enforccmcnt . . . . . . . . . . . . . . . . . . . . . . Rcliancc on Modcl Forms . . . . . . . . . . . . . . . . . . . . . . . . Duty to Rcvisc Prior Disclosurcs . . . . . . . . . . . . . . . . . . Regulation of Crcdit Advertising . . . . . . . . . . . . . . . . . . EfTcct of Truth-in-Lcnding on State Law . . . . . . . . . . . . Credit Billing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chnptcr 34 REGULATION O F OTHER CONSUMER CREDIT PRACTICES 34-5 34-1 0. 34-15 34-20 34-25 34-30 Thc Consumcr Credit Protection Act . . . . . . . . . . . . . . Rcstrictions on Garnishnlcnt . . . . . . . . . . . . . . . . . . . . . Dcbt Collection Practices . . . . . . . . . . . . . . . . . . . . . . . . Crcdit Rcporting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Crcdit Discrimination . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unfair or Deceptive Practices-The Federal Trade Commission 1mprovcn)cnt Act . . . . . . . . . . . . . . . . . . . . Plain English Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . .xxiii

.......... ..........

.

Chapter 31 DEFAULT AND ENFORCEMENT OF SECURITY INTERESTS 3 1-5 31-10 31-15 3 1-20 3 1-25 3 1-30 Default Generally . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Repossession of the Collateral .................... Constitutional Limitations on Secured Party Rcmcdics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Disposition of Collateral After Dcfault . . . . . . . . . . . . . . Retention of the Collateral in Discharge of the Obligation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Liability for Failure to Comply With Code 523 524 526 529 53 1 532

549 551 552 553 553 555 556 558 558 560 5 62 563 564 564 565 565

..........

Chapter 32 DEBT ADJUSTMENT AND BANKRUPTCY 32-5 32-10 32-1 5 32-20 32-25 Nature of Insolvency . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rcmedics for Insolvency . . . . . . . . . . . . . . . . . . . . . . . . . Waiver or Cancellation of Debts .................. Assignment for Benefit of Creditors ................ Receiverships .................................. xxii 535 536 536 538 538

569 569 570 571 573 576 576

.4

34-35

T A B L E OF C O N T E N T S C h a p t e r 35 P R E S E R V A T I O N OF C O N S U M E R D E F E N S E S A N D C L A I M S : THE H O L D E R IN D U E C O U R S E RULE Section Page Introduction Abolition of H o l d c r in D u c C o u r s c Stntus b y FTC Transactions C o v e r e d b y F I T R u l e . . . . . . . . . . . . . . . . Preservation of Claims and Defenses U n d c r t h e Uniform C o n s u m c r Credit C o d e . . O t h c r S t a t c L a w Limiling H o l d c r in D u c Course Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

TABLE OF ABBREVIATIONS579 580 581 583 5901 ..................... Automatcd Clcaring Housc Automatic Investment Service A.I.S. American Law Institute A.L.I. Amcricnn Law Rcports A.L.R. Ala. L. Rcv. ................ Alabnmn Law Revicw Am. Dec. .................. American Decisions American Reports Am. Rep. Ann. Cas. ................. Annotated Cases Ariz. L. Rev. ............... Arizona Law Review Arizona Statc Law Journal Ariz. St. L.J. Ark. L. Rcv. ............... Arkansas Law Kcview A.T.M. .................... Automatcd Teller Machine Banking L.J. ............... Banking Law Journal Fcderal Board of Contract Appeals B.C.A. B.C.C. .................... Bank Collection Codc (American Bankers Association) B.E.A. .................... Bills of Exchange Act (English) B.H.C. .................... Bank Holding Company B.U.L. Rev. ................ Boston University Law Review Bus. Law. .................. Business Lawyer Calif. L. Rev. .............. California Law Review Rutgcrs Camden L a w Review Rut. Cam. L. Rev. Case W. Res. L. Rev. ........ Case Western Reserve Law Review Customer Bank-Communications C.B.C.T. Terminal C.C.C. .................... Commodity Credit Corporation C.F.R. .................... Code of Federal Regulations Cleveland State Law Review Clcv. St. L. Rev, Columbia Law Revicw Colum. L. Rev. Commercial Law Journal Com. L.J. Conneclicut Law Review Conn. L. Rev. Corncll L.Q. ............... Corncll Law Quarterly Community Rcinvestnlcnt Act CRA Dcposilory Institutions Deregulation DIDC Commiltcc Dcpository Institutions Deregulation and DIDMCA Monctary Control Act of 1980 E C O A .................... Equal Crcdit Opportunity Act Electronic Fund Transfer OFT Fcdcrnl Banking Lnw Rcports ( C C H ) F.D.L.R.

35-5 35-10 35-15 35-20 35-25

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T a b l e of Cases

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . T-1

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List of T a b l e s Number Page 1 . S t a t e B a n k Commissioners 11 2. Regulations of t h e B o a r d of G o v e r n o r s of the 24 F e d e r a l Reserve System 3. Regulations of Comptroller of C u r r e n c y 43 4. Regulations of t h e Federal Deposit I n s u r a n c e C o r p o r a t i o n .................................... 47 5. M a x i m u m Limits on Insured Deposits . . . . . . . . . . . . . . . . 48 6 . S t a t e E n a c t m e n t s of U C C a n d A m e n d m e n t s . . . . . . . . . . . 163 7. H i e r a r c h y of R u l e s Binding o n B a n k s 168

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I

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1

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xxiv

xxv

TABLE OF ABBREVIATIONSFCA Federal Credit Administration Foreign Credit Insurance Association FCIA Fair Debt Collection Practices FDCP Federal Deposit Insurance Act FDI FDIC Federal Deposit Insurance Corporation Federal Reserve Bulletin Fed. Res. Bull. Federal Home Loan Bank FHLB Federal Home Loan Bank Board FHLBB FHLBS ................... Federal Home Loan Bank System FHLMC Federal Home Loan Mortgage Corporation FICB Federal Intermediate Credit Bank F.I.R.I.R.C.A. Financial Institutions Regulatory and Interest Rate Control Act of 1978 F N M A .................... Federal National Mortgage Association Federal Open Market Committce of the FOMC Federal Reserve System F R B ...................... Board of Governors of the Federal Reserve System Federal Savings and Loan Insurance FSLIC Corporation F. Supp. Federal Supplement FTC Fcdcrnl Tratlc Conin~issior~ 17.2cI Pcdcrd I(cporlcr, Sccond Scrics Georgia Law Kcvicw Ga. L. Rev. Gco. L.J. Georgetown Law Journal Geo. Wash. L. Rev. George Washington Law Review Harvard Law Review Haw. L. Rev. Iowa L. Rev. ............... Iowa Law Review Ill. L. Rev. Illinois Law Review Kan. L. Rev. University of Kansas Law Review Ky. L.J. Kentucky Law Journal L.R.A. Lawyers Reports Annotated Lawyers Rcports Annotatcd (New Series) L.R.A. (N.S.) Michigan Law Review Mich. L. Rcv. Minn. L. Rev. .............. Minnesota Law Review Miss. L.J. Mississippi Law Journal N.C.C.B. .................. National Consumer Cooperative Bank North Carolina Law Review N.C.L. Rev. N.C.U.A. National Credit Union Administration Ncb. L. Rev. ............... Nebraska Law Review (Uniform) Negotiable Instruments Law N.I.L. Notre Dame Law. Notre Dame Lawyer NOW ..................... Negotiable Order of Withdrawal Nw. U.L. Rev. Northwestern University Law Review N.Y.U.L. Rev. New York University Law Review Ohio State Law Journal Ohio St. L.J. Oregon Law Review Or. L. Rev.

TABLE OF ABBREVIATIONSPCA PIN R.C.L. REA Reg. A to Z RESPA R.T.F.P.A. ................. San Diego L. Rev. Santa Clara Law. SMSA So. Calif. L. Rev. Stan. L. Rev. Stat. Tenn. L. Rev. Tex. L. Rev. TILA Tul. L. Rcv. U.B.L.A. U.C.C. U.C.C. (U.L.A.)

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....................

....................

...................... Production Credit Association ...................... Personal Identification Number .................... Ruling Case Law ...................... Rural Electrification Administration ................ Federal Reserve Regulations ................... Real Estate Settlement Procedures Act Right to Financial Privacy Act .......... San Diego Law Review ............ Santa Clara Lawyer .................... Standard Metropolitan Statistical Area ........... Southern California Law Review ............... Stanford Law Review ...................... Unitcd States Statutes at Large .............. Tennessee Law Review ............... Texas Law Rcview ..................... Truth-in-Lending Act ................ Tulane Law Review .................. Uniform Bills of Lading Act .................... Uniform Commercial Code (Official............

................... ...................... ...................... ................ .................. ......... .............. ................. .............. ................... .................... ............................ .................. ................ .................. ..................... ........... .............. .............. ............... ................

Text 1972) Uniform Commercial Code (Uniform Laws Annotated) U.C.C.C. Uniform Consumer Crcdit Codc U.C.M.A. Unilorln Chnllcl Morlgngc Act U.C.S.A. Uniform Conditional Salcs Act Uniform Common Trust Fund Act U.C.T.F.A. University of Chicago Law Review U. Chi. L. Rev. University of Cincinnati Law Review U. Cinn. L. Rev. University of Colorado Law Review U. Colo. L. Rev. U.F.A. Uniform Fiduciaries Act U.F.C.A Uniform Fraudulent Conveyances Act University of Florida Law Review U. Fla. L. Rev. U. 111. L.F. ................. University of lllinois Law Forum U.L.A. Uniform Laws Annotated U. Pa. L. Rev. .............. Univcrsity of Pcnnsylvanin Law Rcvicw University of Pittsburgh Law Review U. Pitt. L. Rev, U.S.A. Uniform Sales Act U.S.C. .................... United States Code U.S.C.A. .................. United Slates Code Annotated U.S. Comp. Stat. ............ Unitcd States Conipiled Statutes U.S.L.W. United States Law Weck U.S.T.A. .................. Uniform Stock Transfer Act U.T.R.A. Uniform Trust Receipts Act U.W.R.A. Uniform Warehouse Receipts Act Vanderbilt Law Review Vand. L. Rev. rc Vill. L. Rev. ............... Villanova Law Review Wash. & Lee L. Rev. ......... Washington & Lee Law Review Wash. L. Rev. .............. Washington Law Review

....................

............. .................... .............

................. .................. ................ ............. ............ ............ .................... ...................

..................

.................. .................. ................. ..............

xxvi

xxvii

TABLE OF ABBREVIATIONSWash. U.L.Q. W. Va. L.Q. W. Va. L. Rev. Wm. & Mary L. Rev. Wis. L. Rev. Yale L.J.

.............. Washington University Law Quarterly ............... West Virginia Law Quarterly ............. West Virginia Law Review ........ William & Mary Law Review ............... Wisconsin Law Review ..................Yale Law Journal

PART I

The Nature and Regulation of Banking: An Overview

xxviii

Chapter 1

NATURE O F BANKINGSection

Page

1-5 1-10 1-151-20 1-25 1-30 1-35

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Classification of Banks . . . . . . . . . . . . . . . . . . . . . . . . . . The Emergence of the National Government in Banking . . . . . . . . . . . . . . . . . . . . . . . . . State Regulation of Banks . . . . . . . . . . . . . . . . . . . . . . . . An Outline of the National Banking System . . . . . . . . . . Correspondent Banking . . . . . . . . . . . . . . . . . . . . . . . . . . Banks Changing From One System to the Other . . . . . . .

3

56 9 14 15 17

5

INTRODUCTION

Thc comnicrcial bank is the most common typc of banking institution. Its principal business is to accept deposits, make loans, collect commercial paper, and arrange the transfer of funds. Most of the material in this book will be devoted to these commercial banking functions. Commercial banking functions arc not thc only activities thnt banks perform. Thcrc arc many othcr typcs and [unctions of banks, such as the reserve banks that are really bankers' banks; investment banks, whose chief business is underwriting securities for large corporations; and savings banks, which accept money, usually on time deposit, for the purposc of encouraging savings. Thcrc arc also many specialized banks, such .as land banks, foreign trade banks, and the like, that are chartercd to enter certain kinds of business. The federal government has created many such special banking organizations to carry out special federal policies, and brief descriptions of some of these organizations are provided in a subsequent chapter.' Recent changes in federal banking law have blurred some of these distinctions as dcscribed below.2 The abovc-mentioned types of banks should be carefully distinguished from the so-called trust company. A trust company is not really

. L 2

See Chapter 8.See 8 7-95.

g 1-5

OVERVIEW

NATURE OF BANKING

3 1-10

a bank at all; instead of borrowing and lending money, it accepts funds for the purpose of investment. The beneficial interest in such funds, however, remains in the original owner and not in the bank itself. In many statcs trust companics arc combincd with banks or arc allowed to pcrform banking functions in addition to their duties as trustees.' There are also a number of personal finance loan organizations, authorizcd by the laws of the scvcral statcs, that loan small amounts of money to consumers at higher than the usual legal rates. Since thesc organizations normally do not accept deposits but dcpcnd upon thcir owrl cr~pilelI I I I ~ol11cr S O U ~ C C Sof credit to furnish t l ~ c futlds l o r lending, they are not banks in the proper sense. Many banks have small loan departments that make the same type of loans.' It is not uncommon for a single large bank to exercise all of the functions mentioned above, and in addition they often operate safedeposit and trust departments, but these are special branches of activity that are not usually classified as commercial banking. Until recently, the regulatory regimes under which banking in the United States was conducted confined commercial banking functions to those financial institutions that were organized as state or national banks. The enactment of the Depository Institutions Deregulation and Monctary Control Act of 1980, however, authorized some commercial banking activities to be undertaken by thrift institutions as wcll as banks.n As a result, there is a growing similarity of functions between commercial banks and savings institutions. Under the Act, for example, savings and loan associations, credit unions, and savings banks can now give their customers checking privilege^.^ The laws and regulations that govern commcrcial banking arc numerous and complex. The various types of financial institutions engaging in commercial banking activities are matched by an equal diversity of statutes and regulations controlling the activities of these institutions. At the federal level alone, responsibility for regulating banking activities has bccn givcn to a numbcr of scparatc agcncics; whcn regulatory autllority is shnrcd by st:~tcnntl tcclcrnl ngcncics, thc conlplcxity or tllc law is compounclcd. In addition, thc Inw governing thc transactions of commcrcial banks is complcx. T l ~ c Uniform Conlnlcrcial

Code (U.C.C.)' has brought a desirable uniformity to the legal treatment of such activities as the collection of commerciaL paper and checking accounts, but there is also an increasing numbcr of special purpose statutes, frcqucntly intcndcd to provide spccial consumcr protection, that affect the activities of commercial banker^.^ Moreover, there are many new lcgal issues raised by technological developments in banking (c.g., transfcrring funds electronically) that are not addrcsscd by the U.C.C. Modern banking has become an enterprise where careful legal cor~nsclis csscntinl. This book is intcntlctl to scrvc ns n guide for tllc olficcr cngngcd in commcrcial banking transactions and the nttorncys called upon to advise in banking matters.

8 1-10

CLASSIFICATION O F BANKS

Although originally there was a common-law right to enter the banking business," the power and influence of banks'today are such that banking is now universally recognized as an activity charged with the public intcrest, subjcct to careful control by both state and federal laws and administrative rules. In addition to laws prescribing various forms of organization, all banks are responsible to and regulated by either the state o r thc federal government, often by both at once, and frequently by more than one federal agency. Such regulation includes the issuance of a charter creating the legal organization (usually a corporation), the inspection of the books of the bank, and numerous regulations about the nature of the business conducted by the bank. When the charter is issucd by thc state, such banks are known as state banks and their busincss is supervised by officials usually called state banking comrnissioncrs. When the federal government issues the charter, such banks are known as national banks and are governed by the federal banking laws and by numcrous fcdcrnl administrative agcncics, which arc discussed Iwlow."' All nntionnl brinks :lrc mcn~hcrsor lllc Fctlcrnl Rcscrvc Systcrn nnd must bc insurcd by thc Fcdcrnl Dcposit Insurance Corporntion ( F D I C ) . Stntc bnnks may choosc, but arc not rcquircd, to bccomc nlcnl-

The Depository Institutions Deregulation and Monetary Control Act of olsn pcrrnila a:cvitiga nnd lonn nssocintiona to crlgngc in trust r~ctivilics under certain conditions. See 12 U.S.C.A. !j 146(n) (Wcst 1980). * See 12 U.S.C. !j 85 (1976), Rockland-Atlas Nat'l Bank of Boston v. Murphy, 329 Mass. 755, 110 N.E.2d 638 (1953).19808

See !j 7-95. Id.

SCC Chnnlcr 9 nnd Pnrt 3. SCCPnri5. O State v. Scougal, 3 S.D. 55, 51 N.W. 858 ( 1 8 9 2 ) ; Chase Nat'l Bank v. Sanford, 284 U.S. 660 (193 1 ); Northeast Factor & Discount Co. v. Jackson, 223 Ga. 709, 157 S.E.2d 731 ( 1967). See also 1 A. Michie, Banks and Banking 5 I (pcrrn. ed. 1973). CC l o See Chapters 2-4.7

8 1-15

OVERVIEW

NATURE OF BANKING

9 1-15

bers of the Federal Reserve System.ll (Even nonmember state banks are subject to the regulatory authority of the Federal Rcserve Board to some extent, however.)I2 Membership in the Federal Reserve System also involves insurance of deposits by the FDIC, State banks may obtain FDIC insurance without becoming members of the Federal Rcscrve System.la A few state banks are neither insured by the FDIC nor are they members of the Federal Reserve System. There are, therefore, four classes of commercial banks: national banks, state member banks, nonmember insured state banks, and noninsured state banks. Subsequent chapters will show how this classification scheme determines, in large measure, the laws and agencies that will exercise regulatory authority.

5 1-15

THE EMERGENCE OF THE NATIONAL GOVERNMENT IN BANKING

The complex structure of our modern banking system is the product of controversies accompanying the development of banking, and particularly federal involvement in banking, that date from the first days of our nation. Controversy first emergcd over the creation of a ccntral national bank. The first Secretary of the Treasury, Alexander Hamilton, supported creation of a national bank. T h e first Secretary of State, Thomas Jefferson, opposed it. Hamilton prevailed and Congress created the First Bank of the United States, giving it a charter of twenty years. The bank was not only the largest bank of the time, it was also the largest corporation in the United States. The bank was located in Philadelphia but had branches in other major cities." The First Bank of the United States was a success. At that time, the currency in circulation (except for coins and some greenbacks) consisted mainly of notes issued by state banks. The notcs of thc First Bank of the United States came to account for about 20 percent of the notes in circulation, giving the national economy the benefit of a uniform and reliable currency.l5 Some hostility to a central bank persisted, however, and to it were added complaints of foreign domination and charges of unconstitutionality. The growing number of state banks joined the cause against the First Bank of the United States, arguing that the national bank was not

necessary in view of the increased number of state banks. T h e state banks rescntcd the practice followcd by thc First Bank of rctiring from circulation all state bank notes it received by returning them to the issuing bank for payment. This practice required the state banks to maintain larger reserves of funds than othcrwisc would have bcen necdcd. Opposition to the First Bank became so strong that when Jefferson's Republican party came into power in 1801, a bill to recharter the bank failed, and the bank died when its charter expired in 181 1.18 After the First Bank's charter expired, the nation experienced serious cconomic problems from the lack of an effective banking system. Although a number of state banks cxistcd, the bank notes they issued were often of dubious quality. The disruptions of the War of 1812 heightened the problem. Bank failures became common after 1809 l 7 and, with the expiration of the First Bank in 181 1, there was no central bank to comc to the assistance of the weaker banks.I8 These and other difficulties in managing the federal government's financial affairs without a national banking mechanism persuaded a narrow majority of Congress of the desirability of a national bank, and in 1816 Congress chartered the Second Bank of the United States.lD The Second Bank of the United States was larger than the first, and many c a m to view it as too powerful, Prcsidcnt Andrcw Jackson nlnong them. 'During Jackson's first tern1 as President, his political rival Henry Clay convinced Congress to pass a bill extending the charter of the bank. Clay, as a prcsidcntial aspirant, then hoped to exploit Jackson's expected veto of the bill as a political issue in thc 1832 prcsidcntial clection. Thc plan backfircd when Jackson's veto, accompanied by a ringing message attacking thc constitutionality of thc bank, brought him widesprcad popular support, and hc was reelected by a substantial margin. Four years later, in 1836, the charter of the Second Bank of the United States expired.20 Although the constitutionality of thc Bank was attacked during this period, as early as 1819 thc U.S. Supreme Court had upheld thc powcr of Congress to establish a national bank. Chief Justice Marshall, in the historic case of McCullocl~v . Marylat~d,ruled that the chartering of the First Bank of the United States was a mcasurc "necessary and proper" to the exercise of Congress' fiscal powers under the Constitution to raise revenue, borrow money, and regulate c o m m e r c ~ .Undcr the suprenlacy ~~

la Id.

Federal Reserve System is discussed in Chapter 2. See Chapter 2. 18 Federal deposit insurance is discussed in Chapter 3. 1 4 Johnson, Historical Beginning-The Federal Reserve 8 ( 1980). l5 White, Banking Law 8 (1976).

11 The

1'

Id.

at 9. Johnson, note 14 supra, at 8 . z0 Id. at 10; Whitc, notc 15 supra, at 16. 21 17 U.S. 316 (1819).I R Id.

6

5 1-15

OVERVIEW

NATURE O F BANKING

5 1-20

clausc of thc U.S. Constitution, which nlakcs thc laws of fhc United States superior to state law, Chief Justice Marshall held that the establishment of the bank could not be restricted by inconsistent state Icgislation. This dccision was reaffirmed fivc years latcr in Osborn v . Bank oj the United States.22 After the demise of the Sccond Bank of the United States, banking was carried on through state-chartered banks. This period saw thc enactment of state legislation authorizing "free banking." Much of this legislation, which madc it easier to incorporate state banks, was patterned aftcr the New York Frec Banking Act,of 1838. As a result, the numbcr of state banks grew. It was no longer necessary to obtain a special statc charter; anyone who met the minimum incorporation requirements could establish a bank. Thc systcm of local statc banks that subsequently cmcrgcd led to problcms. Banks varicd grcatly in thc adcquacy of thcir capital nnd rcscrves retaincd against bank notes and dcmand deposits. Some banks engaged in risky lending policies. The bank notes issued by the individual banks were of disparate quality. T h e amount of credit extended by banks fluctuated erratically without regard to the needs of the cconom y.28 Finally, in 1863, the Civil War increased prcssurc for a sound financial and monetary system, and Congress adopted the National Bank Act of 1863. This Act, together with amendments in 1864 and 1865, reestablished a national banking system. It did not create a central national bank, but it did provide for the charter of national banks. T o insure the strength of thc new national banks the Act imposed requirements relating to reserves, the amount of notes that could be issued, and restrictions on lending. In 1865, Congress imposed a tax on the notes issued by state banks in order to make the notes issued by the national banks thc currcncy o f the Unitcd Statcs. Thc constitutionalily of this tax was affirmed by the Supreme Court in a dccision upholding in broad terms congressional power to adopt appropriatc legislation to "sccure a sound and uniform currency for the country." 24 It was cxpcctcd that thc tax on statc bank notcs would causc statc banks either to convert to national charters o r to disappear, but ncithcr of these expectations occurred. The increase in the use of checks as a means of payment provided an alternative source of funds for the state banks in the form o f dcmand deposits, and statc banks continucd to cxist alongside thc ncw national banks.'"2z

T h c lack of a ccntrnl banking systcm continucd to be n wcakncss in the national economy. It was diflicult to shift bank reserves to meet the crcdit nceds of the country, and the currency provided by the banks was not flexible cnough to mcet denlands for it. Thc financial panic of 1907 led to extensive examination of the nation's banking structure and finally, after prolonged political debate and compromise, Congrcss enacted the Federal Reserve Act. Under the Act, Congress authorized the establishment of the Federal Reserve System. The Act did not create a central national bank. Instead, thcrc were to be rcgional Federal Rescrvc Banks, with a central Federal Reserve Board to supervise the System. National banks would have to become members of the System, and state banks would have the opportunity to become members. The national banking system continued to come under pressure despitc thc irnprovcments stcrnming from the Fedcral Rescrve Act. A la& numbcr of bnnk failurcs occurrcd, and thc strcsscs of the Grcnt Depression prompted Prcsidcnt Rooscvelt to declarc an emergency bank holiday in March of 1933. When the banks reopened, a series of efforts to increase national regulation and control of the banking industry occurred. In the Banking Act of 1933, Congress established the Federal Deposit Insurance Corporation (FDIC), through which qualified banks would be insurcd. This Act, in addition to providing for insurance, also imposed regulatory requirements designed to strengthen the banking system. Although the insurance was originally limited to member banks of the Federal Reserve System, Congress later cxtended it to state banks. Although substantial changes have since occurred in the regulation of banking, the basic framework of the U.S. banking systeni was put in place with the adoption of the Banking Act of 1933. The Act provided for a dual system of state banks and national banks. It gave the federal government regulatory control over banking through the chartering of national banks, administration of thc Fcdcral Rcscrvc Systcm, and supcrvision of banks insured by the Fcdcral Deposit Insurance Corporation.

1-20

STATE REGULATION OF BANKS

22 U.S. 738 ( 1824).

Johnson, notc 1 supra, at 10. 2 4 Veazie Bank v. Fenno, 75 U.S. 533 (1859). 26 Johnson, note 14 supra, at 1 1.2a

Comprehensive federal banking legislation was not adopted until passage of thc National Bank Act of 1863 and subsequent amendments to that Act. Originally, all banks were controlled by statc law, either common or statutory, and many states had constitutional provisions governing thc banking busincss. As cxpcricncc with banking grcw, stntc laws on thc subject proliferated to the point that thcre arc now myriad statutes enfranchising banking corporations and creating departments of state govcrnnicnt to rcgulatc, supcrvisc, and inspcct thcni. 6. Today thcrc is a dual, state and fcderal, system of banking rcgulation. Statc law governs the regulation of state banks unless preempted

5 1-20

OVERVIEW

NATURE OF BANKING

3 1-20

by federal law as a result of the supremacy clause of the U.S. Constitution. Under the supremacy clause, federal law overrides conflicting state law. Thus, in the case of state banks that are members of the Federal Reserve System and state banks that are insured by the Federal Deposit Insurance Corporation (FDIC), there will be both state and federal regulation of the banks' actions. State law covers all aspects of the banking business conducted by state banks: issuance of charters, which set out in detail the powers necessary to carry on daily banking activities such as receiving deposits; prescribing the size of reserves to protect depositors; making loans; investing in specified securities; owning and managing real estate; trading in commercial paper; issuing circulating bank notes; and financing businesses. Each state has created a department of banking, under various titles, that supervises and regulates statc banks within its jurisdiction. Thcsc dcparlmcnts cmploy bank cxamincrs and othcr oficials to inspcct the operation of the state banks. Thc books of thcsc banks arc subjcct to periodic audits, and the banks themselves are requircd to issuc annual or semiannual financial statements, which are reported to thc banking dcpartmcnt, and which may later be madc public. Statc banking commissioners, in addition to chartering banks, supervise and rcgulatc banks to insure thcir solvcncy and liquidity. If audits disclose that the banks are not sound, the commissioner may demand that more capital be raised either by assessment of the stockholders or from outside sources. If the commissioner deems the bank to bc bcyond solvcncy, hc may closc and liquidate it, distributing the assets according to law to creditors, depositors, and, if anytiling remains, to the stockhoIders.lB The state banking commissioners also have the power to make rules and regulations to carry out their duties and to implement the slatutes. Thus the binding state rules governing the operation of banks may be found in three sources:(1) The constitution of the state;

these states the regulations are kept on file in the bank commissioner's office, which will usually send, on request, copies of the rules desired. The official addresses of the bank commissioners' ofices are contained in the Table of State Bank Commissioners. TABLE 1.Alabama

Stale Bank CommissionersFlorida

Supcrintendcnt Department of Banking Montgomery, Alabama 361 30Alaska

Comptroller Department of Banking and Finance Tallahassee, Florida 32304Georgia

Director, Division of Banking Sccuritics and Corporations Dcpartment of Commercc Juncau, Alnskn 99801'

Commissioner Dcpartmcnt of Banking and Finnncc Atlnnto, Gcorgin 30303Hawaii

Arizorla

Superintendcnt of Banks Banking Dcpartmcnt Phocnix, Arizonn 85007Arka~~sas State Bank Commissioner

Director Dcpartment of Regulatory Agencies Wonolulu, Hawaii 96809lrlal~o

Bank Department, Department of Commerce Littlc Rock, Arkansas 72201Calilornia

Director Department of Finance Boise, Idaho 83720Illinois

Superintendent of Banks Banking Departrncnt San Francisco, California 94104Colorado

Commissioner Banks and Trust Companies Springfield, Illinois 62701 Indiat~a Supervisor Banks and Trust Companies Division, Dcpartment of Financial Institutions Indianapolis, Indiana 46204Iowa

( 2 ) The statutes passed by the legislature; and ( 3 ) The rules promulgated by the banking commissioners.

Commissioner Division of Banking, Dcpartment of Regulatory Agencies Denver, Colorado 80203Conneclicut

The constitutions and the statutes are regularly published and should be available at most law libraries; the regulations are a diflercnt matter. A few states have official publications similar to the Federal Register, which is discussed in 3 9-45, or keep central files, as required by statute, that contain the text of all the administrative regulations having the force of law. However, the majority have no such requirements. In

Commissioner Banking Department Hartford, Connecticut 061 15Delaware

Superintendent Department of Banking Des Moines. Iowa 50309Kansas

*

Slate Bank Commissioner Department of Administrative Services Dover, Delaware 19901

Commissioner State Banking Department Topcka, Kansas 66612

OVERVIEW

N A T U R E OF B A N K I N GNorth Carolina Commissioner Banking Commission Raleigh, North Carolina 27602 North Dakota Commissioner Department of Banking and Financial Institutions Bismarck. North Dakota 58505 Ohio Superintendent Division of Banks, Department of Commerce Columbus, Ohio 43215 Oklal~oma Commissioner Banking Department Oklahoma City, Oklahoma 73105 Oregon Superintendent of Banks Department of Commerce Salem, Oregon 973 10 Pennsylvania Secretary of Banking Department of Banking Harrisburg, Pennsylvania 17 120 Rhode Island Deputy Bunking Cornmissioncr Department of Business Regulation Providence, Rhodc Island 02903 South Carolina State Treasurer State Board of Financial Institutions Columbia, South Carolina 29201 South Dakota Director + Division of Banking and Finance Pierre, South Dakota 57501 Tennessee Commissioner Department of Banking Nashville, Tcnncsscc 37219 Texas Commissioner Banking Department Austin, Texas 78705 Utah Commissioner Department of Financial Institutions Salt Lake City, Utah 84101 Vermont Commissioner of Banking Department of Banking and Insurance Montpelier, Vermont 05602 Virginia Commissioner of Financial Institutions Bureau of Financial Institutions Richmond, Virginia 23261 Washington Supervisor of Banking Division of Banking, Department of General Administration Olympia, Washington 98504 West Virginia Commissioncr Department of Banking Charleston, West Virginia 25305 Wisconsin Commissioner O f i c e of Commissioner of Banking Madison. Wisconsin 53703 Wyoming Examiner Banking Division Cheyenne, Wyoming 82002

TABLE 1. State Bank Commissioners(continued)

Kentucky Commissioner Department of Banking and Securities Frankfort, Kentucky 40601-

1

Louisiana Commissioner Office o f Financial Institutions, Department of Commcrce Baton Rouge, Louisiana 70804 Maine Superintendent Bureau of Banking, Department of Business Regulation Augusta, Maine 04333 Maryland Bank Commissioner Department of Licensing and Regulating Baltimore, Maryland 21201 Massachusetts

Missouri Commissioner Division of Finance, Department of Consumer Affairs, Regulation and Licensing Jeffcrson City, Missouri 65101 Montana Administrator Financial Division, Department of Business Regulation Helena, Montana 59601 Nebraska Director Department of Banking and Finance Lincoln, Nebraska 68509 Nevada Superintendent Banking Division, Department of Commerce Carson City, Nevada 89710 New Hampshire Bank Commissioner Banking Commission Concord, New Hampshire 03301 New Jersey

II

Commissioner Department of Banking and Insurance Boston, Massachusetls 02202Michigan Commissioner Financial Institutions Bureau, Dcpartment of Commcrce Lansi&, Michigan 48909 Minnesota Commissioner of Banks Department of Commerce St. Paul, Minnesota 55101 Mississip p l Commissioner Department of Banking and Consumer Finance Supervision Jackson, Mississippi 39205

Commissioner Department of Banking Trenton, New Jersey 08625New Mexico

Direclor Financial Institutions Division, Commerce and Industry Department Santa Fe, New Mexico 87503New York

Superintendent Banking Department Albany, New York 10047

OVERVIEW

NATURE OF BANKING

s 1-30

5 1-25

AN OUTLINE OF THE NATIONALBANKING SYSTEM

1

As a result of the historical development of banking in the United States, there are three principal federal regulatory agencies that regulate commercial banks: the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation (FDIC). There is some ovcrlap in functions between these agencies, which at times has led to differing views on the policies t o be followed in bank regulation. For the most part, however, the agencies have cooperated in exercising their re~ponsibilities.~' Each of the agencies will be discussed in detail in subsequent chapters.2E Briefly, The Office of the Cornptroller o the Currency is f responsible for chartering national banks. Its primary responsibility is supervising the activities of the national banks. The Board of Governors of the Federal Reservc System, of course, has regulatory authority by statute over all the banks that arc members of the Federal Reserve System and some authority over depository institutions that are not mcmbers of the Federal Reserve System. In this respect, the authority of the Board of Govcmors overlaps to some extent the authority of the Office of the Comptroller of the Currency, since all national banks must be members of the Federal Reserve System. Insofar as supervision of the banking activities of the member banks is concerned, however, the Board of Governors has generally pursued a policy of allowing the Comptroller of thc Currency to be responsible for the c examination of national banks that arc rncrnbcrs of ~ h Fcdcral Rcscwc System. The Board of Governors, through the individual Fcdcral Rcserve Banks, is responsible for examining state member banks. The FDIC has regulatory authority over the banks and other depository institutions whose deposits are insured b it. Since the FDIC insures the deposits of all member banks of the Federal Reserve System, there is an overlap of authority between the Board of Governors of the Federal Reserve System and the Office of the Comptmller of the Currency. T o avoid duplication of effort, the FDIC limits its supervision to those state banks that are not members of the Federal Reserve System but whose deposits are insured by the FDIC.

There are also state banks that are neither members of the Federal Reserve System nor have their deposits insured with the FDIC. These statc banks arc rcgulatcd by the appropriate state banking agency. As discusscd in Chaptcr 2 on the Fcdcral Rescrvc System, the Board of Governors has some regulatory authority over even these institutions. Additional agencies have regulatory responsibility for savings and loan associations. Federal savings and loan associations are chartered and rcgulatcd by thc Fcdcral Home Loan Bank Systcrn, to which they are required to belong. Additionally, all federal savings and loan associations must have their deposits insured by the Federal Savings and Loan Insurance Corporation. This corporation has the responsibility of determining that the associations it insures are following safe and sound practices. Sincc the members of the Fcdcral Home Loan Bank Board serve as the Trustees of the Federal Savings and Loan Insurance Corporation, the two agencies pursue complimentary policies. The Federal Savings and Loan Insurancc Corporation, howevcr, has the powcr to insure the dcposits of savings and loan associations that are not members of the Federal Home Loan Bank Board. Whcn such statc associations obtain insurance from the FSLIC, they submit to the authority of the corporation to examine and supervise their activities. The manncr in which crcdit unions arc rcgulatcd is described in Chapter 7.

t

1-30

CORRESPONDENT BANKING

21

Hackley, "Our Baming Banking System," 52 Va. L. Rev. 565, 771

(1966).In Thc Board or Govcrnora of thc Fcdcrnl Rcscrvc Systcm and the Comptroller of the Currency are discussed in Chapter 2, and the Federnl Deposit Insurance Corporation is discusscd in Chapter 3.

Corrcspondcnt banking is n systcn~of rclationships bctwccn banks which cnablcs funds to bc transfcrrcd and chccks to bc paid from onc part of the country to another. The largc distances between cities and towns in the United States contributed to the development of the correspondent banking system. In earlier days, to facilitate' the collection and payrncnt of checks it was often convenient for a town (or community) bank to maintain an account with a larger metropolitan bank. The community bank could use this account to make payrncnt to persons within thc service area of the correspondent bank who had checks that were drawn on the community bank. Having such an account could also assist the community bank in collecting chccks that were drawn on institutions locatcd within the service area of the correspondent bank. Through a nationwide network of such correspondents, the banking system developed a workable collection-payment mechanism. The rclationship bctwcen the community bank and the correspondcnt bank dcvclopcd to include thc provision of additional scrviccs by thc corrcspondcnt banks. Anlong thc most important of thcsc wcrc thc giving of i~ivcst~ncnt ndvicc and tllc lending of funds. Additionnlly,

8 1-30

OVERVIEW

NATURE OF BANKING

'1-35

the correspondent bank often made loans to officers of the small-town community bank. Since the correspondent arrangement involved the community bank maintaining a substantial interest-free demand deposit with thc corrcspondcnt bank, thc corrcspondcnt bank gcncrally offered the services below cost. Since enactment of the Financial Institutions Regulatory and Interest Rate Control Act of 1978, correspondent banks must be careful to avoid making loans to the officers, dircctors, and major stockholders of their community bank customers on terms not generally available to other customers.2o Similarly, the community bank may not make loans to the officers, directors, o r principal stockholders of the banks where it has a correspondent account on terms other than those generally available to its other customer^.^^ The Act does not prohibit such loans: what jt proscribes is favorable treatment. N o loans may be made "unless such extension of credit is made on substantially the same terms, including interest rates and collateral as those prevailing at the time for comparable transactions with other persons and does not involve more than the normal risk of repayment o r present other unfavorable features." Violations of the Act carry a civil penalty of not more than $ I ,000 per day for each day during which the violation exists. These penalties are assessed initially by the Cornptrollcr of the Currcncy for national banks, the Board df dovernors of the Federal Reserve System for a state member bank, and the Federal Deposit Insurance Corporation (FDIC) for insured nonmember state banks.82 The Act further establishes reporting requirements whenever an extension of credit is made to the executive officer o r major stockholder of a bank that has a correspondent relationship with thc bank extending the Both the person to whom the credit is extended and the bank that the person receiving the credit is affiliated with must file reports." These reporting requircmcnts apply only in thc case of banks insurcd by the FDIC, but thc prohibition of thc Act against favorable loans to ollicers, dircctors, and major stockholdcrs npplics to d l banks, state and federal.36 The manipulation of correspondent balances to serve the private

advantage of the officer of the bank also can give rise to criminal Iiabilities for misapplication of bank funds.86

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5 1-35

BANKS CIIANCINC FROM ONE SYSTEM TO THE OTHER

Sometimes banks find it desirable to change their status from state to national bank or vice versa. At one timc, the requirement of membership in the Federal Reserve System, which carried with it (he obligation of maintaining reserves as set by the Board of Governors of the Federal Reserve System, provided an incentive for national banks to convert to state banks. The Depository Institutions Deregulation and Monetary Control Act of 1980 removed this incentive by extending reserve requirements to all banks.$' A national bank desiring to convert to a state bank may do s o by a vote of two-thirds of each class of its capital stock and by a majority vote o f its board of director^.^^ Federal law also permits a national bank to consolidate with or merge into a state bank in the state where the national bank is located.80 Although the consolidation or merger is allowed by fcderal law, it must also satisfy the law of the state in which the national bank is located and, thus, must have the approval of the statc banking authority.'O Such convcrsions o r nlergcrs are permissible only in states where state law does not restrict state banks in converting to national banks." Dissenting stockholders have the right to withdraw from the association. In that event, their stock is appraised under the supervision of the Comptroller of the Currency, and they are entitled to bc paid thc appraised amount in cash for their stock.42 The stock so purchased is then disposed of in accordance with the law of the state. It is also possible for state banks to become national banks by conversion or merger. Thc procedure for deciding upon the conversion must be according to thc statc law. Whcn such a decision has bcen

2O

30

12 U.S.C. 5 1972(2)(A) (Supp. 111 1979). See 8 4-40. 12 U.S.C. I972(2) (A)(Supp. 111 1979).Id.

8'

82 8%Id.

12 U.S.C.

l972(2) ( F ) (Supp. 111 1979).

85

12 U.S.C. 8 1972(2)(G) (Supp. 111 1979). 12 U.S.C. 8 1841( c ) , 1971 (Supp. 111 1979).16

Unitcd States v. Brookshire, 514 F.2d 786 (10th Cir. 1975); United States V. Mann, 517 F.2d 259 (5th Cir. 1975). cert. denied 423 U.S. 1087 (1976). See Bell & Oliver, "Corrcspondent Bank Loans After the Financial Institutions' Regulatory and Interest Rate Control Act of 1978," 34 Bus. Law. 1347-1357 (1979). 12 U.S.C.A. 5 461 (b) (West Supp. 1981 ). 12 U.S.C. 5 214a (1976). 12 U.S.C. 8 215(a) (1976). 12 U.S.C. 8 214c (1976). Id. Sce Ellis v. State Nat'l Bank, 434 F.2d 1182 (5th Cir. 1970), cert. denied 402 U.S. 973 ( 197 1 ). . i 4 2 12 U.S.C. 8 Zl4a(b) (1976).

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1 3 1-35

OVERVIEW

I made,

the state bank must meet the qualifications required of national

I banks and wiU become subject to the supervision of the Comptroller of

the Curren~y.'~ Mergers of state banks into national banks, national banks into state banks, and national banks with each other will be further discussed ! in a subsequent chapter."

Chapter 2

THE FEDERAL RESERVE SYSTEMThe SLruclure of the Federal Reserve System . . . . . . . . The Functions of the System . . . ... Board of Governors ,. . . . .. . Orders, Regulations, and Interpretations Open Market Operations .. .. . . . . Federal Reserve Banks . . . . . . . . . . . . . . .. . Directors of the Reserve Banks . . . . . . . . . . . . . . . . Powers and Duties of Reserve Banks . . . . . . . . Depository Functions of Reserve Banks . . . . . . . . . . Reserves ..................................... Discounts and Advances . . . . . . . . . . . . . Check Collection and Fund Transfers .. ..... . .. Federal Reserve Note Issues . . .. . .. . . Examination of Banks . . .. . .. . . . .. . . . Regulation of Interest and Dividends Paid by Banks . . Credit Controls . . . . .. . The Relationship of the Federal Reserve System to Savings Institutions . . . . . . . . . . . . . . . . . The Comptroller of the Currency . . . . ... . . . ... . . . . . . Bank Holidays .

. . . . . . . . . . .. . . . . . .. . .. . . . . . . . . . .... . . . .. .. . .. . . . . . ... . . .. . . .. . . . . . .. . .. . . .. . . . . . . .. . . . . . . . . . . . . . .. .. . . . .. . . . . . . . .. . . .. .. . . .. . . . .. . .. . . . . . . . . . .. ... . . .. . . . . ...... . . . .. ...... ... . . .. . . . . . . . . .. . . .

Page

19 20 22 23 25 2729 30

3031 33

34 3637 38 38

40 41 44

TIfE STRUCTURE OF TIIE FEDERAL RESERVE SYSTEMAs discussed in $ 1-15, the United States has continuously chartered national banks since the National Bank Act of 1863. After the demise of the Second Bank of the United States in 1836, however, the country did not have a central national bank. During the recession of 1907 it bccanle apparent that, because of this lack, the national banking *system was seriously flawed. The banking system did not possess the flexibility to channel funds from one region of the country to another

3 2-10

OVERVIEW

FEDERAL RESERVE SYSTEM

.-lo

i6

I

when necessary to meet the requirements of national commerce. Problems arose not only because of the difficulty in arranging loans and extensions of credit between areas with excess reserves and those with shortages, but also bccausc currency shortages inhibited the economic growth of some regions. Accordingly, after extensivc study and intcnsc political maneuvering, Congress passed the Federal Reserve Act in 1913, which created a ncw federal system of banking known as the Federa1 Reserve S y s t ~ m . ~ The Federal Reserve Act created a three-part structure: the Board of Governors, the Federal Reserve Banks, and the member banks. The Board of Governors acts as the governing .body of the Federal Reserve System. There are twelve Federal Reserve Banks. The country is divided into twelve reserve districts, and each district has one Reserve Bank. The Rcscrve Banks are bankers' banks in that their capital stock is hcld by thc banks