California Goes Public With Banks

Financial Services Law

One of the many bills enacted into law during the California Legislature’s end-of-session rush was Assembly Bill 857, which authorized the creation of “public banks” to support local economies and community development and address infrastructure and housing needs for localities.

The new law is set to expire seven years after its regulations are promulgated. We believe public banks, if formed, could function largely as depositories for public funds that were otherwise held by money-center banks, although there is the potential for public banks to also service smaller banks (including de novo banks) where daily operating costs can inhibit profitability.

What happened

The new law defines the term “public bank” as “a corporation, organized as either a nonprofit mutual benefit corporation or a nonprofit public benefit corporation for the purpose of engaging in the commercial banking business or industrial banking business, that is wholly owned by a local agency, as specified, local agencies, or a joint powers authority.”

Cities wishing to open a public bank must obtain a certificate of authorization from the Department of Business Oversight (DBO), provide a viability study, comply with the legal requirements applicable to nonprofit corporations and obtain deposit insurance through the Federal Deposit Insurance Corporation.

Each public bank must also include a specified purpose statement in its articles of incorporation and make conforming changes. Local agencies are authorized to deposit funds in the public banks and to invest in the banks, subject to certain requirements. In turn, the banks may make distributions to their members.

The DBO has permission to approve two public bank licenses per calendar year, with no more than 10 public banks in operation at the same time.

Pursuant to the law, public banks are prohibited from competing with local financial institutions and can only conduct retail activities in partnership with local financial institutions. Until Governor Gavin Newsom signed AB 857 into law, North Dakota was the only state with a public bank (the Bank of North Dakota, founded in 1919). While California is the first state since North Dakota to enact a law permitting public banks, it remains to be seen how many cities will take advantage of the new law.

To read AB 857, click here.

Why it matters

To the extent public banks could serve as a supercorrespondent bank (for example, cover the back-office, technology and other costs that make it impossible for small banks to function profitably), public banks could be a workable solution that stimulates activity for a new wave of de novo banks. This effort would involve a significant commitment on the part of cities organizing public banks, and the economics of such a public bank would have to justify the expense.



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