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State-run banks in California could attract deposits now held at national banks

Public banks, a rarity in the U.S., could become more common with the passage of a new California law.

California Assembly Bill No. 857 will let municipalities in the state open public banks, government-run depositories that can lend to public and private entities as long as they serve a community or public purpose. That could include small business, affordable housing or infrastructure lending depending on a community's needs, said Jennifer Kwart, communications director for the office of Assemblymember David Chiu, one of the bill sponsors.

Governments often bank with large national banks, and the goal behind the bill is to allow municipalities to use their deposits as they see fit, according to Kwart. The state's major cities record billions of dollars in revenue currently kept at commercial banks. San Francisco, for example, banks with Bank of America Corp. and U.S. Bancorp, Kwart said. The city had total net revenue of $12.21 billion for the 2018-2019 fiscal year.

"We want to be able to give local jurisdictions and cities the ability to bank elsewhere, where perhaps ... taxpayer dollars aren't being used to pay large fees or high interest rates that a traditionally large bank would be charging," said Kwart. "That's the public's money, and it's not really serving a public service."

Only one other state banking model exists in the U.S. Bismarck, N.D.-based Bank of North Dakota takes all deposits for the state, as well as from some municipalities and private citizens.

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But analysts said the proposed California public banks would be different from the Bank of North Dakota. Deposits from individual cities and municipalities in the Golden State will be large sums relative to the state of North Dakota, said Gary Tenner, a California bank analyst with D.A. Davidson. The Bank of North Dakota also has a captive deposit base, receiving all deposits from the state government, but North Dakota municipalities can choose whether to deposit with The Bank of North Dakota or at private banks, according to the bank's president and CEO, Eric Hardmeyer. The California law only allows local municipalities, not the state, to form banks.

The Bank of North Dakota has outperformed banks in the state, region and across the U.S. in profitability metrics. Its return on average assets in the second quarter of 2019 was 2.56%, up 14 basis points on a year-over-year basis. The bank's 19.17% return on average equity far outpaces the median for banks in the state, which was 12.10% in the second quarter of 2019. The bank also has an extremely low efficiency ratio of 14.38%, mostly due to its low tax expenses. However, its net interest margin is slightly lower than others in the state, the region, and the U.S. at only 3.03% in the second quarter of 2019.

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The Bank of North Dakota operates more like a bankers' bank than a traditional commercial bank, said Hardmeyer. The bank finances economic development in the state mainly through participating in loans originated by local banks. The bank manages the state's 529 student loan program, buys mortgages from local banks, and provides loans for agriculture and industry in the state.

Participating with local banks has allowed the Bank of North Dakota to maintain a good relationship with banks in the state. "We are here to support the private banking sector," Hardmeyer said in an interview.

Bank of North Dakota can take private deposits with no restrictions, but retail banking is not a focus, said Hardmeyer.

"We don't offer credit cards [or] debit cards and have felt that kind of activity belongs in the private sector," he said. The bank also does not operate traditional branches for customers.

The California bill prevents public banks from competing with community banks or credit unions, said Kwart. "The bill authorizes a public bank to engage in any sort of local banking activity that is not already offered by a local financial institution," she said.

The California banks "in theory" would be allowed to offer retail banking services, Kwart said, but only if there are no banks or credit unions operating in the municipality. According to S&P Global Market Intelligence data, only two counties in California have no bank or credit union branches.

But the bill has its critics, who say there is no demand for a public bank. The voters of Los Angeles rejected a proposal for the city to establish a public bank in November 2018.

"We haven't seen a big public outcry for the banks," said Beth Mills, senior vice president of communications with the California Bankers Association, in an interview.

Participating in loans with community banks may be a more effective way for California to accomplish its goals, said Tenner.

Public banks may be viable in California, but they would need the right leadership, Tenner added. "From the ability to have balances to fund that public bank, there's certainly the ability to do that," he said. "It's a question of finding the right group to run it."