Irreconcilable Differences: Analyzing the Split in the First and Second Circuit Courts of Appeals’ Decisions on National Bank Act Preemption of State Interest-on-Escrow Laws

Why It Matters

The divergent rulings dictate whether banks must pay escrow interest in key markets, shaping compliance strategies and litigation risk for the banking sector.

Key Takeaways

• Second Circuit holds NBA preempts NY escrow‑interest requirement.
• First and Ninth Circuits maintain state laws are not preempted.
• Split creates uncertainty for national banks’ escrow‑interest practices.
• OCC’s proposed escrow rule influences courts but lacks final deference.
• Banks may face higher litigation risk and operational costs.

Pulse Analysis

The recent Second Circuit decision in Cantero III revives a contentious debate over the National Bank Act’s reach into state‑mandated escrow‑interest requirements. By interpreting TILA and RESPA as granting banks a broad, incidental power to set escrow terms, the court concluded that New York’s minimum‑interest rule "significantly interferes" with a core banking function. This analysis diverges sharply from the First Circuit’s approach in Conti, which read Dodd‑Frank as preserving a stronger role for state consumer‑financial regulation, and from the Ninth Circuit’s reliance on procedural grounds to uphold California’s law. The split underscores how courts are still grappling with the nuanced comparative test articulated in Cantero II, leaving banks without a uniform national standard.

Agency influence further muddies the waters. The OCC’s interim‑final and proposed rules, which assert broad escrow‑setting authority for national banks and label state interest mandates as preempted, were cited by the Second Circuit but received only limited deference after Loper Bright clarified the Skidmore standard for agency interpretations. The dissent warned that the OCC’s simultaneous grant of discretion and blanket preemption creates a logical inconsistency, echoing concerns that courts may be over‑relying on agency proposals that lack final rulemaking status. This dynamic illustrates the growing tension between judicial preemption analysis and evolving regulatory guidance.

For banks, the practical fallout is immediate. Institutions operating in New York must reassess escrow‑interest policies, while those in First‑ and Ninth‑Circuit states face heightened litigation risk if they continue to withhold interest. The split also signals that state legislatures may pursue new escrow‑interest statutes, betting on favorable circuit precedent. Risk and compliance teams should monitor pending Supreme Court action, track OCC rule finalization, and consider contingency plans—such as maintaining interest payments or seeking waivers—to mitigate operational disruptions and legal exposure across the fragmented appellate landscape.