Could Industrial Bank Charter Lure Wal-Mart, Amazon or Facebook?

By Jeff Bater

Wal-Mart’s scuttled bid to start a bank a decade ago silenced industrial loan charter applications, but new attempts by two fintech firms to enter the sector could unleash a wave.Online lender SoFi, which is short for SocialFinance, and payment processor Square have applied for industrial loan company (ILC) charters in Utah backed by the Federal Deposit Insurance Corp.

ILCs or industrial banks are financial institutions that may be owned by nonbank holding companies. State-charted institutions that obtain deposit insurance from the FDIC are exempt from extensive regulations of the Bank Holding Company Act (BHCA), including supervision by the Federal Reserve.

SoFi filed for federal deposit insurance in June and Square applied in September.

Google and Apple?

“If either one were granted, you would see a stampede by very large commercial and industrial companies seeking to obtain ILC charters,” George Washington University Law School Professor Arthur E. Wilmarth Jr. told Bloomberg BNA. “Why wouldn’t Wal-Mart want to come back for an ILC charter? Why wouldn’t Google, Apple, Facebook, Microsoft, and Amazon all want to get ILC charters as well?

“All of them would benefit greatly from having access to the Fed’s payment system and the Fed’s discount window, as well as having the ability to accept FDIC-insured deposits — the cheapest funding available in the private market — and to make loans on a nationwide basis with the benefit of usury preemption.”

V. Gerard Comizio, a banking partner at Fried, Frank, Harris, Shriver & Jacobson LLP in Washington, said he thinks a state banking charter of this type, where the parent company is not a traditional financial services company, will be an optimum way to enter the system

“Clearly, I think you’re going to see more of this,” he told Bloomberg BNA. “Ten or 15 years ago, we weren’t talking about PayPal and Square; now, they are inbred parts of the financial system and they’re not banks — yet.”

The FDIC’s processing time varies, but applications for insurance are generally acted on within four to six months — but only after the application is accepted by the agency as substantially complete.

Certain portions of the ILC applications will be available for public review and comment, under FDIC procedures for startups. Rep. Maxine Waters (D-Calif.) has already asked the regulator to hold at least one public hearing on SoFi’s request for federal deposit insurance.

The FDIC could not immediately comment on whether it will hold a public hearing on SoFi or on Square.

More Fintech Bids

George Sutton, an attorney at Jones Waldo Holbrook & McDonough, PC in Utah, said if SoFi and/or Square’s applications are approved, more fintech firms might make bids for ILC charters.

“But it really depends on the company and its particular business plan,” Sutton told Bloomberg BNA. “I don’t think that fintechs are drawn to an ILC charter for any reason other than a way to operate more stable loan programs funded by deposits. A fintech ILC would be like any other bank.”Retail giant Wal-Mart applied to the FDIC in 2005 to obtain insurance for a proposed industrial bank. Opposition by community banks, labor unions, and others led to the regulator placing a short-term moratorium on approving insurance for industrial-bank applicants. The retailer subsequently withdrew its application in 2007.

The financial crisis that followed in 2008-2009 squashed charter activity, and the 2010 Dodd-Frank Act placed a three-year moratorium on ILC applications.

The new requests from SoFi and Square are reviving old debates about whether it’s proper for an ILC parent company to avoid regulation as a bank holding company. Examples of those requirements include Fed supervision and capital and liquidity requirements at the holding company level.

Community banks have already objected to SoFI’s deposit insurance application and its use of the ILC charter to avoid the BHCA restrictions and Fed oversight. The Independent Community Bankers of America (ICBA) urged the FDIC to deny the application and impose a moratorium on future ILC deposit insurance applications — as the agency did a decade prior during the Wal-Mart debate.

Regulatory Arbitrage?

Brian Simmonds Marshall, policy counsel for Americans for Financial Reform, says the ILC charter amounts to “regulatory arbitrage.” The AFR is a nonprofit coalition of more than 200 civil rights, consumer, labor, business, investor, faith-based, and civic and community groups.

“If you want the rights of banks, you have to take the responsibilities and obligations of banks,” Marshall told Bloomberg BNA. “You have to take the bitter with the sweet.”

In December, the Office of the Comptroller of the Currency (OCC) proposed special charters for fintech firms that lend money or engage in other banking activities but do not accept deposits, which could include online platform lenders, payment providers, and money transmitters.

The OCC’s proposal has triggered litigation from New York and other state regulators on grounds the federal banking regulator doesn’t have the authority to issue special fintech charters. The OCC has vigorously defended its charter authority, but has also said that it remains in the early stages of developing final rules for accepting or reviewing fintech charters.

“Since the OCC has not described the features of a fintech charter, it is hard to say which might work better,” Sutton said.

ILCs, on the other hand, cannot take commercial checking accounts. “That basically precludes opening branches or competing directly with full-service banks,” Sutton said. “ILCs work best as specialized lenders operating without branches.”

Minor Drawbacks

To Wilmarth, the drawbacks of an ILC seem relatively minor. “You get all the benefits of a banking charter, but you’re exempted from many of the most important requirements, which are based on status as a bank holding company.”

Jo Ann Barefoot, a fintech consultant and former U.S. deputy comptroller of the currency, thinks there will be more charter applications, especially if the OCC’s fintech charter is blocked or mired in uncertainty and if the FDIC shows receptivity to granting ILCs.

“There is pent-up demand among some of the strong fintechs to get bank charters, and I expect companies will pursue the paths that appear most navigable,” she told Bloomberg BNA in an email.

“Furthermore, it may not evolve as an either/or option,” Barefoot said."Both may become available, along with continued robust growth of fintechs within the state licensing system — which is also working toward becoming a more attractive option. All three approaches may evolve together.”

She added that any kind of innovator might take the ILC route. “SoFi and Square are very different kinds of companies,” Barefoot said. “We could see this strategy from lenders — not necessarily marketplace lenders — and payments companies in particular.”

Regulators must figure out how to adapt to the innovators, and Barefoot says they have their work cut out for them.

“If they don’t let them into banking, however, we’ll see most innovation evolving outside the banking system and far removed from federal regulatory oversight,” she said. “That would not be good. Federal regulators need deep engagement with the cutting edge of innovation, as technology transforms finance.”

To contact the reporter on this story: Jeff Bater in Washington at jbater@bna.com

To contact the editor responsible for this story: Michael Ferullo at MFerullo@bna.com

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