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The Next Wave of Tech Banks? Industrial Loan Companies Explained

Dec. 17, 2020, 4:01 PM

A banking structure once pursued by corporate giants like Walmart is poised for a comeback thanks to new rules that could attract tech companies such as Amazon or Facebook looking to get a foothold in finance.

The Federal Deposit Insurance Corporation approved final regulations for “industrial loan companies” to get deposit insurance as part of a bank charter application. The rules require parent corporations to enter into agreements with the FDIC on capital and liquidity levels for their proposed banking units, and take other steps to maintain safe and sound operations.

The move comes amid renewed interest for the special banking charters—from tech companies like Japanese e-commerce giant Rakuten and traditional manufacturers such as General Motors—after more than a decade of little or no activity.

1. What is an ILC?

They are state-chartered financial institutions owned by commercial firms. The charters were established in the early 20th century to help industrial workers ignored by mainstream banks get access to credit and other financial services.

Also called industrial banks, the roughly two dozen ILCs in operation today are owned by manufacturers like John Deere, Harley Davidson, and Toyota. They are supervised by state regulators but also must get insurance from the FDIC.

2. What are the benefits?

ILC charters offer tech companies entry into the U.S. banking system with fewer regulatory demands than other bank holding companies. Since ILCs aren’t defined as “banks” under the Bank Holding Company Act, their parent companies aren’t subject to oversight by the Federal Reserve.

Many companies such as Google, Apple, and Paypal have preferred to partner with existing banks to offer lending, payments, or deposit services.

Holding an ILC charter allows tech companies and other nonbanks to avoid paying partner banks for their services. Bank status also provides a cheap source of funding through customer deposits, and allows direct access to the Fed’s discount window and payments system, a major enticement for companies specializing in lending or payments.

3. What is the FDIC doing?

The final rules approved Dec. 15 would give a parent company more control over the industrial bank than what was originally proposed.

A parent company must hold “less than 50%,” of the seats on an industrial bank’s board, a significant change from the 25% cap in the proposed rules. ILCs would have to obtain FDIC approval to change directors or senior executives for three years after the bank’s formation, but not indefinitely, as originally proposed.

The rules also outline capital and liquidity requirements for industrial banks and require the parent company to undergo FDIC examinations in addition to state supervision.

4. Why now?

The FDIC says it needed to formalize longstanding expectations for applicants. The agency has received more than a dozen applications since 2017, after a decade of little activity following Walmart’s failed 2005 bid to form an ILC amid strong opposition from community banks, labor unions, and others.

The agency granted two deposit insurance applications in March, paving the way for student loan servicer Nelnet Inc. and mobile payments company Square Inc. to form industrial banks in Utah.

GM’s lending arm, General Motors Financial Co., filed ILC charter and deposit applicationson Dec. 11.

Japanese e-commerce platform Rakuten’s application is being closely watched as an indicator of the FDIC’s willingness to grant deposit insurance to a major tech firm. The company has twice submitted and withdrawn deposit insurance applications in response to agency feedback, and is soon expected to file a third time.

5. What are the risks?

Opponents say allowing nonbank giants to form banks without Fed oversight introduces significant risk to the banking system.

That was true during the 2008 financial crisis when GM’s previous lending arm, GMAC, held an ILC charter but was forced to convert to a Fed-supervised bank holding company in order to receive bailout money. The U.S. government was forced to take a majority stake after the banking unit took on heavy mortgage and auto lending losses, and GM ultimately sold the rest of the company to Ally Financial in 2013.

Privacy and data collection is also cited as a risk by ILC opponents. Tech giants like Amazon or Google could use the vast amounts of consumer data they collect, such as purchase history or browsing data, to target millions of existing customers with new financial products and services.

6. What’s next?

The final rule takes effect April 1, though companies can file applications with the FDIC at any time.

Lawmakers from both parties have already voiced opposition to the agency’s embrace of ILCs.

Jelena McWillams, who intends to stay as chairman until her term expires in 2023, also faces increased opposition within the agency. Two board members, the heads of the Office of the Comptroller of the Currency and the Consumer Financial Protection Bureau, are expected to be replaced by the Biden administration. The FDIC already has a Democratic board member in former agency chairman Martin Gruenberg.

To Learn More:

—From Bloomberg Law

Square, Nelnet Get OK to Form Banks from State, U.S. Regulators (1)

Industrial Bank Applicants Need Parents’ Capital, FDIC Proposes

Japan’s Rakuten Seeks Utah Bank for U.S. Lending, Credit Cards (2)

—From Bloomberg News

Wall Street Faces Prospect of Amazon Bank as FDIC Eases Path

GM Finance Unit Seeks Charter for a Bank in Salt Lake City (1)

To contact the reporter on this story: Lydia Beyoud in Washington at lbeyoud@bloomberglaw.com

To contact the editors responsible for this story: Michael Ferullo at mferullo@bloomberglaw.com; Roger Yu at ryu@bloomberglaw.com; Jo-el J. Meyer at jmeyer@bloombergindustry.com