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Banks seek Congress’ help to block fintech path to ‘industrial’ charters

Industry group expects efforts to have bipartisan support on Hill

A bank industry group accuses financial technology firms like payment processor Square Inc. of trying to exploit a banking law loophole. (Courtesy Shutterstock)
A bank industry group accuses financial technology firms like payment processor Square Inc. of trying to exploit a banking law loophole. (Courtesy Shutterstock)

A bank industry group is lobbying Congress to block financial technology firms, such as online lender Social Finance Inc. and payment processor Square Inc., from obtaining an obscure form of a state bank charter that would let them operate nationally with little federal supervision.

The Independent Community Bankers of America last week distributed a policy paper around Washington calling for an immediate moratorium on providing federal deposit insurance to industrial loan companies, or ILCs, which are chartered by only a few states — most notably Utah.

Now, the ICBA says it’s presented the report to FDIC Chairwoman Jelena McWilliams and is set to discuss the issue with members of Congress in the days ahead, focusing on members of the Senate Banking and House Financial Services committees.

The group says industrial charters are a loophole in the banking law that Congress should close. Fintechs that own state-chartered ILCs would not be subject to supervision by the Federal Reserve and would not have to divest any nonbanking-related commercial activities, “leaving a dangerous gap in safety and soundness oversight,” ICBA said.

“In the new era of dominant Big Data, social media and e-commerce conglomerates, artificial intelligence, and financial technology, we should be cautious before giving these companies yet more reach into the economic lives of Americans,” the group wrote in its 2019 legislative agenda. “Any such far-reaching change should be debated by Congress.”

Square, SoFi Bank and student loan company Nelnet Bank, or their affiliates, explored obtaining a Utah ILC charter rather than commercial bank charters. ICBA says they’re looking at this route because their parent companies wish to retain and extend nonbank commercial activities while avoiding supervision by the Federal Reserve as bank holding companies. Under federal law, if companies acquire a traditional bank charter, they need to divest themselves of nonbank-related affiliates.

The fintech industry is pushing back.

“As thousands of traditional bank branches close, many communities are losing banking options. Limiting consumers’ banking choices in these circumstances is not going to help the American economy,” Nat Hoopes, executive director of fintech industry group Marketplace Lending Association, said in an emailed statement. “Digital banks” could help to fill these gaps, he said, and spur innovation from within the banking system rather than outside it.

“The industrial loan company charter is a long-established and well-regulated state banking option that has proven very durable, and today’s fintech companies should be able to apply,” he said.

Industrial loan companies, sometimes called industrial banks, are similar to commercial banks. They emerged in the early 1900s as small niche lenders that provided consumer credit to low-to-moderate income workers who were generally unable to obtain loans from commercial banks, according to the Federal Reserve Bank of St. Louis. ILCs may use the word “bank” in their names, such as Toyota Financial Savings Bank and WebBank.

In exchange for their state charters and access to federal deposit insurance, ILCs must comply with certain federal safety and soundness and consumer protection laws applicable to FDIC-insured banks.

“Although subject to many bank regulations, ILCs have a few key advantages over traditional banks,” the St. Louis Fed wrote in an October 2017 analysis of potential fintech interest in industrial loan company charters.

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Bank data questioned

Unlike the owners of banks, the corporate owners of ILCs operate outside the prudential regulatory framework established for bank holding companies.

That’s the source of contention, according to the community bankers.

“The integration of these technology and banking firms would not only result in an enormous concentration of financial and technological assets but also would pose conflicts of interest and privacy concerns to our banking system,” the bankers group wrote in its 19-page policy paper.

The group said these companies have the potential to abuse the data they will get if they’re allowed to start operating as banks, referring to missteps made by tech firms that use data for marketing products and services and for targeted political messages.

“Adding personal, financial data — monthly paycheck direct deposits, account balances, expense patterns, political contributions, history of late fees, transaction records, etc. — would take targeted marketing to a whole new level,” the bankers’ group wrote. “Before we give up our last vestige of privacy and lurch into a new era of corporate saturation, let’s hit the pause button and engage in an informed debate about the future economic life of our country.”

Utah is the leader of only a handful of states that charter commercially owned industrial loan companies. Paul Merski, ICBA’s executive vice president for congressional relations and strategy, said it’s not likely that Congress will tolerate a small number of jurisdictions having a disproportionate influence on national banking policy.

“A single state, Utah, representing less than 1 percent of the U.S. population, should not be allowed to unilaterally determine national financial regulatory and economic policy,” ICBA’s policy paper said.

ICBA said its efforts will have bipartisan support on Capitol Hill.

Merski pointed to a December 2006 letter from a bipartisan group of 107 House members to Sheila Bair, the FDIC chairwoman at the time, asking the agency to extend an existing freeze on ILC applications for federal deposit insurance by commercial firms as evidence of widespread support for a new moratorium. Merski noted that many of the signatories are still in Congress, including Rep. Maxine Waters, who now chairs the House Financial Services Committee. In addition, some signatories of the 2006 letter have moved to the U.S. Senate in the years since.

The FDIC had placed a six-month moratorium on deposit insurance applications by ILCs following widespread opposition to a proposal by retailer Wal-Mart Inc. to create a federally insured bank with an industrial loan company charter.

Congress would later impose a three-year moratorium in 2010 with the Dodd-Frank Act. That moratorium expired in 2013.

While the FDIC has not approved an ILC applicant for deposit insurance in more than a decade, the issue resurfaced as fintech companies explore the idea.

A spokesperson for Square said the ILC charter was intentionally designed for companies that engage in activities that extend beyond banking services.

“Square Capital is uniquely positioned to build a bridge between the financial system and the underserved, and an ILC will allow us to engage directly with regulatory bodies to continue these efforts,” he said. “We trust the FDIC to safely oversee and regulate these organizations as they have done successfully for decades.” 

Nelnet Bank withdrew its ILC application in September, calling the withdrawal a temporary setback and saying it is an “ideal” candidate for such a charter. SoFi declined to comment.

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