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Fintechs try old bank charters as ‘everything old is new again’

Industrial loan companies experience resurgence as fintech industry sees their potential as a vehicle for setting up national financial institutions

The entrance to the Federal Deposit Insurance Corporation (FDIC) in Washington, D.C.
The entrance to the Federal Deposit Insurance Corporation (FDIC) in Washington, D.C. (George Rose/Getty Images file photo)

A federal plan designed to help booming financial technology innovators enter the traditional banking system won’t be sidelined for long by the COVID-19 pandemic, legal experts predict.

Citing the pandemic, the Federal Deposit Insurance Corporation last month gave the public more time to comment on a proposal unveiled in March that would require parent companies of so-called industrial banks to serve as a source of financial strength as a condition for receiving deposit insurance coverage. Fintech companies are hoping to secure industrial bank charters to get their foot in the door of banking.

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A limited freeze in the rule-making caused by the virus is unlikely to slow the rapidly growing trend of fintech firms looking to use this century-old method to become a bank, according to several fintech watchers contacted by CQ Roll Call.

“Everything old is new again,” said Norman H. Roos, senior counsel at the Robinson+Cole law firm, in an interview. Roos has been keeping tabs on the growth of industrial bank applications to the FDIC by financial technology companies. These companies increasingly view the little-known process as a way to obtain deposit insurance and, thus, compete in the market with traditional banks.

Industrial loan companies

Industrial banks, otherwise known as industrial loan companies, started as state-chartered financial institutions that made uncollateralized loans to low- and moderate-income workers who couldn’t get such loans from banks, according to the Federal Reserve Bank of St. Louis. Eventually, ILCs became eligible for deposit insurance, subject to federal safety and soundness supervision by the FDIC.

ILCs — which are today chartered by only a few states, chiefly Utah — fell into relative obscurity over the years, losing favor with some regulators and lawmakers. In 2006, the FDIC placed a six-month moratorium on ILC deposit insurance applications, citing potential risks to the federal deposit insurance fund. The temporary ban followed widespread opposition to retailer Wal-Mart Inc.’s plan to create a federally insured bank using an industrial loan company charter. Congress later imposed a three-year moratorium in 2010 with the Dodd-Frank Act.

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But the ILC concept has come roaring back as the exploding fintech industry has discovered its potential as a vehicle for setting up national financial institutions that can navigate the hodgepodge of federal and state laws and regulations governing the financial services markets.

Fintechs with customers throughout the U.S. often need to obtain licenses in all 50 states and the District of Columbia, a complex, expensive and time-consuming burden. Setting up an ILC would enable them to avoid that multistate process while simultaneously avoiding the strict Federal Reserve supervision faced by many traditional bank holding companies.

Facilitating fintechs

The FDIC’s current industrial loan company proposal is widely seen by financial industry observers as an effort to facilitate fintechs setting up industrial banks.

The day after the proposal, the FDIC approved two deposit insurance applications, one by San Francisco-based payment services provider Square Inc. and one by Lincoln, Nebraska-based Nelnet Inc. to create the internet-only Nelnet Bank to originate and service private student and other consumer loans.

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The two approvals were the first in more than a decade. Japan-based e-commerce company Rakuten Inc. later filed an application, with plans to set up Rakuten Bank America.

Since 2017, nine ILC deposit insurance applications have been filed, according to banking attorney Scott A. Coleman, a partner with Ballard Spahr LLP. Coleman told CQ Roll Call he believes this trend will continue.

“The application processes have taken years in some cases, and applications have been withdrawn and resubmitted, but the process is likely to continue,” he said. “The COVID-19 pandemic has likely slowed the process for new applications, but I expect we will see additional action on pending applications and new applications.”

The reason is that so-called alternative payment providers are looking for the ability to take insured deposits without being regulated as bank or financial holding companies, “which could limit the business plan of the parent company or its shareholders,” Coleman said in an email.

Moreover, Roos expects the FDIC to be more likely to approve these applications than previously because fintech’s rise is leading regulators to “think outside the box” and consider new ways — or “old ways,” in the case of ILCs — of dealing with financial technology firms.

It won’t be easy going, however. The traditional banking industry and members of Congress have expressed opposition to the FDIC granting ILC applications.

“I would encourage the FDIC not to approve any new ILC applications until after the agency receives and considers feedback on the new regulatory proposal from experts, stakeholders, and Congress,” the chairwoman of the House Financial Services Committee, Rep. Maxine Waters, D-Calif., wrote in March to FDIC chief Jelena McWilliams.

Waters said she and other lawmakers have “concerns with regulatory oversight of ILCs generally,” citing the need for strong consumer protection and reinvestment, and the importance of preserving the separation of banking and commerce.

Also in March, the Independent Community Bankers of America, an industry group, said it was extremely concerned about the FDIC’s proposed rule-making on industrial charters and its approval of Square and Nelnet. The organization last year distributed a policy paper around Washington calling for an immediate moratorium on such approvals.

Regulation legislation

In response to Rakuten’s application, Sen. John Kennedy, R-La., introduced legislation last year that would require the Fed to regulate ILCs and demand industrial loan companies to “comply with specified reporting, examination, and ownership requirements.”

“It’s just a bad idea for commerce and banking to mix,” Kennedy said in November. “Not only is it unfair to community banks who have to play by different rules, it’s bad for consumers.” The ICBA supports Kennedy’s bill, which has been referred to the Senate Banking Committee.

Still, Prat Vallabhaneni, a former FDIC attorney and currently a partner at White & Case LLP’s banking and fintech practices, told CQ Roll Call he doubts that Kennedy’s proposed legislation will gain much traction.

“Although there was some momentum, on both sides of the aisle, for a congressional response last fall, the issue is unlikely to receive immediate renewed attention due to the dwindling number of legislative days in the Senate, Congress’ current focus on the COVID-19 pandemic, and the current lack of momentum on the issue.”

Vallabhaneni said the FDIC’s “pro-business philosophy” combined with “the intense industry interest in this charter, which is lawful, seems to have given rise to the approvals.” Absent a change in the FDIC leadership or the law, he believes there “almost certainly” will be more fintech ILC approvals in the future.  

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