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Lawmakers fret over backdoor entry to banking for big companies

Industrial loan companies seen as aid to big tech and big retail

“If you want to be a bank, you need to be regulated like a bank,” says Rep. Blaine Luetkemeyer.
“If you want to be a bank, you need to be regulated like a bank,” says Rep. Blaine Luetkemeyer. (Caroline Brehman/CQ Roll Call file photo)

Lawmakers from both parties are expressing concerns about potential risks posed by state-chartered industrial loan companies that can blend financial services and other commercial activities.

At a hearing last week, they questioned whether the process sought by financial technology companies that have no history of taking deposits will give these companies a backdoor entry into banking that could exempt them from some oversight.

Rep. Ed Perlmutter, D-Colo., said the entry of commercial companies into the financial services arena poses questions about “market fairness and financial stability.”

Perlmutter is chairman of the House Financial Services Consumer Protection and Financial Institutions Subcommittee, which held the hearing on banking charters on April 15. The majority Democrats titled the hearing “Banking Innovation or Regulatory Evasion,” but they found plenty of company among Republicans who had their own concerns.

Prompting the concern was a move by the Federal Deposit Insurance Corporation late last year to finalize a rule to let nonbank industrial loan companies, including fintechs, obtain deposit insurance in some cases.

The rule codified the process for approving and supervising these institutions, stoking questions about whether any big tech or retail company could use an ILC charter to enter the financial services sector.

Some applications had already been authorized on a case-by-case basis before the rule was finalized, such as the approval of deposit insurance for Square Financial Service Inc., an industrial loan subsidiary of the payments startup Square Inc.

“I’ve always said that if you want to be a bank, you need to be regulated like a bank,” said Rep. Blaine Luetkemeyer. The Missouri Republican is the ranking member on the subcommittee.

“The rise of the ILC approvals and applications does raise questions of banking and commerce separations, safety and soundness, and privacy,” he said. “For 60 years we kept the banking and commercial stuff apart, and now we’re allowing it to get mingled together and every day it gets mingled more and more.”

Some fintech companies see ILCs as a vehicle to provide products and services to customers without the parent falling under typical banking supervision. The ILCs, which first emerged in the early 20th century, are regulated by the state where they are chartered. The subcommittee said in a memo that there are currently 25 ILCs taking deposits under charters in a handful of states.

The FDIC paused issuing insurance for industrial loan companies after unsuccessful attempts by Walmart and Home Depot to secure ILC insurance in the early 2000s. Congress extended the moratorium to 2013 after the 2008 financial crisis.

Erik Gerding, a professor at the University of Colorado Law School, said big commercial enterprises operating banking services would undercut rivals in both commerce and financial services.

No consolidated supervision

“We should worry about a banking system that could quickly devolve into being dominated by the three bigs: big Wall Street, big tech and big retail,” Gerding said.

Industrial loan companies aren’t subject to “consolidated supervision” by the Federal Reserve, the mechanism through which the regulator can track risk and activity across a conglomerate, including nonbank subsidiaries of a bank. Consolidated supervision allows banking regulators to ensure that large conglomerates aren’t “playing games” with the subsidies and privileges that come with banking, Gerding said.

“We should, in short, worry about the core reasons that we separate commerce and banking: to prevent concentrations of economic and political power, to prevent distortions in commercial markets that allow unfair government-subsidized competition and to prevent distortions in banking markets,” he said.

Undermining the integrity of national banking charters would also push banks to take on riskier behaviors to compete, Gerding said.

Brian Brooks, former acting comptroller of the currency under President Donald Trump, said it would be a mistake to “put the baby out with the bathwater” when it comes to ILC charters.

“It’s a very different question to ask should Walmart be able to get an ILC versus should Affirm or Brex, which are lending companies, be able to get an ILC charter,” Brooks said. “Let’s just talk about the actual companies that are actually applying for ILC charters today. They’re not Walmart. They’re not Amazon. They’re not Google. They’re financial companies.”

“The question is, which is a riskier scenario, letting them in the system so they can be supervised,” Brooks said. “Or we can keep them out of the system.”

Banking industry groups, including the Independent Community Bankers of America, criticized the FDIC’s rule in public comment letters, asserting that overlap of commerce and banking without imposing more stringent standards could expose the whole financial system to volatility.

“These proposed supervisory enhancements fall considerably short of what is needed to ensure the safety and soundness of these companies,” ICBA wrote.

The American Bankers Association urged the FDIC to include specific grounds for denial of an application in the rule amendment in its own comment letter that expressed worry over commingling banking and financial services with other industries.

Lawmakers devoted less time at last week’s hearing to questions about another avenue for fintech: the special purpose national bank charters that the Office of the Comptroller of the Currency issued to fintechs in 2016. Courts held up the implementation of the charter that would have allowed financial technology companies to avoid seeking approval on a state-by-state basis.

Democrats asked witnesses whether state-issued charters, such as Wyoming’s charter for special purpose depository institutions, provided adequate protections. Wyoming last year approved such a charter for cryptocurrency custody company Kraken Bank.

Kristin Johnson, a professor at Emory University School of Law in Atlanta, said lawmakers should undertake “very careful evaluation” of any extension of charters to cryptocurrency firms.

“There is more than sufficient evidence in the cryptocurrency space already that exchanges not only experienced solvency crises, but they are subject to cyberattacks that have left them unable to satisfy a customer’s deposits,” she said. “They’ve also been subject to any number of scams and misconduct more broadly.”

Michael Shaw contributed to this report.

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