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The next wave of tech banks? Industrial loan companies explained

A banking structure once sued by corporate giants like Walmart is set to return thanks to new rules that could lure tech companies like Amazon or Facebook looking to gain a foothold in finance.

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

The move comes amid renewed interest in special banking charters – from tech companies like Japanese e-commerce giant Rakuten and traditional manufacturers like 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 enterprises. Charters were established at the turn of the 20th century to help industrial workers ignored by traditional banks access credit and other financial services.

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

2. What are the advantages?

ILC charters offer technology companies entry into the US banking system with fewer regulatory requirements than other bank holding companies. Since ILCs are not defined as “banks” under the Bank Holding Company Act, their parent companies are not subject to Federal Reserve oversight.

Many companies such as Google, Apple and Paypal have preferred to partner with existing banks to provide loan, payment or deposit services.

Having an ILC charter allows tech companies and other non-bank organizations to avoid paying partner banks for their services. Bank status also provides a source of cheap funding through customer deposits and allows direct access to the Fed’s discount counter and payment system, a major draw for businesses specializing in loans or payments.

3. What does the FDIC do?

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

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

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

4. Why now?

The FDIC says it needed to formalize long-standing 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 attempt to form an ILC amid strong opposition from the from community banks, unions and others.

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

GM’s loan arm, General Motors Financial Co., filed ILC charter and filing applications on December 11.

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

5. What are the risks?

Opponents say allowing non-bank giants to form banks without Fed oversight poses a significant risk to the banking system.

This 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 the money from the bank. bailout. The U.S. government was forced to take a controlling stake after the banking unit suffered heavy losses on mortgages and auto loans, and GM eventually sold the rest of the company to Ally Financial in 2013.

Confidentiality and data collection are also cited as a risk by opponents of ILC. 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 products and services. financial.

6. What’s the next step?

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

Lawmakers on both sides have already expressed opposition to the agency’s membership in ILCs.

Jelena McWillams, who intends to remain president 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 Office of Consumer Financial Protection, are expected to be replaced by the Biden administration. The FDIC already has a Democratic board member in former agency president Martin Gruenberg.

To learn more:

—From Bloomberg law

Square and Nelnet Obtain Authorization to Form Banks from State and US Regulators (1)

Candidates for industrial banks need parents’ capital, FDIC suggests

Rakuten from Japan Seeks Bank of Utah for Loans and Credit Cards in US (2)

—From Bloomberg News

Wall Street faces Amazon Bank prospect as FDIC softens lane

GM’s finance unit seeks charter for bank in Salt Lake City (1)

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