Industrial Loan Company

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From the course by Duke University

FinTech Law and Policy

6 ratings

Duke University

FinTech Law and Policy

6 ratings

Being a successful FinTech firm requires more than just great technology; it also requires an understanding of the laws and regulations applicable to your business. This course will provide you with that understanding. You will learn about the critical legal, regulatory, and policy issues associated with cryptocurrencies, initial coin offerings, online lending, new payments and wealth management technologies, and financial account aggregators. In addition, you will learn how regulatory agencies in the U.S. are continually adjusting to the emergence of new financial technologies and how one specific agency has proposed a path for FinTech firms to become regulated banks. You will also learn the basics of how banks are regulated in the U.S. If you are unfamiliar with how these new financial technologies work, fear not. We will begin each new course section with a high-level overview of the underlying technology. While the course is principally focused on the U.S. FinTech industry, we cannot possibly cover every relevant legal and regulatory issue. Therefore, this course should not be construed as legal advice. Rather, the goal of the course is to familiarize you with the key legal and regulatory challenges FinTech firms in various sectors face, as well as the critical policy debates that are occurring in Washington D.C. and state capitals across the country.

From the lesson

Banking Regulation in the U.S.

Many FinTech firms are interested in becoming regulated banks. This module will teach you about the process of becoming a bank and the government agencies responsible for regulating banks in the U.S. We will look at the Office of the Comptroller of the Currency’s proposal to grant a new type of bank charter specifically for FinTech firms and the options currently available to FinTech firms that would like to become a bank.

Special Purpose FinTech Charter11:08

Industrial Loan Company5:29

Meet the Instructors

Lee Reiners, CFA
Executive Director, Global Financial Markets Center
Duke University School of Law

In the previous lecture, we talked about the OCC's proposed FinTech charter,

which at the time of this recording, is in limbo.

But rather than wait around in the hopes that the OCC

will one day except FinTech charter applications,

several FinTechs we're interested in becoming a bank or pursuing other alternatives.

The principle alternative that we will talk about in this lecture

is industrial loan company, or ILC charter,

which is a type of charter that gives non-financial institutions the ability to enter

the banking industry without being subject to

the same level supervisory oversight that applies to commercial banks.

Industrial loan companies emerged in

the early 1800's as small niche lenders that provided

consumer credit to low and moderate income workers

who were generally unable to obtain consumer loans from commercial banks.

ILCs have changed dramatically in size and structure since it's early days.

Thirty years ago, there were around 120 ILCs open for business,

and industry assets totaled $7.5 billion.

Today, there are only 25 ILCs in existence and industry assets exceed $180 billion.

ILCs are state-chartered with only a handful of states authorizing them,

Utah being the most prominent among them due to their low corporate tax rate,

virtually non-existent usury caps,

and friendly regulatory environment.

ILCs have virtually all the same powers and privileges as insured commercial banks,

including the protections of the federal safety net such as

deposit insurance and access to the Federal Reserve's discount window and payment system.

Many ILCs even use the word 'bank' in their name,

including Toyota Financial Savings Bank,

Web Bank, and BMW Bank of North America.

The key difference between ILCs and commercial banks is that

ILCs operate on a special exception to the federal bank holding company act,

which means they are not subject to the same Federal Reserve prudential supervision,

as applies to bank holding companies.

They are therefore not required to maintain the separation of banking and commerce,

which Congress has historically mandated for bank holding companies.

Policy-makers from both parties have largely supported this separation.

Due to concerns that have allowed to control a bank,

commercial entities would simply use it to provide

subsidized funding to the non-bank subsidiaries,

thereby creating an uneven playing field for

those commercial firms that do not own a bank.

In addition, because banks receive FDIC deposit insurance,

which lowers their overall cost of funding,

taxpayers would in effect be subsidizing the operations of the commercial entity.

Therefore, the ILC charter is an attractive option

for some FinTech firms who are looking to become a bank,

and gain access to consumer deposits,

because the corporate owners of an ILC are not

subject to consolidated supervision by the Federal Reserve.

Harley Davidson, Toyota, and Target, all own ILCs.

But unlike bank holding companies,

these companies do not have the Federal Reserve,

or any other federal making agency,

looking into all of their activities.

Rather, the FDIC and relevant state banking agency,

will supervise and examine the ILC subsidiary in isolation.

It is easy to understand why technology company with a FinTech subsidiary,

would not want the Federal Reserves sniffing around all aspects of their business.

As you might imagine, the ILC charter is somewhat controversial.

In 2005, Walmart applied for

a Utah Industrial Loan Company charter which engendered intense public outrage.

In response, the FDIC enacted a moratorium on new ILC charters,

and in 2010, the Dodd-Frank Act required

a temporary moratorium ILC charters which expired in 2013.

The FDIC has yet to approve an ILC application since that temporary moratorium expired.

But several FinTech firms are hoping that

the FDIC will change their stance on ILC applications.

In June of 2017, online lenders, SoFi,

applied for a Utah based ILC charter that

allowed them to open a full service online only bank.

SoFi ended up withdrawing their application

several months later after a series of scandals tarnished the company's reputation.

In September of 2017,

the payments processors, Square,

also applied for a Utah based ILC Charter.

You've probably all seen Square devices plugged into

iPads at a local coffee shop or farmer's market,

the company has been solely branching out into providing small business loans,

and an ILC charter will allow the company to fund these loans with deposits.

Square's ILC application is still pending.

If the FDIC will re-approve it,

it would likely usher a new wave of new ILC applications

from FinTech firms eager to gain access to customer deposits.

Beyond the OCC's FinTech charter and the ILC charter,

another option available to FinTech firms eager to become a bank,

is to apply for a standard National Bank Charter.

This is what mobile-only financial institution,

Vero Money did in July of 2017.

There's no requirement that a national bank have brick and mortar branches,

and Vero is hopeful that their application will be approved by the OCC and FDIC.

While the path FinTech companies must take to become a bank remains uncertain,

the desire to access cheap customer deposits,

and freely operate nationwide, is not going away.

Expect more FinTech companies to apply for some form of Bank Charter in the years ahead

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