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
Lee Reiners, CFAExecutive Director, Global Financial Markets Center
