Despite the fact that they are currently being hotly pursued by technologists, the Industrial Loan Charter (ILC) is not exactly a new idea. The concept – originally called a Morris loan – first appeared on the American financial services landscape in 1910, and has occupied a fairly small corner of the financial services marketplace ever since.
ILCs are used to form industrial loan companies, better known as industrial banks. An industrial bank is an FDIC-insured depository institution that is generally subject to the same banking laws and regulations as any other bank charter type, with the important exception of the Bank Holding Company Act of 1956. That law prohibits bank holding companies from participating in commercial activities not directly or closely related to financial services. Industrial banks are not subject to BHCA. All industrial banks are chartered in Utah – and there are only 17 such charters issued, 15 of which are currently active.
Because they are not all that common, ILCs are usually a fairly invisible part of the financial services landscape. Wide interest in them does pop up from time to time, however, usually at around the time when a big player makes serious moves toward attaining one.
Before this year, the last time that happened was in 2006, when Walmart made a move on an ILC. Walmart initially had sought to own a bank that offered full consumer banking services – though by time of its final push 11 years ago, that ambition had been radically scaled back. Walmart claimed it wanted to leverage the proposed bank mainly for the purpose of lowering costs of its backroom processing of check and credit card transactions and to offer high-interest certificates of deposits.
Ultimately, that effort was pushed back by a coalition of unions, consumer groups, community banking groups and legislators that did not trust Walmart’s business plan or intentions once they had the license and FDIC deposit insurance in hand.
And while much has been quiet on the ILC front ever since, as of 2017, two big FinTechs made them very visible again: Sofi in June and Square in mid-September.
SoFi, due to other corporate issues, has already abandoned that effort. But Square continues to actively seek the specialized charter as they push forward on their path to greater scale.
“As we scale, it’s becoming increasingly important that we have direct relationships with regulators,” said Jacqueline Reses, who leads Square Capital and will be the chairman of the bank. Ms. Reses further noted that the choice to apply for an industrial loan company charter as opposed to a traditional banking license allows Square to continue to participate in the parts of its business that are entirely non-financial, such as selling hardware payment terminals and offering food delivery through its Caviar app.
Square already has an SMB lending arm – Square Capital – which it operates through a deal with Utah-based Celtic Bank. That lending operation has been fairly successful for Square, and has lent out over $1.8 billion to more than 141,000 firms.
Square’s other business concerns, such as installment loans and Square Cash, will remain outside of the bank. That is, if that bank ever comes into being – something the Independent Community Bankers of America (ICBA) is quite determined to prevent.
In the near term, the trade group for community banks is pushing for the Federal Deposit Insurance Corporation (FDIC) to deny a federal deposit insurance application by Square, and to declare a moratorium on any and all such charter applications for the next two years.
Longer term, ICBA Executive Vice President and Senior Regulatory Counsel Christopher Cole told PYMNTs in a recent conversation, they should be shut down.
“Industrial banks began as entities to help the industrial worker – they were like credit unions for industrial workers [who] couldn’t get loans with traditional banks back in the early 20th century,” Cole said. “It’s an anachronistic idea that has stuck around in the law that should just be shut down.”
An Unleveled Playing Field
The ICBA has a long history of opposing ILCs, most notably in 2006, when it was part of the coalition that blocked Walmart.
And while both SoFi and Square are much more clearly financial services companies than Walmart is, the reality, Cole noted, is that Square has a lot of commercial business.
With their hands in food delivery, hardware, software, online commerce and a merchant services provider, Cole said that it’s “not a huge stretch” to believe Square could decide to scale up any or all of those enterprises.
And as the operator of an ILC, nothing would stop from them from being able to do just that.
“A firm [with an ILC] can engage in any activity it wants to – they could open a retail business, buy a newspaper chain or operate a tech business,” Cole emphasized. “They can do pretty much any activity they want. A bank can’t, because they are legally barred from it, and that creates the very uneven playing field that we are talking about.”
Cole and the ICBA’s contention is that there’s no good reason to offer such a big advantage so as to disadvantage community banks – not when, he said, community banks actually bring special expertise to the marketplace.
“Community banks are relationship bankers, and I don’t see how [ILCs] can serve the community better than being a relationship banker,” Cole maintained. “[Community banks] do a better job being a consumer advocate and helping our consumers and SMBs than large banks, because we are so consumer centric.”
The Systemic Risk
Perhaps Cole’s biggest concern is the precedent it would set if Square is successful at securing such a charter. Cole said that would kick open the door for others who have a reasonable interest in operating a bank.
“If you think about the major players – Amazon, Apple, Google and PayPal,” Cole said, “they might all have a desire to establish a footprint here.”
Cole thinks that will introduce unforeseen risk into the system.
“When a commercial company [like Square] owns a bank, there is some risk that is inserted – and that risk gets bigger the bigger the company,” Cole pointed out. “The commercial company can easily be incentivized to make the bank favor the commercial company when it regards their competitors.”
There are also questions of data, he noted – and how the tech firms who are also in the business of gathering and sorting it can use what they learn from consumers’ banking habits across their larger business lines.
“There are a lot of unknowns,” Cole noted, “and a lot of them carry some pretty significant risks for the system.”
What’s Next
Broadly, Cole noted, ICBA would like to see the entire ILC loophole removed from banking – but that would require an act of Congress.
And those can take a while.
For the time being, Cole explained, the ICBA has requested that the FDIC declare a moratorium on such banking licenses, to give Congress time to consider the broader issues associated with the modern application of the charters.
Such moratoriums have happened in the past – for a year in 2006 and 2007, and for three years after the passage of Dodd-Frank in 2010.
But, as SoFi and now Square have demonstrated, the interest is there, and the FinTechs aren’t going away.
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