Industrial Loan Companies and Fintech in Banking

Industrial Loan Companies and Fintech in Banking

November 29, 2019
Industrial Loan Companies and Fintech in Banking
Several states offer a type of bank charter for industrial
ILCs can be owned by a nonfinancial parent company,
loan companies (ILCs). Certain ILC features of ILCs and
creating an avenue for commercial firms (e.g., retailers,
their regulation—particularly that their parent holding
manufacturers, or possibly technology companies) to own a
companies can be nonfinancial, commercial firms not
bank. This raises questions over whether ILCs create an
supervised by the Federal Reserve—have made ILCs the
unacceptable mixing of banking and commerce.
subject of perennial policy debate. Recently, several
technology companies have applied to establish new ILCs,
In addition, under federal law, an ILC parent company that
refocusing interest on the issue.
meets certain criteria is not necessarily considered a BHC
pursuant to the Bank Holding Company Act of 1956 (P.L.
Industrial Loan Companies
84-511), and thus generally is not subject to regulatory
In the United States, depository institutions operate under a
supervision by the Federal Reserve. (An exception would
number of charter types offered at either the state or federal
occur in cases where an ILC or its parent is designated a
level. Each type determines which activities are permissible
systemically important financial institution, over which the
for the institution, which are restricted, and which federal
Federal Reserve does have supervisory authority. See CRS
bank agency or agencies will regulate the institution. In
Report R42150, Systemically Important or “Too Big to
addition, a depository may be owned by a parent company,
Fail” Financial Institutions, by Marc Labonte.) This may
which in the vast majority of cases (ILCs excepted, as
raise questions over whether appropriate regulatory
discussed below) is a bank-holding company or thrift-
supervision of ILCs is in place, and whether their regulatory
holding company (hereinafter collectively referred to as
treatment puts BHCs and their banks at an unfair
BHCs) regulated by the Federal Reserve.
competitive disadvantage.
Originally, ILCs formed to serve niche lending markets (the
Debated Issues
name comes from their initial business of making loans to
Separation of Banking and Finance. In general, the
industrial workers), were not allowed to accept deposits,
United States has historically adopted policies to separate
and were restricted in the types of loans they could make.
banking (for the purposes of this In Focus, meaning
Over time, market changes and changes to state and federal
deposit-taking) and commerce (i.e., buying and selling
law and regulation have narrowed the differences between
goods and services).
the products and services provided by ILCs and by
commercial banks and savings associations.
Rationales for such policies involve preventing a number of
interrelated problems. One is that a mixed organization’s
Table 1. ILC Statistics, Third Quarter 2019
banking subsidiary could have incentives to make decisions
Number
24
based on the larger organization’s interests, rather than on
safe and sound banking principles. For example, it may
Total Assets
$141.4 bil ion
choose to make overly risky loans to customers of its
commercial parent. While the bank subsidiary may suffer
Total Deposits
$109.4 bil ion
losses on such overly risky loans, the organization on the
Chartering States UT (14); NV (4); CA (3); HI, IN, MN (1)
whole may not, since the loan proceeds were paid to the
commercial parent to make a purchase. Meanwhile, the
Source: iBanknet, accessed on November 21, 2019, at
funding to undertake this imprudent lending would be
http://www.ibanknet.com/scripts/cal reports/fiList.aspx?type=ilc.
backed by federal deposit insurance (i.e., by the taxpayers).
For this reason, proponents of separating banking and
Currently, ILCs chartered in some states are allowed to
commerce argue it prevents an inappropriate extension of
accept certain types of deposits if the ILC is approved for
bank safety nets to commercial enterprises. In addition, they
deposit insurance by the Federal Deposit Insurance
argue that a combined enterprise, with financing operations
Corporation (FDIC). As a result, certain state charters allow
in-house and in part funded through taxpayer-backed
ILCs to operate nationwide as full-service, FDIC-insured
deposits, could more easily achieve the size and financial
banks. Similar to state banks, the FDIC and a state agency
resources necessary to exercise anticompetitive market
regulate ILCs, and those agencies have the authority to
power. ILC oppoenents assert that commercial firms’
prohibit or restrict certain transactions between the ILC and
ownership of ILCs exposes the U.S. banking system and
the parent holding company. Though the differences
economy to these risks.
between banks and ILCs have narrowed, important legal
and regulatory differences remain, two of which are the
In contrast, ILC proponents assert these concerns are
source of contentious debate.
overstated and do not justify preventing the potential
realization of certain benefits. Potential benefits of mixed
https://crsreports.congress.gov

Industrial Loan Companies and Fintech in Banking
organizations include economies of scale (organizations can
Continuing concerns over ILCs led Congress to mandate
reduce costs with an in-house bank); risk diversification
another moratorium (this one lasting three years, ending in
(mixed organizations are not entirely exposed to bank or
July 2013) on granting new ILCs deposit insurance in the
commercial risks); information efficiencies (commercial
Dodd-Frank Act (P.L. 111-203). Even though this
companies may have knowledge about customers’
mandatory moratorium ended, as of today the FDIC has not
creditworthiness or needs that a bank would not); and
approved any new ILC applications. Some ILC proponents
costumer convenience (financing and purchasing becomes
have suggested that the FDIC has unilaterally placed a
“one-stop shopping”). Furthermore, they argue that current
moratorium on approving ILCs, despite the fact that ILCs
ILCs continue to fulfill their original role as important
are permitted under current law.
financial service providers to niche markets.
Fintech Firms and Renewed Debate
Different Treatment Between Charters. U.S. depository
Recently, four firms intending to start an ILC applied for
institutions operate under a number of charter types, and
FDIC insurance, although two of those have since
each is regulated differently. One of the rationales for this
withdrawn their applications. The remaining applicants are
system is that it allows institutions with different business
companies called Square and Rakuten. Square sells
models and ownership arrangements to choose a regulatory
computer hardware and software that enable electronic
regime appropriately suited to their business needs and
payments to businesses. Rakuten is a Japanese online
risks. Under this system, a variety of institution types can
retailer that owns a shopper rewards company in the United
be deployed to meet market needs. However, the
States. Both are arguably financial technology (or fintech)
fragmented regulatory framework can potentially create
companies that are primarily commercial in nature. In
certain challenges. One is that, in some circumstances,
addition, observers have speculated that technology giants
institutions engaged in very similar businesses may
such as Google, Amazon, and Apple might have reason to
nevertheless be subject to different regulations in such a
want a bank charter, possibly including an ILC, in the near
way that one group is at a competitive disadvantage to
future.
another. Further, this system may create avenues for
institutions to actively seek out charters and ways to
ILC opponents argue new fintech firms can (particularly
structure themselves largely to side-step certain regulations,
using the internet) very quickly become a large national
often characterized as finding loopholes.
presence, raising concerns over market power and the
extension of government safety nets. The potential that one
The balance policymakers aim to strike is to have enough
or more of the big tech companies conceivably would want
differentiation between charters and regulatory regimes to
a charter has heightened these concerns.
provide for appropriate tailoring, while not inadvertently
creating regulatory gaps that could allow excessive risk to
ILC and fintech proponents assert fintech firms can safely
enter the banking system and economy. ILC opponents
bring innovative and beneficial technologies into banking
argue their parent company exemption from Federal
and potentially increase the availability of financial
Reserve supervision is an example of a problematic
services, and the FDIC’s apparent unwillingness to grant
loophole. Proponents argue current FDIC and state ILC
insurance is unjustified.
supervision is sufficient, and the charter allows companies
to serve markets that would not be otherwise.
Selected Legislative Alternatives
Given recent developments, Congress may seek to address
Controversies and Moratoriums
ILC policy issues. If Congress determines ILCs allow too
These issues played a prominent role in the public
much integration between commerce and banking, it could
controversy sparked during Walmart’s and Home Depot’s
limit or prohibit commercial activity at parent companies
ultimately unsuccessful efforts to secure ILC charters
that own ILC subsidiaries or revoke the FDIC’s authority to
between 2002 and 2008. Public opposition to allowing the
grant ILCs deposit insurance. Conversely, if Congress
companies to acquire the charters generally focused on the
determines ILCs are beneficial and well regulated, and that
market power and fairness aspects of allowing such large
the FDIC is inappropriately holding up their applications, it
retailers with numerous locations nationwide to provide
could direct the FDIC to decide on applications without
bank services. Many observers predicted the retailers would
regard to whether the applicant is an ILC.
be able to use market power to run small banks out of
business. In contrast, the efforts’ proponents argued there
If Congress determines that the lack of Fed supervision of
could be cost savings in payment processing and that
ILCs’ parent holding companies is problematic, it could
certain customers would be better able to access financial
extend the Fed’s regulatory authorities to include ILC
products at retail locations.
holding companies. In the 116th Congress, S. 2839 would
pursue this approach.
Amid that debate, the FDIC imposed an official moratorium
in 2006 on the acceptance, approval, or denial of ILC
Finally, to consider the issues further, Congress could
applications for deposit insurance while the agency
reinstate a moratorium on FDIC insurance approvals for
reexamined its policies related to these companies. That
ILCs.
moratorium ended in January 2008. By that time, perhaps
due in part to the public controversy or the then-unfolding
David W. Perkins, Analyst in Macroeconomic Policy
financial crisis, Walmart and Home Depot had withdrawn
from their attempts to secure a charter.
IF11374
https://crsreports.congress.gov

Industrial Loan Companies and Fintech in Banking

Disclaimer
This document was prepared by the Congressional Research Service (CRS). CRS serves as nonpartisan shared staff to
congressional committees and Members of Congress. It operates solely at the behest of and under the direction of Congress.
Information in a CRS Report should not be relied upon for purposes other than public understanding of information that has
been provided by CRS to Members of Congress in connection with CRS’s institutional role. CRS Reports, as a work of the
United States Government, are not subject to copyright protection in the United States. Any CRS Report may be
reproduced and distributed in its entirety without permission from CRS. However, as a CRS Report may include
copyrighted images or material from a third party, you may need to obtain the permission of the copyright holder if you
wish to copy or otherwise use copyrighted material.

https://crsreports.congress.gov | IF11374 · VERSION 20 · NEW