Industrial banks and industrial loan companies – recent FDIC actions; implications for parent companies

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Financial Services Alert

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What is an industrial loan company? A long-standing charter alternative for firms seeking to engage in banking and related financial services is the industrial bank or industrial loan company (collectively, ILC). Currently, state law in California, Hawaii, Minnesota, Nevada, and Utah allows for ILCs to be chartered, but not all of those state regulators appear to be actively accepting charter applications. Although ILCs have existed for over a century, Congress did not make them eligible for deposit insurance from the Federal Deposit Insurance Corporation (FDIC) until the 1980s.

ILCs generally have authority to exercise many of the same powers as traditional banks. Regarding deposits, ILCs may offer savings accounts, certificates of deposit, and negotiable order of withdrawal accounts, but they cannot offer demand deposit accounts. They also are generally able to offer the same consumer and commercial lending products as traditional banks.

Much the same as a state nonmember bank, ILCs are regulated by the banking department of the state where they are chartered and by the FDIC. An important difference, however, is that ILCs are excluded from the definition of bank for purposes of the Bank Holding Company Act (the BHC Act). Thus, parent companies of ILCs are not regulated by the Federal Reserve as it relates to permissible activities or investments, reporting, examination, or mandatory capital requirements, among other requirements imposed by the BHC Act. This has allowed automakers, energy companies, electronics firms, healthcare providers, and other commercial businesses that could not otherwise satisfy certain BHC Act requirements to utilize an ILC within their organization.

Why is it important now? The ILC charter drew significant attention in 2006 when a major retail company sought to form an ILC and the banking industry rallied together to object, in part, on grounds that such a model could undermine community banking. Congress imposed a moratorium on the FDIC’s authority to grant deposit insurance to new ILCs. That moratorium expired in 2007 without legislative changes. However, the FDIC appeared to view itself as restricted by the moratorium and the industry generally assumed the charter option was not available.

Last month, however, the FDIC approved deposit insurance applications for two new ILCs. Until these approvals, no applications had been approved since before the moratorium. This allows other commercial businesses and financial technology firms that have delivery of financial services products as an element of their business operations to consider an ILC for their operations.

What is the impact for parent companies? Almost simultaneously with its approval of the two new ILCs, the FDIC published a Notice of Proposed Rulemaking seeking comment on proposed rules outlining its approach to regulation of ILC parent companies. The new proposed rule, to be codified as Part 354 of the FDIC Rules and Regulations, will apply to each FDIC approval of deposit insurance applications, non-objection to a change in control notice, and approval of a merger application that results in an ILC becoming a subsidiary of a company that is not subject to consolidated supervision by the Federal Reserve Board (in other words, any company that is not otherwise a bank holding company under the BHC Act).

Consistent with the Federal Deposit Insurance Act, the FDIC has historically required parent companies of ILCs seeking deposit insurance to enter into capital and liquidity maintenance agreements as precondition for approval. This approach is not inconsistent with other federal regulators that charter other types of financial institutions that are outside the definition of a bank for purposes of the BHC Act, such as national trust banks. It is also not likely inconsistent with the approach most organizations would otherwise assume to be the case, which is that they have an obligation to maintain subsidiary entities in safe financial condition or to serve as a financial backstop by maintaining a subsidiary’s capital and liquidity levels. However, in this case the FDIC, within defined parameters set in the agreement, effectively decides what constitutes safe financial condition and appropriate capital and liquidity.

Somewhat beyond what other regulators have previously mandated or FDIC historic practice, however, the FDIC proposed rules would require ILC parent companies (as opposed to the ILC itself) to maintain adequate levels of capital and liquidity as well – thereby acting as a “source of strength” for the subsidiary ILC similar to what is required for bank holding companies under the BHC Act. The written agreement would also include consent to FDIC examination of the parent company and its subsidiaries with respect to, among other things, compliance with the written agreement and relevant laws and regulations. The agreement would also limit the parent company’s representation on the ILC’s board to 25 percent, which is something that we view as potentially the most objectionable aspect of the proposed rules; it exceeds existing independence requirements imposed in other banking regulations.

The FDIC believes that the rulemaking would provide transparency to ILC applicants and the broader public as to what the FDIC requires of parent companies of ILCs approved for deposit insurance.

What should I take away for these developments? Commercial enterprises, financial technologies firms, and other businesses that have historically understood they could not have an FDIC-insured banking institution within their organization should reassess the potential benefits of an ILC. In doing so, however, recognize that it, not surprisingly, comes with meaningful regulatory considerations and compliance obligations.

Public comments to the proposed rules are due to the FDIC by June 1, 2020.

Find out more about this development by contacting any of the authors.