A sprawling Japanese internet services company has joined a growing list of technology-focused companies seeking to launch industrial banks, none of which have yet succeeded.
Founded in 1997, Tokyo-based Rakuten Inc. entered fintech and banking in Japan and Europe more than a decade ago. Though its internet and financial segments are two distinct arms of its business, the company created an ecosystem that links them in an online marketplace much like Amazon.com Inc. Now, Rakuten hopes to expand its financial services offering into the U.S. It filed an application in July to become a Utah-based industrial loan company, or ILC, with the Federal Deposit Insurance Corp.
But the FDIC has not approved an ILC application in more than a decade, and industry experts question whether Rakuten's application will break that streak.
Rakuten already has one strike against it as a tech-enabled company, according to Todd Baker, managing principal at Broadmoor Consulting LLC. In the wake of massive data breaches and a new focus on consumer privacy, tech companies looking to enter financial services are facing extra scrutiny. An approval from the FDIC would raise the specter of tech giants like Amazon and Alphabet Inc.'s Google LLC entering financial services, Baker said in an interview.
Being a foreign-owned company is also a strike against the proposed bank in the current political environment, Baker added. But another industry expert said foreign ownership is of "no concern" to opening an industrial bank in the country. Ray Specht of Specht Leadership Consulting said the FDIC and Utah's state regulatory agency will likely ask additional questions and contact the parent company's foreign regulators, but there is no additional risk.
Specht was the president and CEO of industrial banks Toyota Financial Savings Bank, Volkswagen Bank USA, and Wright Express, now WEX Bank, during their chartering processes. Both Toyota and Volkswagen had foreign-owned parent companies, similar to Rakuten.
"If you look at the commercial banking industry, there are a large number of foreign banks here in the United States already," Specht said in an interview. "This is something that is not unique to the industrial loan industry."
Long road ahead
If approved, Rakuten will succeed where others have not.
Although the FDIC is again open to reviewing such applications, no still-operating industrial bank has been approved since the financial crisis. Following the Great Recession, Congress passed a moratorium on industrial banks that ended Jan. 31, 2008, but the regulatory body had previously chosen not to resume reviewing applications.
Rakuten, which owns 43 companies in the U.S., hopes to link its existing internet services business in the country with a newly formed financial services business. Its proposed industrial bank, Rakuten Bank America, seeks to offer a wide array of banking services, including consumer loans, credit cards and deposits, merchant acquiring, and commercial loans and savings accounts, according to its application.
American financial services firms have kicked off another wave of ILC applications in recent years, but none have won approval so far.
Payment processor Square Inc., nonbank student loan refinance company Social Finance Inc., and student loan repayment company Nelnet Inc. all considered launching industrial banks to augment their current offerings. SoFi and Nelnet have withdrawn their applications. Square, which refiled its application in December 2018, is still waiting on a response from the FDIC.
Walmart Inc. applied for an industrial bank charter in 2005, prompting swift outcry from small banks that argued the retail giant was exploiting a legal loophole. Walmart withdrew its application in 2007.
Closing the 'loophole'
Advocates for the ILC charter option say it levels the playing field for banks by regulating nonbanks that aim to do banking activities. But the Independent Community Bankers of America, a trade group for small U.S. banks, has long advocated against this option.
Becoming an industrial bank is a commercial company's only avenue to enter the banking industry unless it launches a separate banking operation. With an ILC charter, an industrial bank is not subject to the Bank Holding Company Act that governs traditional U.S. banks and their owners. That means industrial banks also do not have oversight from the Federal Reserve.
Paul Merski, ICBA's executive president of congressional relations and strategy, said a "firewall" should separate banking from commerce. In an interview, Merski specifically warned against approving companies like Rakuten and other tech-enabled applicants that have broad reach into consumer data and the payment system.
The ICBA has called on Congress to close what it calls a loophole that permits industrial banks, but Merski said it would take a statutory change of either extending the moratorium on ILC approvals or new statutes that would shut down process altogether.
"Now that companies are again trying to exploit this loophole, I think Congress will be able to quickly act in shutting it down," Merski said.
But the Government Accounting Office, which studied the ILC industry at Congress's request following the financial crisis, did not recommend a repeal of federal provisions allowing commercial firms to own industrial banks. A January 2018 study from the Utah Center for Financial Services, an independent research center at The University of Utah, concluded that approval of new ILCs would help U.S. financial institutions compete in the global marketplace. Only seven states allow ILCs, and many are headquartered in Utah.
"The U.S. is out of step with international norms because the vast majority of countries do permit the mixing of banking and commerce," the report's authors wrote.