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FDIC looking to end industrial bank charter purgatory

Some applicants may soon find out if they can launch their proposed industrial banks.

The handful of companies that have applied for an industrial loan company charter in recent years have been stuck in limbo waiting for regulators' response. With an application filed as recently as October 2019, the long-running debate of industrial banks' legality has resumed on Capitol Hill, where lawmakers of both parties are questioning the ILC charter.

While the Federal Deposit Insurance Corp. has not approved an ILC charter since before the financial crisis, the regulator has revamped its process for evaluating the applications, a move that could finally lead to new ILCs opening their doors if they are approved.

FDIC Chair Jelena McWilliams said pushback from the Independent Community Bankers of America, a banking trade group, and others has not changed her drive to process these charters.

"So long as Congress says they should exist, my job is to figure out, within the framework that Congress gave us, can we process an application and approve it?" McWilliams said in an October 2019 interview.

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Some applicants, like Square Inc. and Nelnet Inc., have been seeking a charter for years. Both companies have withdrawn and refiled their applications. The FDIC's new process more closely resembles applying for a full-service national bank charter, McWilliams said. Potential organizers can now go to the FDIC on a preliminary basis to have confidential discussions and receive feedback. The organizer will not file for a charter until the two sides deem the application to be "substantially complete," McWilliams said.

Once a charter application has been filed, the FDIC then has 120 days to process it. McWilliams declined to discuss any pending applications, or whether the new process applies to them, but outlined the general approach her agency takes.

The FDIC looks at the proposed bank's source of strength, McWilliams said. It considers who would back the bank and if it would pose a risk to the deposit insurance fund. Organizations seeking this charter must be profitable, she added.

"That's a point of contention for some of the tech companies because they may have a lot of equity," McWilliams said, because equity at the parent company level does not equal capital at the proposed bank.

Industrial banks perform well

During the financial crisis, more than a hundred banks turned to the FDIC for help, but none were ILCs. More recent data show that industrial banks are outperforming traditional banks in the seven states where ILCs can be chartered.

The two types of banks are not entirely comparable, however. An industrial bank has access to the Federal Reserve's discount window and payments system. It can accept deposits and issue credit. Industrial banks, like full-service national banks, are regulated and insured by the FDIC. But an ILC was likely created for a different purpose than a typical bank, said Gregory Rubis, a partner at Pepper Hamilton, in an interview. Industrial banks are usually formed to meet a specific need for the commercial parent company, such as Toyota Financial Savings Bank providing auto loans to Toyota Motor Corp. customers.

An S&P Global Market Intelligence analysis found that industrial banks outperform national banks in the same states on several key banking metrics. Looking at the median performance of the existing industrial banks in the third quarter of 2019, compared with the median performance of national banks in the states that offer the ILC charter, industrial banks have a higher return on average equity and a better efficiency ratio. They also have a higher net interest margin and a lower rate of nonperforming assets.

Opponents of the ILC model argue that industrial banks have a competitive advantage and lack oversight. The ICBA has long called on Congress to close the "loophole" that allows industrial banks to exist. Paul Merski, ICBA's group executive vice president of congressional relations and strategy, said previously that a "firewall" should separate banking from commerce.

Industrial banks are not regulated by the Fed, but that is "in no way an attempt to bypass any regulation," said Rakuten Bank America President and CEO Lee Carter. "It just happens to be that the ILCs are not required to have a holding company."

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Eyes on Rakuten

Rakuten Bank America applied for an ILC charter in July 2019 because it allows a commercial company to own a bank directly, Carter said in an interview. The special-purpose national bank charter offered by the Office of the Comptroller of the Currency would not have allowed the bank to take deposits — something Carter said Rakuten wants to do. The legality of that charter has also been called into question in New York courts.

Tokyo-based Rakuten Inc. has created an ecosystem that links its internet and financial segments in an online marketplace, much like Amazon.com Inc. Opponents of the application argue against Rakuten because it is both tech-enabled and foreign-owned. In the wake of massive data breaches and a new focus on consumer privacy, such companies face extra scrutiny in the U.S.

In launching an industrial bank, Rakuten aims to provide financial services to existing U.S. customers. "We're not going after a new group of people," Carter said.

The banking head also sees commercial ownership — one of the major criticisms leveled against the ILC charter — as a strength. During a downturn, the parent company could provide additional cash and infuse more capital, an option not available to most community banks or holding companies, Carter said. Only a handful of ILCs struggled during the financial crisis.

Although industrial banks are not community banks, they do create their own community, Carter believes.

"We are a 'community bank' in our sphere and infrastructure," he said. "We don't want to serve every client in the United States. We only want to serve our existing clients. To the effect that our clients create a community, it's kind of the 21st-century community bank, where we define communities in groups of clients instead of in groups of geographies."

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