14 years after Walmart, banks face a new ILC bogeyman

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WASHINGTON — Over a decade after bankers stopped Walmart from chartering an industrial loan company, the industry sees a new villain in its never-ending fight over the ILC charter. Its name is Rakuten.

The Japanese e-commerce giant has eclipsed Square, the payments-focused fintech firm also awaiting ILC approval from the Federal Deposit Insurance Corp., in drawing the strongest reactions from the banking lobby.

The level of industry opposition raises new questions about whether the extended freeze on chartering ILCs — which has essentially been in place since Walmart's 2005 application drew a storm of controversy — is beginning to thaw or a new battle over a new banking aspirant is just beginning.

“We’ve fought for a long time to close loopholes used by the owners of industrial loan charters to mix commercial and financial services,” said Chris Cole, executive vice president and senior regulatory counsel at the Independent Community Bankers of America. “With Rakuten, it’s a completely new level.”

While the ICBA has opposed the ILC bid by Square, a financial company, other trade groups have stayed on the sidelines. By contrast, Rakuten, which plans to use its proposed ILC to expand financial services offerings on its U.S. online rebates platform, has united the banking industry in opposition.

An FDIC-backed financial institution affiliated with an online retail giant echoes the concerns the industry had about Walmart's bid in the early 2000s, which bankers said raised concerns about product tying and public policy issues. They now see Rakuten's application as attempting to breach the traditional separation of banking and commerce.

“We see some serious issues and dangers in Rakuten’s application,” said Wayne Abernathy, executive vice president for financial institutions policy and regulatory affairs at the American Bankers Association. “There’s always a danger when you allow nonfinancial services to get into banking. Rakuten crossed that line and didn’t try to hide the fact.”

The ABA is opposing the bid even though it counts ILCs among its members and is generally supportive of the charter. The group submitted a joint letter to the FDIC in August with the Bank Policy Institute expressing its concerns about the proposed Rakuten Bank America.

Some have suggested the stakes are higher with Rakuten's bid than that of Square. The latter has been seen as an indicator of the FDIC's stance toward ILCs under Trump-appointed Chair Jelena McWilliams. Although several potential applicants are said to be waiting in the wings, observers note that a nonfinancial company like Rakuten could renew congressional interest in restricting the charter and the type of uproar that ultimately led Walmart to back out.

Several firms are waiting to see how the FDIC approaches the issue, said a regulatory lawyer who spoke anonymously, citing potential conflicts.

“It’s all going to come to a head when the FDIC moves forward. That’s when Congress gets involved,” the lawyer said. “As soon as you have a target, this will be a big issue on the Hill.”

But advocates of the ILC industry, which is based mostly in Utah, suggest that bankers' objections are merely competitive, and that firms seeking a charter are following a route with a strong legal basis.

“Here’s a company that wants to provide banking services to its customers in America that’s willing to run through the front door, get a banking charter and subject themselves to the same regulations as every other bank,” said Howard Headlee, president of the Utah Bankers Association and a longtime advocate for the use of ILCs.

“There’s a legitimate complaint with companies that want to do the same services as banks without playing by the same rules,” he said. “But this just looks anti-competitive.”

What is Rakuten?

Rakuten is sometimes referred to as the Amazon of Japan, but the comparison is misleading because Rakuten focuses on rewards and rebates. Unlike other e-commerce models, Rakuten's business is driven by loyalty programs that provide cash back and other rewards on online purchases. Rakuten also does not sell its own products on its e-commerce platforms.

The ILC would bring basic banking services to customers of Rakuten America, which is small next to the Japanese parent and built around the skeleton of Ebates.com, a cash-back rewards service that Rakuten purchased in 2014 and rebranded earlier this year as Rakuten.

Lee Carter, president and CEO of Rakuten Bank America, said the bank's plan is to offer credit cards with cash back, checking and savings accounts, and CDs on the U.S. platform.

"We want to provide a core suite of direct consumer products to an existing customer base," Carter said.

But the ABA and the Bank Policy Institute in their letter raised a host of concerns partly tied to the potential for Rakuten to have more ambitious goals.

“The emergence of technology companies that view financial services as an adjunct to a broader nonfinancial customer relationship presents fundamental and serious issues that currently existing ILCs do not," the two groups said.

The trade groups warned of the potential for Rakuten's ILC to play a subordinate role in "advancing the nonfinancial affiliate’s core business." They also highlighted concerns about the way fintech firms use data.

"A nonfinancial affiliate providing an e-commerce platform linking customers and merchants could use data from customer accounts at the ILC to set pricing for consumer purchases," they warned.

Carter said concerns about how the ILC would use data are unfounded.

“When it comes to data sharing, we would have all the same restrictions as an ILC as any other bank,” he said. “Synergy doesn’t apply to financial data — it’s not allowed by law. We’re not selling data to third parties and we can’t share data back to affiliates unless it's allowed via customer opt-in.”

Walmart’s shadow

Although they’ve been around since the turn of the 20th century, ILCs — also known as industrial banks — have faced controversy thanks to the Walmart application. The resulting backlash over its bid eventually led the retailer to rescind its application in 2006 before the FDIC had made a decision.

Today, it’s impossible to talk about ILCs without acknowledging the shadow of Walmart’s example.

But some ILC onlookers hope the FDIC will move forward with its current list of pending applications since the firms now looking for approval do not carry the same public baggage that Walmart did when it sought approval from the FDIC.

“The debate around Walmart was fundamentally a political debate,” Headlee said. “People were talking about their labor practices and about political parties. You had all these other issues that dominated the discussion besides banking.”

He noted that there was nothing controversial about Walmart's ILC application at face value.

“Walmart’s banking application was simple and straightforward,” he said. “I don’t sense that the people who understood what the application was about were raising issues about the application itself.”

ILC advocates also point to the strength of the nation’s industrial banks today. Only two ILCs failed between 2007 and 2010, while hundreds of traditional banks failed.

“In the past 35 years, industrial banks have had some of the best records with the strongest capitalization, and being the most profitable and safest group of banks the FDIC insures,” said George Sutton, an attorney at Jones Waldo Holbrook & McDonough in Utah.

New faces, old problems

After Walmart’s failed bid, the ILC debate cooled down considerably. But so did new applications. On several occasions officials put a moratorium on ILC charter bids, including a three-year freeze established in the 2010 Dodd-Frank Act. Between 2009 and 2017, the FDIC did not receive a single application for an ILC.

Yet McWilliams signaled a willingness to review industrial loan charters early in her tenure. While no ILC has been approved for deposit insurance yet, a number of companies have applied to become industrial banks, including Square and Amerinat, a loan servicer.

Community bankers say the threat of a potential surge of approved ILC applications is self-evident. Community banks have been dwindling in number for decades, and bankers say adding to the already fierce competition they have to contend with could further hasten the industry’s consolidation.

“The industry doesn’t need more competition from nonbanks and unregulated areas of banking,” said the ICBA’s Cole. “If anything, it might be over-competitive. Community bankers are already competing with credit unions, nonbanks, big banks and regionals. With deposits, it’s almost a war out there.”

But the banking industry also has broader policy concerns.

In its application submitted in July, Rakuten said it envisioned a “synergistic ecosystem” linking financial technology and its internet services “in the form of an online marketplace that creates strong loyalty and value for both merchants and consumers who sell and shop there, respectively.”

That set off alarms for the ABA, which until that point had largely stayed above the ILC fray.

Rob Morgan, a vice president of emerging technology at the ABA, said tech companies with banking powers could potentially use data in ways not intended for regulated institutions.

“Take email: Tech companies offer email without charging customers, take a loss on it, but get better data in order to offer other, better products,” Morgan said. “We think that’s a bad model for banking and dangerous for consumers.”

But Carter says that “synergistic ecosystem” shouldn’t be understood as a data free-for-all.

Instead, he said, Rakuten’s approach would mirror the company’s strategy in Japan, with an emphasis on “brand value perspective.”

“The idea is to provide value through a lot of different services to several aspects of life and at every turn, you give rewards via loyalty benefits for interacting. Our U.S. aspirations aren’t that different,” he said.

Rakuten’s approach to American banking “isn’t a data play; it’s a value play,” he said. He pointed to the company’s decision to rebrand the relatively popular Ebates.com in 2014, to simply “Rakuten” earlier this year. “It’s all about the power of the brand and communicating that the company can provide additional services,” he said.

Carter said that if Rakuten Bank America’s application is approved, early operations will be humble, mostly centered around credit cards, loyalty rewards programs and holding deposits in savings accounts for existing customers. It would then move on to work more directly with merchants and payment processing.

But down the line, Carter said, Rakuten plans to expand the reach of its banking services beyond its current users. "While we plan to market to Rakuten’s customer base, our products and services will be available to all U.S. consumers, regardless of any Rakuten affiliation," he said.

ILC charter remains 'unscathed'

McWilliams has remained mum on the potential timing of its first ILC approval. But she said the agency will ultimately defer to the law in deciding the fate of pending applications.

If an ILC applicant meets the statutory requirements and meets "the same requirements put before banks, I don’t know that we necessarily should decline them,” McWilliams told reporters after an event Wednesday. “Congress says this form of entity should be approved if they meet this criteria. Our job is to process the application. If they meet the criteria, we move on.”

“The bottom line on ILCs is, whether you like them or not, they’re in the statute,” McWilliams said, referring to the Bank Holding Company Act.

Yet the furor over Walmart's application at the time led to movement in Congress to restrict commercially owned ILCs, but that legislative effort died down after Walmart withdrew its application.

Cole said that community banks have “started to hear some renewed interest from both the Senate and House” to pursue a similar bill, but he declined to name any supporters.

Still, other analysts say that for all the firepower that’s been trained at the existence of ILCs from the banking industry, the legal framework behind it remains strong.

“For better or worse, industrial loan charters have continually been tested in terms of their ability to be legal,” said V. Gerard Comizio, a partner in the corporate department and chair of the banking practice at Fried Frank’s Washington office. “Over many years, going back to Walmart in 2006, the ILC has emerged basically unscathed as a legal charter.”

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ILCs De novo institutions E-Commerce Fintech regulations Licenses and charters Jelena McWilliams FDIC Walmart Square