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Is Congress spoiling for another fight over ILCs?

WASHINGTON — More than a decade ago, Washington was up in arms when Walmart applied for an industrial loan company charter, leading to bipartisan legislation to ban retailers from owning such banks. The bill never passed, but opposition to Walmart's ILC was enough for the company to drop its bid.

Now, community bankers are again rallying behind legislation to prevent commercial firms from controlling ILCs in the wake of a new application — from the Japanese tech giant Rakuten. But it is unclear if the latest bill, authored by Sen. John Kennedy, R-La., will gain the same kind of traction.

“Congress has regularly since the Walmart issue arose … declined the invitation to pass legislation to prohibit ILCs and I don’t see anything that would alter that mix right now,” said V. Gerard Comizio, senior counsel at Fried Frank.

But others see a legislative initiative to stop commercially owned ILCs — which in the past has been led by small banks — potentially taking on new relevance with fintech firms being the current group looking for a way into the banking system.

“This is a bipartisan initiative that used to be powerful, fueled by community banks,” said Karen Petrou, managing partner at Federal Financial Analytics. “But in my opinion, [it] is even more potent now that the banking industry as a whole is unified in the face of challenger digital banks.”

She added that the legislation could be viewed favorably in that it is not a blanket prohibition on tech firms getting in the banking arena.

“It’s not a generic tech-finance barrier,” Petrou said. “It’s an industrial loan charter company restriction. While you would see more tech-friendly members opposing this limit, I think there is also a very potent body of support for this.”

Last month, Kennedy Introduced the Eliminating Corporate Shadow Banking Act of 2019, which would prevent ILCs — also known as industrial banks — from being controlled, directly or indirectly, by a commercial firm. The bill appears to be aimed at Rakuten, an online shopping site focused on cash rebates, but also at larger tech giants such as Google.

While the bill currently has no co-sponsors, Kennedy said in a brief interview that he is “just getting started putting together support” and that he “will” have co-sponsors as the proposal moves through the legislative process.

The legislation resembles a similar effort in 2006 and 2007 when Walmart's application galvanized banks of different sizes, labor unions and other opponents to fight the retailer's bid. In the House, then-Reps. Barney Frank, D-Mass., and Paul Gillmor, R-Ohio, wrote a bill prohibiting firms primarily engaged in nonfinancial activities from owning ILCs.

That bill attracted 145 co-sponsors, but was never enacted. Yet the damage seemed to be done. Walmart pulled out in March 2007. Months later, Senate Banking Committee members, including the current ranking member, Sen. Sherrod Brown, D-Ohio, introduced a similar bill.

“The last go-around it was the largest retailers trying to mix banking and commerce,” said Paul Merski, executive vice president for congressional relations and strategy at the Independent Community Bankers of America, the group most consistently opposed to ILCs.

“And it seems now it’s the largest tech companies trying to mix banking and commerce. It was a bad idea then and it’s a bad idea now," Merski said. "We really don’t want to be extending the FDIC insurance safety net to commercial activities.”

But in the midst of an impeachment inquiry, and with a host of other measures that Senate Banking Committee members are trying to advance before the 2020 elections, some analysts are skeptical that the issue will gain much traction in Congress.

In addition to Kennedy's bill, Rep. Jesus "Chuy" García, D-Ill., has crafted three House proposals intended to restrict tech firms from entering the banking system. One would reportedly require ILC owners to face stronger supervision. Currently, the parents of ILCs are exempt from bank holding company requirements.

"None of these bills have a clear path to passage in this Congress, but they serve as noteworthy mile markers given the evolving relationship between banking and technology," Isaac Boltansky, director of policy research at Compass Point Research & Trading, said in a research note last month.

Meanwhile, ILC advocates argue Kennedy's legislative approach is misguided since ILCs are supervised the way other state-chartered banks are, with direct oversight from a state regulator and the Federal Deposit Insurance Corp.

“Industrial banks are regulated like all the regular banks and the holding companies are also regulated in a different way but in a way that has proven to be effective,” said Howard Headlee, president of the Utah Bankers Association. Industrial banks are most prevalent in his state.

He added that some traditional bankers believe the ILC regulatory model could be applied to all community banks that choose to operate without a Federal Reserve-regulated bank holding company.

“The community bankers that I talk to are very interested in the idea of streamlining their holding company regulation, utilizing the bank-centric model that the FDIC employs versus the consolidated model that the Fed employs,” Headlee said. “That’s the discussion that should be happening.”

Comizio said he is skeptical that the Rakuten application could spur the same kind of congressional interest that Walmart elicited. At the time, many observers argued that giving Walmart banking powers opens the door to the retail giant having an automatic nationwide branch network through its stores.

The concern was that the retailer would "instantly have 3,000 branches in the U.S.," Comizio said.

Kennedy's bill also faces only limited support from the banking industry.

Rakuten's application has drawn stiffer opposition from multiple trade groups, compared with the ILC bid of the payments company Square. But so far, the ICBA is the only group to express support for the senator's legislation.

A spokesperson for the American Bankers Association said the group publicly opposed Rakuten’s application to obtain an ILC charter because it does “not believe the company’s business model is focused primarily on providing financial services.” But the group has stopped short of supporting Kennedy’s bill.

“ABA firmly believes that our economy benefits from having a highly competitive banking industry featuring banks of all sizes and charters, including niche charters like ILCs,” said Sarah Grano, vice president of public relations at the ABA. “In light of that, we oppose a ban on ILCs while continuing to support a case-by-case review of applications to ensure only those businesses primarily focused on financial services can qualify for an ILC charter.”

Lee Carter, head of banking development for Rakuten, says he thinks the company is being mischaracterized as a nonfinancial firm.

“40% of our worldwide revenue comes from financial services,” Carter said. “We have been painted a little bit into a corner where we’re not a financial services firm. … That’s not true."

Community bankers’ main argument against commercial firms controlling ILC stems from concerns that the companies aren’t competing on the same regulatory playing field.

“The real issue is using a loophole to skirt existing rules and regulations to get into the financial space,” Merski said. “There’s nothing innovative about using loopholes to skirt a regulation. If anyone wants to innovate in the financial space, that’s fine, but it should be a level playing field for the players already operating in the space.”

But Gilbert Schwartz, a partner at Schwartz & Ballen LLP, noted that while ILCs are not subject to the Bank Holding Company Act regulations directly, they are still regulated by the FDIC.

“How are they skirting regulation?” Schwartz said. “Yes, they are not being subjected to the Bank Holding Company Act directly … a lot of community banks are not subject to the Bank Holding Company Act. … The ILCs are regulated by the FDIC. They are regulated just like all the community bankers are regulated.”

Schwartz added that he thinks it’s more of a competition issue for community bankers, rather than about keeping banking and commerce separate.

“The reality is this is a competition issue,” he said. “The community bankers … view these innovative entities as competition.”

He also noted that in contrast to Walmart abandoning its bid in the face of opposition, fintech firms now interested in the ILC charter might have more tolerance for a legislative debate.

“These innovators have a lot more appetite to take on adverse public opinion than Walmart. Walmart was an institution that had to respond to different communities,” said Schwartz. “Now I think the fintech companies have a different attitude."

Carter added that Rakuten isn’t backing out of its application.

“The guidelines for our application are very clear,” he said. “We meet all the statutory requirements. … We haven’t hesitated at all. We’re pushing forward to get to the end point of our application.”

FDIC Chair Jelena McWilliams has indicated an openness to considering ILC charter applications, and told the Senate last week that she believes the regulator has ample authority to regulate ILCs.

“So from the perspective of the depository institution, the ILC is regulated the same way as a bank,” McWilliams said. “In fact, when Congress gave us authorities to approve deposit insurance for ILCs, it gave the same statutory standards as it gave to banks.”

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