Rakuten withdrawal a relief for banks, but ILC saga's far from over

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WASHINGTON — Although banks’ immediate fear about Rakuten’s banking ambitions has been alleviated, critics of the company’s bid for an industrial loan company are not abandoning their fight against technology firms and retailers obtaining ILCs.

Rakuten, an e-commerce conglomerate sometimes referred to as Japan’s Amazon, withdrew its ILC application for the second time last month, according to recent Federal Deposit Insurance Corp. records.

But the proposed bank’s CEO said the company will reapply, just as banking industry representatives keep the pressure on policymakers to restrict the ILC charter.

“It’s a victory in the sense that Rakuten was going to be an unprecedented approval for an industrial bank,” said Chris Cole, executive vice president and senior regulatory counsel of the Independent Community Banks of America, of the company’s withdrawing its application. “If the FDIC approved them, we believed that they would have been willing to approve something like an industrial bank for Amazon or Apple, really any of the large tech companies.”

But, Cole added, “the work will never stop until we close the loophole, and for that, we need legislation.”

Yet analysts say critics of the ILC charter have a hard case to make in convincing Congress or the FDIC to impose another moratorium on the niche bank type, one of the last licenses available to commercial companies.

“We had a moratorium before, and it was intended to be a timeout. We’ve had the timeout. So I think there’s a relatively steep hill to climb here,” said Isaac Boltansky, director of policy research at Compass Point Research & Trading.

Two bank trade groups, including ICBA, as well as consumer advocates urged lawmakers last month to include a moratorium in coronavirus stimulus legislation. The last freeze, enacted through the 2010 Dodd-Frank Act, expired in 2013.

Banks say a Rakuten bank combined with its online retail offerings would be a dangerous mix, reminiscent of Walmart’s failed 2006 ILC bid.
But in an interview, Lee Carter, CEO of the proposed Utah-based Rakuten Bank America, said his company has not given up its pursuit of a charter.

“We will definitely re-apply,” Carter said. “We continue to work with FDIC on certain issues they've identified with our application. It's been an interesting journey with them, but they've been very thorough in their investigation and review.”

Carter said Rakuten Bank America plans to resubmit its application within the next month — first informally to get initial feedback from staffers before officially refiling in the next couple of months.

The proposed bank has “simplified” its business plan since originally applying for deposit insurance in July 2019, Carter added but he would not provide any specifics.

“When we first applied, we were aggressive with what we wanted to accomplish,” he said. “The process has been instructive but not surprising from what we considered originally when we came into this.”

He added that Rauten’s U.S. banking aspirations wouldn’t dissipate if it became clear the industrial loan charter was not a viable option. “We are looking at other possibilities,” he said.

Other applicants had to reapply

Other tech-focused, nontraditional bank owners tried more than once to convince regulators before getting their charter.

The payments company Square finally obtained ILC approval from the FDIC in March, after having to withdraw a previous bid and reapply. The mobile financial services provider Varo Money received its national bank charter — having won approval from the FDIC and Office of the Comptroller of the Currency — at the end of last month after a three-and-half-year effort.

Ed Mills, an analyst at Raymond James, said the FDIC’s careful process could help alleviate some of the political controversy about ILCs.

“Anything that demonstrates a thoughtful, thorough process, from a political perspective, is something that turns down the political heat on a final decision,” Mills said. “It doesn’t erase it, but to the extent that the last moratorium ended, we didn’t see a flood of approvals [and] didn’t see a process that appeared haphazard or rushed.”

On the same day the FDIC announced approvals for Square and the student loan servicer Nelnet, the agency’s board of directors proposed a rulemaking to codify the agency’s process for considering the deposit insurance applications of industrial banks, including the typical requirements of nonbank parent holding companies via capital maintenance agreements.

Banking industry representatives argue that industrial banks give their owners the ability to compete without meeting regulatory standards for bank holding companies.

“We believe in charter choice, but if these companies are going to be doing banking — which is essentially what they’re doing — the parent companies need to be subject to the same kind of supervision as a bank or thrift,” said Dafina Stewart, senior vice president and associate general counsel of the Bank Policy Institute. “The reason a lot of these companies would choose an industrial bank charter is, you get a lower level of responsibility. That hurts competition by creating an unlevel playing field.”

But ILC advocates say the FDIC’s deliberative process shows the agency is keeping adequate watch over ILCs just like other institutions.

“I think by going slow and being deliberate, the FDIC has facilitated an awareness of the charter — that it is fully insured and a bank charter, subject to all the rules, regulations, taxes and capital requirements of a bank,” said Howard Headlee, president and CEO of the Utah Bankers Association. The state group has traditionally supported industrial banks, a majority of which are based in Utah.

An old controversy has been revived

Concerns about ILCs from community and large banks had simmered for years following the 2008 financial crisis, but they came to a boil more recently when, following the expiration of the Dodd-Frank moratorium, firms such as Square and Rakuten showed interest.

The recent approvals for Square and Nelnet had broken a 12-year freeze in any new ILCs getting approved, over protests from critics who say the charter is a legal loophole crossing a traditional barrier separating banking and commerce.

“We are applying the law as it exists today. Should Congress choose to change the law, we will apply the law as changed by Congress,” FDIC Chair Jelena McWilliams said in a statement to the FDIC board in March.

In late July, a letter signed by the BPI, ICBA and the Center for Responsible Lending urged congressional leadership to institute a three-year moratorium on new industrial banks.

“Congress should not abdicate its duty to address the ILC loophole and allow bank regulators to decide the fate of our banking system,” the groups wrote. “While enactment of legislation to permanently close the loophole is preferable, this intermediate action will give Congress the time necessary to approve an appropriate legislative framework.”

Some lawmakers have shared their concerns, such as Sen. John Kennedy, R-La., a member of the Senate Banking Committee. In a letter addressed to McWilliams in mid-August, Kennedy urged the agency to “refrain from approving any ILC-related applications, pending or otherwise.”

“This will preserve the status quo and avoid potentially devastating changes to our banking system,” Kennedy wrote.

Not the same as Walmart

Still, the issue is largely under the radar, especially without a giant company like Walmart seeking a charter.

“The odds are against an ILC moratorium simply because Rakuten is not eliciting the same degree of fear or concern as Walmart did,” said Boltansky.

Mills said congressional action is “unlikely unless we see a … considerable uptick in action coming out of the FDIC.” The FDIC could potentially take a more assertive position either for or against the charter, he added, if Democratic nominee Joe Biden wins the November election, which could lead to changes in the regulators who sit on the FDIC board.

“The big question to me is whether the board forces anything at the FDIC on this issue if there are leadership changes under a potential Biden administration,” Mills said.

Others said policymakers are unlikely to consider lasting changes to the charter without a clear connection between ILCs and systemic risks.

“Over the last 15 years, there’s been a bipartisan consensus to do nothing unequivocal in this area,” said V. Gerard Comizio, associate director of the business law program at Washington College of Law at American University. “If you take the position that Congress addresses problems when they become crises, there’s nothing propelling this issue.”

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ILCs FDIC Jelena McWilliams Fintech regulations Licenses and charters Nonbank Regulatory reform Square