Square's bid to be industrial bank inflames ILC debate

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WASHINGTON — The payment processor Square is seeking an industrial loan company charter, according to several sources familiar with the matter, further sparking debate over whether fintech companies should be allowed to use the controversial structure.

The company's application, which is expected to be filed with regulators on Thursday, comes after the online lender SoFi applied in June for an ILC, a type of charter that allows companies to own a bank without having to comply with Bank Holding Company Act requirements and face supervision by the Federal Reserve Board. (Industrial loan companies are regulated by state regulators and the Federal Deposit Insurance Corp.)

Community banks and others who support a strong firewall between banks and commercial firms swiftly opposed Square's move, expressing concern it could open the door to larger technology companies seeking the advantages of a bank charter without the same regulatory supervision.

“ICBA’s feeling about Square applying for an ILC is the same about SoFi,” said Camden Fine, the president and CEO of the Independent Community Bankers of America. “If these entities want to be banks, they should apply for banking charters and come under full and unified banking supervision.”

Others are likely to support the move as a natural evolution for the banking industry, which has seen in recent years more fintech companies engaging in banking activities.

"The basic functions of making loans and processing credit card transactions is what a bank would do,” said Lawrence Kaplan, a banking lawyer of counsel at Paul Hastings.

Square, a San Francisco-based company founded in 2009 by Twitter co-founder Jack Dorsey, focuses on facilitating credit card transactions for small merchants. Over time, it has also expanded its offerings to small-business loans, and recently it began expressing an interest in small consumer loans.

The proposed ILC is expected to be led by Lewis Goodwin, the former CEO and president of West Provo, Utah-based Green Dot Bank, an $879 million-asset institution whose parent company was known for its sometimes controversial business lines in fintech. The board of the new bank would be headed by Jacqueline Reses, who currently runs Square’s lending arm, Square Capital.

A spokesperson for Square said the company's "purpose is to empower small businesses and the underserved to participate in the economy. Square Capital is uniquely positioned to build a bridge between the financial system and the underserved, and further expand access to capital.”

ILCs are a window into the banking system for nontraditional financial institutions seeking to access the Federal Reserve payments system and take deposits, which are a cheap source of funding for loans.

But Square’s main purpose for the charter will be to extend its small-business lending business, the spokesperson said. Though it also intends to take deposits, which would provide some amount of funding for its on-balance-sheet loans, the lion share of the company’s loans would still be sold off to third parties.

Square also felt the ILC charter was best suited to its structure, as the company owns a point-of-sale hardware appliance business and even a food delivery service called Caviar.

In addition, an ILC would allow Square to offer loans without having to rely on a bank partner.

Like other fintech companies, Square’s loans have been facilitated by a bank partner, Celtic Bank, a $619 million institution based in Salt Lake City. Since 2014, Square has originated $1.8 billion in loans through Celtic to more than 140,000 businesses, the company’s spokesperson said. But its partnership with the bank will be re-evaluated if Square is successful in its ILC application. Celtic did not immediately comment for this article.

Square said it was encouraged by recent moves by the FDIC to encourage the creation of new banks, according to the spokesperson. The agency, which has to approve all applications for deposit insurance, recently decided to change the period of heightened regulatory scrutiny for new institutions from seven to three years.

Still, Square intends to keep pursuing individual state licenses while it awaits the verdict from regulators on its ILC charter application, the spokesperson said.

Square's decision is likely to prompt further interest from tech firms in obtaining banking charters. The Office of the Comptroller of the Currency is contemplating creating its own federal fintech charter, a move that state regulators have said would be illegal.

"This won’t be the last financial tech company to apply for an ILC charter," said Fine. "You will see more of this in future months and years. Congress is going to have to address this issue. Do they want a commercial banking system regulated uniformly or do they not? That’s the question they are going to have to grapple with."

The ILC is a controversial bank charter that critics say creates a loophole to the separation of banking and commerce, allowing firms to skirt Fed supervision. Supporters of the charter note that ILCs have been regulated successfully for decades by the FDIC and the states, including Utah, Colorado and Nevada, that have allowed such firms.

The debate over ILCs reached a fever pitch in 2005 when Walmart applied for a charter of its own. In response to the backlash, the Federal Deposit Insurance Corp. decided to impose a six-month moratorium on ILC charters. Walmart eventually withdrew its application in 2007.

A new moratorium imposed under the Dodd-Frank Act expired in 2013, but since then the FDIC has approved no new ILCs for deposit insurance. However, the agency has recently made moves to welcome new bank applicants, including the reduction of a higher capital requirement period for de novo institutions from seven to three years.

But the Square and SoFi applications, both from companies that are financial in nature, are distinct from Walmart, a big-box retailer. It's unclear if that distinction will influence the FDIC, which must ultimately approve all ILC applications.

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