Retailers, tech giants shouldn't get ILCs. Especially now.
Federal Reserve Chair Jerome Powell warned in a briefing this week that the nation’s economy is operating far below pre-pandemic levels. Yelp warned that nearly 55% of small businesses that temporarily closed probably will not reopen.
In short, because of the coronavirus pandemic every sector of the economy is suffering at levels far more severe than during the financial crisis a decade ago. If there was ever a time to permanently plug regulatory loopholes that could trigger an even greater economic collapse, it would be now.
And the industrial loan company (ILC) loophole — which allows nonbank retail firms such as Rukuten, Amazon and other retail giants to own banks insured by the Federal Deposit Insurance Corp. — is one of the most glaring and economically dangerous gaps in federal financial regulation.
Insured banks are built to be economic fortresses through a strict body of laws and regulations designed to protect customer deposits and ultimately, widespread financial stability. Retail commercial businesses are not built with such protections in mind.
Recognizing these differences, Congress passed the Bank Holding Company Act of 1956, which prohibits the cross-ownership between the insured commercial banking sector and the retail business sector to prevent a downturn in one sector from spreading to the other. Congress placed a moratorium on ILCs during the 2008 financial crisis to keep the economic calamity from becoming many times greater than it already was.
While an ILC can accept FDIC-insured deposits and offer a wide variety of financial services, it escapes Federal Reserve oversight because ILCs are not defined as “banks” under the BHC Act. As a result, the parents of ILCs avoid a whole body of law and regulation meant to restrict activities that could put customers’ insured deposits — and therefore the entire commercial banking and retail business sectors — at risk.
During an economic crisis brought on by the coronavirus pandemic it is perplexing, therefore, that Congress has not stepped in to pass proposed legislation that would permanently close this dangerous ILC loophole.
Congress was worried enough about this loophole that it imposed a three-year moratorium on the chartering of any new ILCs during the last economic crisis. Obviously, lawmakers saw the potential for cross-sector economic contagion, or they would not have imposed the moratorium in the first place.
Thus far, a downturn in the retail commercial sector has not destabilized the insured financial sector and vice versa. But if the two are combined and intertwined by exploiting the ILC loophole, contagion becomes likely and the potential for a calamity beyond imagination could occur.
And when it comes to an economic pandemic, sheltering in place does not stop the spread. The housing market falls, banks fall, retail commercial firms fall — and struggling taxpayers are left to pay for it all.
Congress must step in and finish the job it started during the last financial crisis by permanently closing the ILC loophole and to protect a vulnerable economy already badly weakened by the pandemic.
So too, the federal bank regulators need to recognize the threat to the deposit insurance system, and to the nation’s taxpayers, and put a moratorium on new ILC applications such as the one by Rakuten (sometimes referred to as the Amazon of Japan) until Congress acts.
As Powell has already noted, the nation is already in a severe economic crisis because of the coronavirus pandemic. During the last economic crisis, Congress understood the potential disaster of mixing banking and commerce and placed a moratorium on the chartering of ILCs.
Now lawmakers must finish the job and permanently close the ILC loophole.