Industrial banks continue to be objects of mystery among federal policymakers, sparking misinformation. As the interest of fintech firms in the banking system brings a focus on the IB charter once again to Washington, it seems necessary to dispel a few common misconceptions.
Industrial loan companies — as IBs are known in federal statute — have been part of the American financial system since the early 1900s, and the Federal Deposit Insurance Corp. has been insuring them since 1982. Among several states that allow the charter, Utah has 15 FDIC-insured industrial banks operating and Nevada has four. Companies that own an IB are exempt from the Bank Holding Company Act. This means they do not have to register for Federal Reserve supervision, although some have become bank holding companies voluntarily. It also means that nonfinancial companies can own an IB.
The criticism of the IB charter is rife with mischaracterizations and some outright lies. In truth, IBs have consistently been the nation’s best-capitalized, most profitable group of banks since the 1980s.
Here are six myths about the charter corrected:
Myth 1: The exemption from the BHCA for owners of an industrial bank is a loophole that circumvents congressional intent.
The Competitive Equality Banking Act of 1987 included an express exemption to the Bank Holding Company Act for industrial banks. It could not be clearer that Congress intended to allow diversified companies to own industrial banks.
Myth 2: IBs operate under different standards than those of other banks.
In fact, the Federal Deposit Insurance Act classifies industrial banks as “state nonmember banks,” the same designation it uses for all state-chartered commercial banks not supervised by the Fed. Like other traditional state-chartered banks, IBs are supervised and regulated by both the FDIC and the state chartering authority, and comply with the same federal laws.
Myth 3: Industrial bank owners and affiliates are not regulated.
IB parents and affiliates are regulated. The main difference is who regulates them and which businesses IB parents are allowed to pursue.
Under a BHC structure, a company often faces more than one federal regulator (in addition to a state regulator): the Fed for the holding company and a different agency for the bank.
But an IB’s parents and affiliates are supervised by the IB’s regulators in coordination with their supervision of the bank. The IB’s regulators can examine affiliates, require information, issue cease-and-desist orders, assess civil money penalties and ban "institution-affiliated parties" from participating in a bank’s business. The owners of an IB must serve as a "source of strength" to the bank, and typically sign contracts with the FDIC that commit to providing additional capital and liquidity to the bank whenever needed.
Over the past 30-plus years and through at least two recessions, this "bank-centric" regulatory model has proven successful in protecting and supporting bank subsidiaries.
Myth 4: It is risky to allow IB holding companies and affiliates to engage in other nonfinancial business activities.
Nothing in the history of IBs has shown that ownership of other businesses presents a risk to banks or the banking system. FDIC Chairman Martin Gruenberg has argued that his agency’s regulatory procedures to isolate banks from their affiliates have worked well, even when a bank's parent gets into trouble and has to enter bankruptcy. Additionally, holding other nonfinancial assets enables an IB's parent to provide more support for a bank than most bank holding companies.
Myth 5: IBs will allow large companies such as Amazon, Microsoft and Walmart to drive small competitors out of business.
Industrial banks do not compete with traditional banks.
In reality, any company with massive marketing power can already directly offer every kind of financial product and service except deposits and general-purpose credit cards, and they can partner with a bank to provide bank-exclusive products under the merchant's brand. Companies can develop more efficient systems, such as Apple Pay and Samsung Pay, to deliver banking products and services, advertise those to their customers, and charge banks for using those systems.
Different federal laws that do apply to an IB are key to preventing unfair competition, especially sections 23A and 23B of the Federal Reserve Act. Those prevent a retailer, for example, from owning a bank that would finance sales at affiliate merchants, or to make loans to an affiliate. Amazon, for example, must partner with an independent bank to provide credit cards that can be used to purchase Amazon’s goods.
Myth 6: Banks will lose control of the nation's payments system if commercial entities are allowed to own banks.
Banks still control the payments system, which comprises credit and debit cards and transactional deposit accounts. Only banks can offer these cards and deposits, and all are subject to the same regulations and requirements. IBs’ participation in the payments system has not affected the system’s operations, nor will it if more IBs are chartered. On the contrary, IBs are not allowed to offer commercial checking accounts; they can offer only credit cards, prepaid cards and debit cards linked to a NOW account.
As corporations look for new vehicles to offer their customers financial services, the policy debate would benefit from facts, not misinformation. IBs are properly regulated, and have proven themselves to be both flexible and safe. Their track record deserves acknowledgment and respect.