Square's ILC bid is a regulatory end run
Like the now famous Bill Clinton political slogan “It’s the economy, stupid” from the 1992 presidential campaign, most in our industry are missing the core issue with Square’s application to form an industrial loan company.
“It’s the ILC loophole, stupid” is an apt expression for refocusing the spotlight on ILCs.
Square itself is not so much the problem as the ILC deposit insurance loophole. It is the same underlying issue that sparked the Independent Community Bankers of America’s opposition to the Walmart application over a decade ago. The ILC loophole allows for an unintended and potentially dangerous expansion of the deposit insurance safety net. (Editor's note: Fine was president and CEO of the ICBA during the Walmart debate.)
When Congress created the Federal Deposit Insurance Corp. in 1933, the deposit insurance safety net was intended for commercial bank consumer depositors only. It was never intended to extend beyond an insured bank to provide a relatively inexpensive source of insured funding for nonbank businesses — whether they be mercantile concerns like Walmart or nonbank financial firms like Square.
Through a series of intended and, in some cases, unintended congressional and regulatory actions over the past 80 years, ILCs have become a conduit for nonbank financial firms to gain access to insured deposits and to siphon those deposits to nonbank commercial firms of every stripe — fintech or mercantile. That is at the core of ICBA’s opposition. We all learned the hard lesson of what happens when rogue nonbank financial interests, like JPMorgan’s infamous London Whale, get their hands on inexpensive insured deposits. It is the insured commercial banks collectively that are required to make up the hole in the fund when such acts occur.
The price of deposit insurance for banks is very rigorous (some argue oppressive) regulation. Banks are among the most heavily regulated private businesses in the world. So one can understand why community banks, which stagger under very heavy regulation, become concerned when nonbank financial firms and their nonbank commercial firms gain access to deposit insurance without having to pay the regulatory cost.
Free markets only work when all stakeholders in a given economic sector are subject to the same rules. When certain participants in the financial sector (or their parent companies) are allowed to offer everything that an insured commercial bank can offer (including deposit insurance) without having to adhere to the regulatory constraints that come with access to deposit insurance, then an entire class of participants in the financial services sector is placed at a severe disadvantage and the “free market” isn’t really free. It is a market that is distorted and stacked against certain participants. How is that an open free market?
Congress should address these loopholes and inequities within the financial services sector as soon as possible. Until then, the regulatory authorities should be very circumspect about expanding the deposit safety net to nonbank firms of every type. Because it is a given that if a large nonbank firm with access to the deposit safety net fails, and millions of consumers are financially ruined, it is the insured commercial banks that will pay the price of restoring the deposit insurance fund and shoulder the inevitable regulatory storm that will follow.