The bids by tech firms Social Finance and Square for industrial loan company charters and federal deposit insurance have rekindled debate over two questions: What is the appropriate regulatory oversight for industrial loan companies, and should fintech platforms be allowed to compete with traditional banks?
Many of the arguments in this debate have less to do with either applicant’s qualifications than with traditional banks’ fear of new, innovative competitors, and with a decades-old turf war between the Federal Deposit Insurance Corp. and the Federal Reserve over the regulation of ILCs.
By way of background, ILCs, state-chartered banks supervised by the FDIC and appropriate state regulator, are exempt from bank holding company rules. This allows ILC parents to bypass Fed oversight and own a bank while being a commercial venture. The ILC charter has historically been opposed by the Fed, while it gives the FDIC the potential to examine some of the largest corporations in the world.
Truth be told, the differences between the FDIC’s regulation of ILCs and the Fed’s supervision of bank holding companies — which operate commercial banks — are minute. A 2011 report by the Milken Institute on ILCs notes that they are subject to the “same restrictions and requirements, regulatory oversight, compliance, and safety and soundness exams as any other kind of bank.” (Disclosure: SoFi is a financial supporter of the Milken Institute. However, it was not involved in the preparation of this op-ed, which represents the opinion of the authors.)
In fact, ILCs face greater restrictions on the types of deposits they are allowed to offer compared to commercial banks. Moreover, as our 2011 report mentions, over the past 50 years Congress has passed legislation slowly gutting the types of federally insured institutions commercial companies can own. The Bank Holding Company Act of 1956 allowed commercial firms to own one bank, nonbanks, multiple thrifts, unitary thrifts and ILCs. However, the Savings and Loan Holding Company Act of 1967 prohibited commercial firms from owning multiple thrift companies. Finally, the Gramm-Leach-Bliley Act of 1999 prohibited commercial firms from owning even unitary thrifts, although it grandfathered existing ones. That left ILCs as one of the last bank charters that can be owned by nonfinancial companies and that can bypass Fed oversight.
But none of this quiets those who view ILCs as a loophole that can be used to avoid Fed oversight. Some may argue that the Fed’s mandate allows better scrutiny of an institution’s soundness than the FDIC can provide. However, former regulators have confirmed that the FDIC and state governments have sufficient statutory authority to oversee ILC holding companies.
That said some of the concerns raised by opponents of fintech firms receiving ILCs or seeking a special-purpose national bank charter do deserve consideration, including the question of how best to apply the Community Reinvestment Act to chartered fintech institutions. The Office of the Comptroller of the Currency and various lawmakers, including Reps. Gregory Meeks, D-N.Y., and Cedric Richmond, D-La., are studying this issue. A refocus on how the nearly 40-year-old CRA is applied (and its overall effectiveness) in an increasingly digital environment is warranted.
But some of the other criticism has less merit. Opponents of SoFi’s application frequently — and wrongly — complain that fintechs are not regulated. This opposition fails to consider the volume of comments submitted by various nonbank platforms to U.S. regulatory agencies in the past detailing the types of federal and state regulation they’re subjected to. These critics are some of the same groups that vigorously oppose partnerships between banks and third party lenders, despite what looks like tacit approval by the FDIC. They also have opposed efforts by the Office of the Comptroller of the Currency to find regulatory balance by creating a more tailored, special-purpose national bank charter for fintech firms, while putting similar pressure on the FDIC to decline SoFi’s ILC application.
What is ironic is that SoFi and Square are actually asking for more regulation, not less, by seeking a charter. This would put leading nonbank fintech providers on more equal regulatory ground with banks — something that mainstream financial institutions say they want. Getting an ILC would add yet another agency — the FDIC — to the regulatory labyrinth the companies must navigate. This should be considered a win for banking industry and consumer advocates who favor more transparency and oversight of fintechs.
Even more notable, the intense scrutiny of SoFi and Square’s applications, which again would bring more regulation, has not been applied to certain banks that plan to restructure and ditch the bank holding company model altogether. In one recent case, Bank of the Ozarks’ Chairman and CEO George Gleason called bank holding companies a “vestige of the past,” adding that the “redundant administrative, accounting, and regulatory cost of that infrastructure was really just wasted money.” Meanwhile, BancorpSouth Chairman and CEO Dan Rollins stated that his company’s reorganization “will eliminate redundant corporate infrastructure and activities and will help alleviate the burden of duplicative regulatory oversight.” Both banks jettisoned the bank holding company model to derive greater efficiencies and more streamlined compliance processes.
Simply put, competitive concerns are masquerading as regulatory issues. Fear of new and innovative companies is driving certain industry and consumer advocates with a sizable presence in Washington to want to erect new barriers, warning that SoFi and Square’s entry into the banking market opens the door for tech giants such as Apple, Alphabet and Amazon to do the same. Such claims are unsubstantiated warnings of a potential problem with the resilience of tech-based holding companies. Yet Apple, Alphabet and Amazon have cash reserves and market capitalizations that far exceed any of the top banks.
Perhaps the debate should focus less on which type of charter offers the most oversight and focus more on whether regulatory frameworks written for another century make sense in today’s digitally driven financial services marketplace. We’re no longer living in the 1950s. SoFi and Square’s applications offer the FDIC the opportunity to reexamine a regulatory system beholden to the past.
Fintech firms like SoFi and Square face an increasingly complex operating environment, in which their business plans run counter to legacy licensing and regulatory regimes. For them, the ILC is a way to offer their consumers new and potentially more appealing choices, while agreeing to be subjected to more regulatory oversight in order to do so. Traditional banks often talk about the need for a level playing field. Aren’t these applications a step in that direction?