Battle Lines Being Drawn as FDIC Examines Industrial Loan Companies

A relatively obscure corner of the banking sector is being thrust into the spotlight — and the Federal Deposit Insurance Corp. may change the ways in which industrial loan companies operate.

In doing so, it may be the case that nonbanks, including FinTechs and especially retailers, seeking a relatively streamlined way to provide banking services and products to end users, might find that road tougher to navigate.

As regulators take a closer look at the sector, questions remain over the systemic risks that might be injected into the sector.

Industrial loan companies/industrial banks (hereafter, ILCs) have been around for more than 100 years. Through the past several years they have served — because the FDIC-insured ILCs are exempt from the Bank Holding Company Act’s definition of a “bank” — as a way in which nonbanks can acquire those ILCs or set them up on their own.

Who’s Got Them — and Who Wants Them

A few FinTechs have used those conduits to make the leap. As noted here back in 2020,  Square become the first FinTech to create a de novo industrial bank in Utah, setting the foundation to begin offering commercial loans to its enterprise customers. Separately, Nelnet, which, among other things, offers loan servicing and payment processing services for FinTechs, was approved to offer deposit insurance and to begin operating as an industrial bank that same year.

As for the commercial firms looking to similarly branch out: Walmart sought an ILC charter in 2005 and then withdrew it in 2007 amid heavy criticism. The critics charged that extending banking protections to commercial businesses that owned or became ILCs would create risk – such a run on deposits or other shocks — that would fall on the FDIC “backstop” but not the commercial company.

Data from at the end of the second quarter of 2024 shows there were 23 industrial banks operating in the U.S., with a combined $232 billion in assets. Drill down a bit into Banknet’s call reports, and WebBank has $1.8 billion in deposits, and $2.2 billion in assets.  Nelnet about $1 billion in deposits and $1.1 billion in assets. Square Financial Services has $255 million in deposits and $816 million in assets.

As for what might change: The FDIC has said in the Federal Register that it “anticipates potential continued interest in the establishment of industrial banks, particularly with regard to proposed institutions that plan to pursue a specialty or limited purpose business model.”

An application from Ford Motor Co. is still pending, and has been for more than two years, indicating the interest that at least some firms have in moving more fully into financial services.

In the meantime, the FDIC is in the midst of its proposed rulemaking process (which would not impact existing ILCs), especially as concerns ILCs that would be tied to commercial companies, and commentary letters are due this week.

PYMNTS has reached out to Square for comment, but has not received a response as of this writing.

In March and September, the National Association of Industrial Bankers website posted letters from a bipartisan group of U.S. senators to the FDIC supporting existing ILC regulation. One letter noted that ILCs “provide critical access to credit opportunities within the regulated banking sector, oftentimes serving customers in areas not traditionally serviced by larger financial institutions.”

Risks to the Economy?

Mickey Marshall, assistant vice president and regulatory counsel at the Independent Community Bankers of America (ICBA), told PYMNTS that the FDIC remains concerned about shell and captive ILCs (the ILCs that have a commercial parent company) “because they have identified heightened risks associated with that business model.”

Marshall, who is involved in drafting the comment letter that will be submitted to the FDIC this week “will support the FDIC’s proposal to apply heightened scrutiny to applications” for those so-called “shell and captive” ILCs.

“We are concerned that ILCs that are owned by commercial companies present a heightened risk of failure — as demonstrated by the failure of GMAC in 2008 [the lending arm of GM had an ILC charter till then] — because they have an embedded conflict of interest in their business model.

“A bank should be a neutral arbiter of credit. But when a bank is owned by a commercial company, it is incentivized to lend to customers of its commercial parent to drive sales, and this inevitably leads to riskier loans getting made, which puts the institution at risk of failure,” he told PYMNTS.

He said it’s possible that a Big Tech stalwart like Amazon or Facebook may opt to pursue a banking charter and then scale quickly, thus becoming systemically critical, as financial panic would spread quickly from there to the economy at large.

Asked by PYMNTS what the “ideal” setting might be for an ILC,  Marshall said that his organization “believes that any company that owns a bank should only be involved in financial business, and we do not object to ILCs with financial parent companies — only those with commercial parents.

“A FinTech that is involved in only financial business should generally be permitted to obtain a bank charter. A non-financial company, like a retailer, should lend to its customers from its own working capital. It should not be permitted to own an FDIC-insured bank, because then it creates risks to the broader banking system.”