Industrial banks and industrial loan companies (collectively referred to as “ILCs”) are FDIC-insured, state-chartered depository institutions. In 1987, ILCs received a statutory exemption from the definition of “bank” under the Bank Holding Company Act (“BHC Act”). Congress did not explain the purpose of the 1987 exemption, but many have argued that the exemption allows commercial firms to acquire ILCs despite the BHC Act’s general prohibition on joint ownership of banks and commercial firms.
On March 17, the FDIC issued a proposed rule (the “Proposed ILC Rule”) that would allow acquisitions of FDIC-insured ILCs by commercial firms, including companies engaged in industrial, retail, and information technology businesses. On March 18, the FDIC approved deposit insurance for ILCs owned by the fintech company Square and the student loan servicer Nelnet. Both firms engage in nonfinancial activities that are not permissible for bank holding companies under the BHC Act. Meanwhile, Rakuten – a large Japanese commercial and technology firm that is often called “the Amazon of Japan” – is pursuing a well-publicized campaign to acquire an ILC.-
The FDIC’s recent actions have reversed the agency’s previous policy of preventing acquisitions of ILCs by commercial firms. The FDIC approved deposit insurance for several ILCs established by manufacturing companies and retail firms prior to 2005. However, when Walmart attempted to acquire an ILC in 2005, the FDIC declared a moratorium on further acquisitions of ILCs by commercial firms. The FDIC did not allow any commercial firms to acquire ILCs between 2006 and March 2020, when the agency approved Square’s and Nelnet’s applications.
The Proposed ILC Rule does not explain why the FDIC decided to make such a fundamental policy change, which could transform our financial system as well as our economy and society. Currently there are only a small number of ILCs owned by commercial firms. The Proposed ILC Rule could result in hundreds or thousands of ILCs owned by commercial firms, with trillions of dollars of assets.
The Proposed ILC Rule is contrary to the public interest for several reasons and should be withdrawn. First, allowing acquisitions of ILCs by commercial firms would undermine our nation’s longstanding policy of separating banking from commerce. That policy ensures that FDIC-insured banks will make lending decisions on an objective basis, instead of skewing their credit policies to support their commercial affiliates and weaken competitors of those affiliates.
Second, acquisitions of ILCs by commercial firms would probably inflict huge losses on the federal safety net for banks during future systemic crises. The federal government bailed out several large corporate owners of ILCs – including CIT, GE Capital, GMAC, Goldman Sachs, Merrill Lynch, and Morgan Stanley – during the financial crisis of 2007-09.
During 2007-09 and the current pandemic, the federal government wrapped the federal safety net for banks around our entire financial system. Federal officials rescued large nonbank financial firms to prevent catastrophic failures of major banks. If we allow large commercial firms to acquire ILCs, it is a virtual certainly that the federal government will have to expand the federal safety net to cover commercial owners of ILCs during future systemic crises. Expanding the safety net to include those commercial owners would impose enormous potential costs on the federal government and taxpayers. It would also undermine the effectiveness of market discipline within major commercial sectors of our economy. The bailouts of two big commercial owners of ILCs in 2008 – GE Capital and GMAC – provide clear warnings about the likely consequences of adopting the Proposed ILC Rule.
Third, allowing acquisitions of ILCs by large commercial firms – including “Big Tech” giants like Amazon, Apple, Facebook, Google, and Microsoft – would pose serious threats to competition and consumer welfare. As shown by China’s experience with Ant Financial and Tencent, “Big Tech” firms are likely to gain control of large portions of our financial markets if they acquire ILCs and obtain access to federal safety net subsidies from deposit insurance, payments system guarantees, and the Fed’s emergency support. Commercial owners of ILCs would also enjoy a decisive competitive advantage over smaller commercial firms that could not afford to acquire ILCs. Ownership of ILCs would enable big commercial firms to increase their market dominance, thereby suppressing competition and limiting consumer choice.
Financial regulators around the world are just beginning to grapple with a wide array of policy issues related to the possible entry of “Big Tech” firms into the banking industry. Those issues include major concerns about unfair competition, conflicts of interest, abusive sharing of customer data, violations of customer privacy rights, and systemic risks. The FDIC should not short-circuit the ongoing consideration of such vitally important issues by permitting “Big Tech” firms to acquire ILCs.
Allowing “Big Tech” firms to acquire ILCs would put tremendous pressure on Congress to remove all remaining legal restraints on joint ownership of banks and commercial firms. “Big Tech” firms would want to build a larger presence in financial markets by acquiring full-service banks. Major banks would demand that Congress create a “level playing field” by allowing them to acquire technology firms. The resulting combinations between technology giants and megabanks would aggravate problems that already exist in both industries due to excessive concentration, dangerous levels of political influence, and “too big to fail” status.
Fourth, the Proposed ILC Rule does not comply with the Administrative Procedure Act (APA). The APA requires the FDIC to provide a public explanation of the factual, legal, and public policy considerations that support its decision to make a fundamental change in policy on acquisitions of ILCs by commercial firms. After providing that explanation, the FDIC must give the public a reasonable opportunity to submit comments on the FDIC’s rationale for its change in policy. The FDIC must not issue the proposed rule or approve any additional acquisitions of ILCs by commercial firms until those actions have been completed.
Art Wilmarth is a Professor of Law at George Washington University Law School. This post is adapted from his recent comment letter filed with the FDIC and his article, “The FDIC Should Not Allow Commercial Firms to Acquire Industrial Banks,” which was published in the Banking & Financial Services Policy Report (May 2020) and is available on SSRN.