A topic of increasing interest in recent months and weeks has been whether and if fintech companies would seek to obtain a bank charter of some sort. The recent decisions by Social Finance Inc. (SoFi) and Square, Inc. to apply for industrial loan company (ILC) charters with the Federal Deposit Insurance Company (FDIC) have reignited the discussion and debate regarding what a “bank” should be for purposes of a bank charter. These applications also indicate that there is at least some interest within the fintech community for companies to seek a bank charter of some sort for lending purposes and to provide other types of credit and banking services without partnering with a traditional bank.

By way of background, industrial loan companies and industrial banks (collectively, ILCs) are not subject to the Bank Holding Company Act (BHCA). Rather, they are FDIC-supervised financial institutions whose distinct features include the fact that they can be owned by commercial firms that are not regulated by a federal banking agency. An ILC is a bank with FDIC deposit insurance operating under a specific charter whose controlling shareholder may be a nonfinancial corporation. Utah is home to the majority of the commercially owned ILCs. An ILC functions essentially like a commercial bank, can make all types of loans, and gather insured deposits. The main exception is that if an ILC has more than $100 million in assets, it may not accept demand deposits. However, this limitation is basically meaningless since ILCs with assets above this dollar threshold may offer NOW accounts, MMDAs, and time deposits (CDs).

Federal law has expressly permitted any type of company to control an ILC for many years, but the Federal Reserve and, more recently, the FDIC, expressed policy concerns with the control of insured banks by commercial firms. The FDIC implemented a moratorium on approvals for an ILC to be controlled by a non-financial firm in 2006-2008, and this policy continued de facto after it officially ended. As you may recall, in March 2007 WalMart withdrew its ILC application it made in July 2005, following the FDIC’s January 2007 decision to extend the moratorium on a number of pending ILC applications. Congress seemed to agree with such policy concerns by including a provision in the Dodd-Frank Act (section 603), which imposed a moratorium on the ability of “commercial firms” to acquire FDIC-insured banks that are excluded from the definition of “bank” in the BHCA: ILCs and credit card banks. However, this statutory provision expired on July 21, 2013 – three years after Dodd-Frank was passed – which means that it is now again legally permissible for retailers, manufacturers, or any type of nonfinancial firm to seek to acquire or establish an ILC.

In addition to the moratorium, the Dodd-Frank Act mandated that the Government Accountability Office (GAO) produce a report on the regulatory implications of such limited-purpose bank charters. The GAO issued its report in January 2012 and neither recommended that Congress repeal the federal law provisions that allow ownership of ILCs and limited-purpose credit card banks by commercial firms nor endorsed any new supervisory requirements. According to the report, the OCC and FDIC (the primary regulators of ILCs and credit card banks) believed that current law as implemented is sufficient for purposes of providing effective regulation and supervision of these banks and their affiliates. The Federal Reserve and the Treasury Department differed, contending that there are gaps in the current regulatory structure and that no regulator has the authority to oversee the entire corporate structure where the limited-purpose bank is a subsidiary of a holding company or commercial company. Congress has taken no further action since. In fact, the expiration of the temporary moratorium contained in Dodd-Frank provides room for argument that Congress specifically intended for such applications to be considered under applicable federal standards and may be approved.

On the one hand, the SoFi and Square applications raise significant banking and commerce questions, including whether current arrangements for overseeing the relationship between an ILC and its parent would provide sufficient safeguards if such a more extensive mixing of banking and commerce were permitted. According to SoFi, the purpose of the charter is to solely provide customers with an FDIC-insured deposit account and a credit card product. Square would reportedly use the charter to focus on small-business lending and deposit products. Yet Square’s business is broader than financial services, and includes Caviar, its food delivery service, and the sale of credit-card processing hardware like its signature dongles. Rep. Maxine Waters (D-Cal.), ranking member of the House Financial Services Committee, has called for the FDIC to hold at least one public hearing on SoFi’s application. Others have urged the FDIC to reject these applications. The FDIC decisions on both applications remain pending as of the date of this post.

On the other hand, the FDIC’s application approval would subject a financial company such as SoFi to be more regulated than it is now. If an overarching policy interest is to create a level playing field, this strategy might offer some tangible benefits and, at least to some degree, ease concerns that fintech companies would be able to offer services and products in direct competition with full-service banks, but without the same degree of regulatory scrutiny.

These applications also follow recent activity by the Office of the Comptroller of the Currency (OCC) to consider granting special purpose national bank (SPNB) charters to fintech companies. In July 2017, Acting Comptroller of the Currency Keith A. Noreika stated that he thinks granting SPNB charters to fintech companies “is a good idea that deserves the thorough analysis and the careful consideration we are giving it.” He noted that the OCC “should be careful to avoid defining banking too narrowly or in a stagnant way that prevents the system from evolving or taking proper and responsible advantage of advances in technology and commerce.” However, the OCC has not determined if it will actually accept or act upon applications from nondepository fintech companies for SPNB charters, and (as of July) had not received, nor was it evaluating, any such applications from nondepository fintech companies.

In late July 2017, one fintech company – Varo Money, Inc. – a mobile banking startup helping customers solve financial problems, manage money and reach financial goals, decided not to wait for the OCC to finalize its controversial fintech charter plan. Instead, it applied to the OCC for a national bank charter and to the FDIC for federal deposit insurance to form Varo Bank, N.A.

Stay tuned as we will be posting additional insights here once there are further updates or developments.