How to Regulate the Unregulated? —Industrial Banks, FinTechs, and FDIC’s New Final Rule

The Federal Deposit Insurance Corporation recently released a final rule with respect to parent companies that own or control industrial banks—or those that want to acquire or charter an industrial bank. The rule will apply certain conditions and commitments when an insured industrial bank or industrial loan company becomes a subsidiary of a company that is not subject to consolidated supervision by the Federal Reserve Board.

Industrial banks, while fully regulated like other state-chartered, FDIC-insured banks, differ from conventional banks. Among other things, they often have diversified parent companies that can provide private capital to help the bank weather economic downturns. Because industrial banks generally choose not to become part of the Federal Reserve system, FDIC serves as the primary federal regulator for these nonmember state-chartered banks—hence the final rule.

Industrial banks are authorized to make all types of consumer and commercial loans subject to both FDIC’s powers and regulations and the relevant state regulatory agencies. FDIC has typically required industrial banks to maintain significantly higher capital and liquidity than other insured banks.

Industrial banks are an interesting category of state-chartered financial institutions and they have captured the FinTech industry’s eye. While the Bank Holding Company Act generally prohibits businesses, retailers, and other commercial corporate entities from owning banks, industrial banks do not qualify as a “bank” under the Act. And the Act does not prohibit a FinTech company from acquiring or chartering an industrial bank. Yet, as of June 30, 2020, only 23 industrial banks existed in the US—most chartered in Nevada and Utah. Only three other states—California, Hawaii, and Minnesota—allow industrial bank charters.

Industrial banks have historically presented controversy. In the mid-2000s, Wal-Mart attempted to charter an industrial bank subsidiary, which met great opposition. Wal-Mart eventually withdrew the charter application but the process resulted in a moratorium against chartering industrial banks. The moratorium has ended—hence the renewed interest in industrial banks.

FDIC recently issued its final rule with respect to industrial bank parent companies. Refer to the press release here with link to the final rule. In brief, before FDIC will approve a company to charter or acquire an industrial bank, the company must do the following:

• Provide—and update annually—a list of all subsidiaries.
• Consent to regulatory examination of the holding company and all subsidiaries, including the industrial bank.
• Meet annual reporting requirements on operations of holding company and all subsidiaries and provide other reports as requested.
• Maintain and report on the security, confidentiality, and integrity of consumer and nonpublic personal information.
• Maintain business and other records as required.
• Cause an independent annual audit of each industrial bank.
• Limit the holding company’s representation on the board of the subsidiary industrial bank to less than 50%.
• Comply with FDIC capital and liquidity rules.
• Enter into a tax allocation agreement.
• If required, obtain FDIC approval for a contingency plan for disposition of the industrial bank without the need for a receiver or conservator.

Could this final rule bring regulatory certainty to the table and cause an uptick in chartering industrial banks? We believe so, but with a new President and Congress, we expect more bumps in the road.

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