Congress’s inaction on ILCs, fintech charters worries bankers

WASHINGTON — Critics of nontraditional bank charters like trusts and industrial loan companies have often looked to Congress to intervene and hold back a potential wave of new entrants into the banking system.

But amid an uptick in new charter bids, lawmakers do not appear any closer to taking legislative action.

Echoing the fears of many bankers, lawmakers have amplified their concerns about the Office of the Comptroller of the Currency recently approving cryptocurrency firms for national trust charters that do not require deposit insurance, as well as approvals by the Federal Deposit Insurance Corp. for new ILCs.

Yet besides a House subcommittee hearing on the subject last month, restricting nontraditional charters isn’t on Congress’s radar. There is no real legislative movement on the issue. Observers say the lack of any action by Congress will likely result further expansion by nontraditional firms into the banking sector.

“The longer these nontraditional charters, particularly those aligned with powerful tech platform companies, are allowed to operate, the more they restructure the financial services market,” said Karen Petrou, managing partner at Federal Financial Analytics. “The market doesn’t care what Congress does until Congress does it. So things are going to change irreparably.”

“I’ve always said that if you want to be a bank, you need to be regulated like a bank,” said Rep. Blaine Luetkemeyer, R-Mo.

Bloomberg News

In fact, there appears to be a more concerted focus among some lawmakers to encourage fintech firms to offer banking services. Sen. Cynthia Lummis, R-Wyo., has made waves by forming a financial innovation caucus.

Still, banks, consumer advocates and other critics are raising more alarms of late as the OCC has approved several applications for crypto entities and other tech-focused firms. The banking industry has also revived criticism of the ILC charter as it fights a bid by the Japanese e-commerce giant Rakuten to get FDIC approval. Some states are passing their own laws to allow special purpose depository institutions to operate.

“What triggers these reactions and hearings is when you have applications,” said Paul Merski, group executive vice president for congressional relations and strategy at the Independent Community Bankers of America. “There was a long period of time — it probably was about eight years where there wasn’t any interest or applications for charters —but now you have Rakuten, which is basically the Amazon of Japan. … So you’re really playing with fire by changing the entire financial landscape.”

Senate Banking Committee Chairman Sherrod Brown, D-Ohio, said last week that he wants to close a loophole that allows commercial companies to own ILCs and ensure that fintech firms aren’t able to skirt consumer protection regulations.

“Nonbanks are using ILC and OCC chartering loopholes to get around banking laws and consumer protections,” Brown said.

But when the House Financial Services subcommittee on financial institutions and consumer protection held a hearing last month examining the risks and benefits of certain financial institution charters, there was no consensus. Rep. Ed Perlmutter, D-Colo., the chairman of the subcommittee, said the panel may “have to have a couple more hearings on this.”

The question about whether to restrict nontraditional bank owners has hung around Congress for over a decade. Before the financial crisis, lawmakers including Brown backed legislative proposals to ban commercially owned ILCs as Walmart pursued a bank charter plan that it ultimately abandoned. But the farthest Congress went was to institute a temporary moratorium on commercially owned ILCs in the 2010 Dodd-Frank Act.

Marcus Stanley, policy director at Americans for Financial Reform, said that nontraditional bank charters aren’t seeing the same scrutiny that Walmart faced in its failed attempt to own an ILC.

“I think this set of issues … has kind of fallen under the radar for too long,” Stanley said. “You are talking about something that could kind of create a potential Silicon Valley version of Wall Street or a merger of giant tech companies with finance.”

Banking industry representatives point out that innovation comes with relatively lax standards for safety and soundness and consumer protection for firms that are able to obtain a nontraditional charter.

“We welcome innovation in the industry and new business models,” said Rob Morgan, senior vice president of innovation and strategy at the American Bankers Association. “What we don’t think makes sense is to create new regulatory structures that provide a lower bar for consumer protection and regulatory oversight.”

Policymakers have historically viewed ILCs, which are state charters that have FDIC insurance and supervision, as a separate policy issue from fintech charters. But members of Congress are beginning to scrutinize the charters as one and same. That could make a legislative response even hard to achieve, some observers say.

“It’s gotten hard, if not impossible, to drill down on any one of these issues without essentially looking at the entire scheme of bank regulation holistically,” said Walter Zalenski, a partner at Buckley.

Merski agreed that the issue of whether to set new policy regarding nontraditional charters has “become more complex.”

“It’s hard for Congress to keep up with these new approaches on fintech charters,” he said. “But at the end of the day, the simple reality is that all financial institutions should be operating on similar rules.”

Advocates have criticized ILCs because they are not subject to Bank Holding Company Act supervision from the Federal Reserve. Meanwhile, in addition to the OCC approvals of trust firms, the national bank regulator’s effort to create a special-purpose fintech charter has faced lawsuits from state banking regulators. Banks and credit unions have warned the agency not to propose a payments charter.

“There are a lot of issues here that are both safety and soundness, consumer protection and [the Community Reinvestment Act], that I think we are just starting to grapple with,” said Tom Feltner, director of policy at the National Community Reinvestment Coalition. “And I worry that many of these charter applications are getting out in front of a clear and well-defined consumer protection and CRA regulatory structure.”

Rep. Blaine Luetkemeyer, R-Mo., the top Republican on the House subcommittee, said that Congress needs to take the time to ensure that fintech companies are able to innovate while still being regulated properly.

“I’ve always said that if you want to be a bank, you need to be regulated like a bank,” Luetkemeyer said. “We believe this can be accomplished, while providing a regulatory and charter framework that allows fintech companies to continue to thrive in the banking industry, while protecting the status of banks as a bedrock of our financial system.”

Ed Hill, senior vice president and head of government affairs at the Bank Policy Institute, said that the time is ripe for Congress to prevent new players from entering the financial services space that are not subject to Bank Holding Company Act regulations.

“We all know that Congress kind of reacts to events,” Hill said. “So these recent applications, and the like, I do think give Congress something sort of tangible to react to. … We would have preferred that Congress passed this years ago, obviously. But I don’t think that’s practical. I really think that the time is right now.”

Special-purpose bank charters have appealed to nonbanks that may not accept deposits or offer other traditional banking services but still want the benefits of a national charter rather than dealing with a patchwork of 50 state laws. Cryptocurrency companies have also sought to operate through a special-purpose depository institution charter in states like Wyoming, where the firms are not required to have deposit insurance through the FDIC.

“The fact is that different fintechs are offering different services than banks,” said George Selgin, senior director and fellow at the Cato Institute’s monetary and financial alternatives center.

Some Republicans in Congress worry that applying bank-like regulations to fintech firms will prevent new innovative players from entering the market.

“The private sector is innovating new ways to meet the needs of all of our consumers,” said Rep. Patrick McHenry, R-N.C., the top Republican on the House Financial Services Committee, at the April hearing. “And we should be encouraging our regulators to seek regulatory requirements that fit these advancements, not hinder them.”

Banks, on the other hand, have warned that fintech companies are being structured in a way to avoid necessary supervision.

“The common theme between many of these charters is a non-depository model which avoids several really important rules that are tied to deposits,” said Morgan. “The non-depository nature means that the Bank Holding Company Act and Community Reinvestment Act won’t apply. All of these rules and regulations are tied to deposits because they used to be an easy proxy for what is a bank.”

Dan Smith, executive vice president and head of regulatory affairs at the Consumer Bankers Association, said that banks do not believe companies should be able to dip their toe in federal regulation.

“We believe that you can’t be a half a bank or a quarter of a bank, you’ve got to be a full bank,” Smith said. “Fintechs are able to take a lot more risk than banks, which puts consumers at risk. … They don’t have capital and liquidity requirements. They don’t have safety and soundness requirements. They are able to do regulatory arbitrage and pick what states they are able to be regulated in.”

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