On March 17, 2020, the Federal Deposit Insurance Corporation (FDIC) approved Square Financial Services, Inc.’s (Square Financial) and Nelnet Bank’s applications for deposit insurance, subject to several conditions. The FDIC also issued a notice of proposed rulemaking (“Proposed Rule”) that would codify the FDIC’s existing supervisory policies that apply to industrial banks and industrial loan companies (ILCs) and their parent companies.

The FDIC’s conditional approval of Square Financial’s application marked the first time the FDIC approved an application for deposit insurance by an industrial loan company (ILC) since before the Great Recession.

Square Financial will be a wholly-owned subsidiary of Square, Inc. (Square) and will offer small business loans nationwide to Square merchants and to businesses that are not part of the Square network. Square Financial will also offer deposit products to Square merchants and to the general public nationally through its website.

The conditions imposed by the FDIC in connection with its approval include the following:

• Square and Jack Dorsey, controlling shareholder of the parent company, are required to execute a Parent Company Agreement with conditions and requirements related to reporting and examination of Square and its subsidiaries, and to allow the FDIC to monitor compliance with laws and regulations governing transactions with affiliates. Square Financial will also be required to maintain a board of directors with a majority of members that are independent of Square and its subsidiaries and affiliates, and parent company representation will be limited to no more than 25% of the members of such board of directors.
• Capital of $56 million will be provided by Square. Square Financial will be required to maintain a leverage ratio and total capital ratio, as defined in the capital regulations of the FDIC, during and after the first three years of operation at not less than the levels specified in the Bank’s business plan.
• To ensure that Square Financial maintains sufficient capital and liquidity, Square Financial, Square and Jack Dorsey are required to execute a Capital and Liquidity Maintenance Agreement with conditions and requirements for Square to provide financial resources to support Square Financial.

The FDIC described the Proposed Rule as a codification of conditions the agency has commonly imposed on significant owners when approving industrial banks for deposit insurance. The new rule would require owners to undertake the following commitments to their bank subsidiaries and the FDIC:

• Limit direct or indirect representation on the bank’s subsidiary’s board to 25%;
• Submit and maintain a list of subsidiaries with the FDIC;
• Consent to FDIC examination of the parent and its subsidiaries;
• Report annually on the parent’s activities, financial condition, operations, intercompany financial transactions and risk profile as well as that of its subsidiaries and affiliates;
• Maintain records as specified by the FDIC;
• Conduct an annual independent audit of the bank subsidiary;
• Maintain the bank subsidiary’s capital and liquidity at specified minimum levels and otherwise ensure sufficient sources of capital or liquidity, and
• Enter into a joint tax allocation agreement establishing that the parent company holds tax assets generated by the bank subsidiary in trust.

Additionally, the Proposed Rule would require an industrial bank controlled by a company that is not subject to federal consolidated supervision by the Board of Governors of the Federal Reserve System to obtain the FDIC’s prior written approval before doing any of the following:

• Making a material change to its business plan;
• Adding or replacing a member of its board of directors;
• Adding or replacing any senior executive officer;
• Employing a senior executive officer who is associated in any manner (e.g., as a director, owner, employee or consultant) with an affiliate of the industrial bank, or
• Entering into any material services contract with the parent company or any of its subsidiaries.

Finally, Rakuten announced on March 23 that it will withdraw its pending application and refile once it has incorporated the FDIC’s new guidance.

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