A proposed rule published by the FDIC on March 31 would create a formal framework for the agency’s supervision and oversight of nonfinancial commercial entities that control an industrial bank. The rule would apply regardless of whether control is the result of a new charter being granted or a change in control of an existing bank, and would cover corporate persons who are not subject to supervision by the Federal Reserve Board under the Bank Holding Company Act (BHCA). According to the FDIC, the rule’s requirements are drawn from charter conditions the FDIC has historically imposed on applicants seeking to establish a de novo industrial bank. In its Federal Register discussion of the rule, the FDIC asserts that a rule “formalizing and strengthening” the FDIC’s supervision of companies that control industrial banks, defined as “Covered Companies,” is necessary in light of the “continuing evolution of the use of the industrial charter” and the unique nature of the applications for these charters that the FDIC is receiving. In addition, the FDIC notes that a formal rule would provide “interested parties with transparency regarding the FDIC’s practices when making determinations on filings involving industrial banks,” including parties who both support and oppose the continued exemption of industrial bank ownership or control from the requirements of the BHCA.¹

Since 2007, the number of industrial banks has significantly declined. Total assets of industrial banks have also declined, from $213 billion in 2006 to $141 billion as of December 31, 2019. No new industrial banks have been established since 2008, though Square received conditional approval from the FDIC to establish a Utah industrial bank on March 18.² Much of this decline is attributable to a series of freezes on approving new industrial banks charters, which were imposed by both Congress and the FDIC, and the most recent of which expired on July 21, 2013. In a public statement in conjunction with the proposed rulemaking, FDIC Chairman Jelena McWilliams emphasized that applications to establish industrial banks will be considered for approval “no different[ly] than any other type of application,” noting that “[q]uestions about the mixing of banking and commerce, and the ability of banks to affiliate with nonfinancial firms,” which remain at the heart of continued controversy regarding the exemption of industrial banks from the BHCA, “involve complicated policy trade-offs that are best addressed by Congress.”

The concerns regarding the mixing of banking and commerce recognized by Chairman McWilliams persist because the industrial bank charter became an attractive vehicle for major U.S. corporations that did not wish to become subject to the BHCA following the passage of the CEBA, most notably Wal-Mart and The Home Depot, the respective 2006 industrial bank applications of which are discussed at length in the proposed rulemaking. To this end, McWilliams noted that two industrial bank applications then pending before the FDIC were both submitted by firms whose activities are primarily financial in nature.³ She cautioned, however, that the FDIC’s action on those applications should not be interpreted as representing either an endorsement or a criticism of the industrial bank charter or its use.

The rule would require a Covered Company to enter into a written agreement with the FDIC that contains certain commitments, including:

• submitting an initial listing to the FDIC of all of the Covered Company’s subsidiaries and updating the list annually

• consenting to the FDIC’s examination of the Covered Company and each of its subsidiaries to monitor compliance with any written agreements, commitments or conditions relating to the FDIC’s approval of the subsidiary industrial bank or banks, as well as with certain legal requirements

• submitting an annual report to the FDIC describing the Covered Company’s operations and activities, and those of its subsidiaries, along with such other reporting that the FDIC may require for purposes of informing it of the Covered Company’s financial condition and compliance effectiveness affecting its industrial bank subsidiaries

• maintaining such records as the FDIC deems necessary for the purpose of assessing the risks to the banks and the Federal Deposit Insurance Fund

• causing an independent audit to be performed on each such bank

• limiting the Covered Company’s representation on each such bank’s board of directors to no more than 25 percent of the directors or members

• maintaining the capital and liquidity of each such bank at such levels as the FDIC deems appropriate

• executing a tax allocation agreement with each such bank that expressly acknowledges that an agency relationship exists between the Covered Company and the subject bank with respect to all tax assets generated by the bank, which assets shall held in trust for the bank and promptly remitted to the bank, and that addresses the amount and timing of any bank-related tax refunds or payments to the same extent as if the bank were a separate company.

In addition to the above-described written commitments, the proposed rule imposes a number of restrictions on a Covered Company’s ability to exercise control over its subsidiary industrial bank(s), including the requirement that no changes may be made to the bank’s business plan without the FDIC’s written approval. For example, written approval from the FDIC will be required before entering into any material contract for services between the Covered Company or any of its other subsidiaries and the subject industrial bank subsidiary. In addition, the Covered Company must implement and adhere to an FDIC-approved contingency plan that addresses potential “significant financial or operational stress that could threaten the safe and sound operation of the industrial bank and one or more strategies for the orderly disposition of such industrial bank without the need for the appointment of a receiver or conservator.”

In the proposed rulemaking, the FDIC solicits feedback on 12 questions, most notably on whether the rule should include a requirement for the Covered Company to conduct “some or all of its financial activities (including ownership and control of an industrial bank) through an intermediate holding company” (Question 5) and whether the rule should apply to the control of other types of banks that are exempt from the BHCA (i.e., credit card banks and limited purpose trust companies) (Question 6). The FDIC will accept public comments on the proposed rule until June 1, 2020.

Key Points

• The proposed rulemaking provides welcome additional transparency and direction regarding the demands that must be satisfied in order to receive the FDIC’s approval for a de novo industrial bank application. In addition, as proposed, the rule would apply equally to a change in bank control, which means it would not be possible to circumvent the rule’s requirements by seeking to acquire an existing industrial bank.

• On its face, the proposed rule seems to eliminate many of the advantages of not being subject to the BHCA, including by potentially requiring a Covered Company to conduct some or all of its financial activities through an interim holding company. However, the primary advantage of owning or controlling a type of bank that is exempt from the BHCA is the ability of a nonfinancial company to enjoy such ownership or control. Bank holding companies are subject to legal restrictions on their nonfinancial activities that would render bank ownership by a nonfinancial company otherwise unfeasible. As FDIC Chairman McWilliams noted in her public statement, nothing in the proposed rule would affect that primary advantage.

• The FDIC’s issuance of the proposed rule, together with its conditional approval of Square’s industrial bank application, should be seen as a clear indication that the FDIC is willing to approve de novo industrial bank applications received from qualified applicants. For nonbank lenders, an industrial bank charter offers numerous significant advantages, including the ability to lend on a nationwide basis without the threat of usury and true lender lawsuits and the ability to generate low-cost funding by accepting savings deposits. Those substantial benefits may well outweigh the burdens of complying with the proposed rule.

Endnotes