Alan Keller: Let’s close the ILC loophole

ICBA is making the case for closing the industrial loan company loophole.

With several technology companies seeking to benefit from a legal loophole allowing them to access the federal safety net while skirting regulatory oversight, ICBA is doubling down on its calls to close the loophole for good. In a recently released white paper, ICBA offers a comprehensive look at the industrial loan company (ILC) loophole, and why it puts consumers and the financial system at risk.

ICBA issued its white paper—Industrial Loan Companies: Closing the Loophole to Avert Consumer and Systemic Harm—as technology companies such as Square, SoFi and Nelnet have sought ILC designations from the FDIC and Utah state regulators. While all three of these tech firms have withdrawn their problematic ILC deposit insurance applications, Square has since reapplied.

There’s no secret why these companies are so interested in this obscure charter type. As ICBA details in the white paper, a loophole in the Bank Holding Company Act of 1956 (BHCA) allows commercial and fintech companies to own or acquire ILCs chartered by just a handful of states without being subject to federal consolidated supervision, and without having to divest their commercial activities.

This creates an uneven playing field relative to community banks and other financial institutions that must meet holding company standards. It also leaves a dangerous gap in safety and soundness oversight while violating the longstanding U.S. separation of banking and commerce activities.

Unsafe and unsound

ILCs are a threat to safety and soundness primarily because their commercial owners are exempt from consolidated supervision, one of the two key provisions of the BHCA. Consolidated supervision by the Federal Reserve allows the agency to understand and monitor holding companies to avoid risks to their subsidiary depository institutions.
Further, parent companies are expected under U.S. banking law to serve as a “source of financial strength” to their subsidiaries, meaning they can inject cash into struggling banks under their control. Conversely, regulators must ensure that parent companies experiencing difficulties will not drain their banks’ liquidity to prop themselves up—creating risks for the banking industry while exploiting its federal safety net.

Without consolidated supervision, regulators cannot effectively enforce this doctrine for commercial ILC holding companies. And even if ILC parents were subject to such supervision, banking regulators do not have the knowledge or expertise to examine commercial holding companies whose governance functions, risk controls, financial operations and accounting practices are starkly different from those of a financial company.

Banking and commerce

The other key tenet of the BHCA is the separation of commercial activities from banking. The law restricts permissible activities and investments of BHCs to banking, managing or owning banks, and a limited set of activities determined to be “closely related to banking.” It also requires all bank holding companies to divest themselves of ownership in any firms that were involved in nonbank activities.

While amendments to the law ultimately led to the 1987 ILC loophole exempting these entities from the definition of “bank,” the basic framework of the BHCA has endured for more than 60 years (see “The tangled history of ILCs” on the next page).

ILCs are the functional equivalent of full-service banks, so commercial ownership of them effectively violates this longstanding American economic policy. Federal law prohibits all other full-service banks, whether federally or state chartered, from being owned by commercial companies.

In the current era of big data, technology conglomerates and artificial intelligence, the separation of banking and commerce is more important than ever before.

In the current era of big data, technology conglomerates and artificial intelligence, the separation of banking and commerce is more important than ever before.

The ILC applications by Square, SoFi and Nelnet are indicative of what might await consumers and the financial system if huge commercial or technology firms like Amazon, Google or Walmart are allowed to exploit the FDIC-insured ILC loophole and operate without adequate supervision.

Many community bankers and others likely remember ICBA’s successful campaign against Walmart’s bid for an ILC charter in 2006. That effort by Walmart and another by Home Depot failed, ultimately leading to a temporary FDIC moratorium on ILC charters and a three-year moratorium imposed by the Dodd-Frank Act. This current campaign by tech firms to exploit the ILC loophole is no different.

Level playing field

The issues of a fair and competitive playing field, separation of banking and commerce, and safe and sound financial industry for Americans are no less important now than they were in 2006. It’s simple: Any company that wishes to own a full-service bank should be subject to the same restrictions and supervision that apply to any other bank holding company.

More than a decade after the Walmart battle, ICBA’s position has not changed: The FDIC should impose an immediate moratorium on approving deposit insurance for ILCs, and Congress should close the ILC loophole permanently.

ICBA is working to ensure that members of Congress and financial regulators read our white paper and get the full story on the long, tangled history of this obscure corner of the financial sector. As we enter a new chapter in the ILC saga, let’s close the book on this risky and inequitable loophole.

The tangled history of ILCs

Dating back to 1910 with a mission to serve industrial workers, the industrial loan company (ILC) has morphed into the fashionable charter of choice for financial firms seeking to benefit from the federal safety net while avoiding legal restrictions and company oversight under the Bank Holding Company Act (BHCA).

That law was enacted in 1956 in response to the growth of diversified bank holding companies. Its goal was separating banking and commerce to limit concentrations of economic power, avoid conflicts of interest and preserve the impartial allocation of credit.

The BHCA subjects bank holding companies to Federal Reserve oversight and capital regulations. It also requires them to serve as a “source of strength” to their bank subsidiaries so holding companies aren’t drawing support from the banking industry safety net.

The ILC loophole cropped up in 1987, when the Competitive Equality Banking Act exempted ILCs from the definition of “bank.” Subsequent amendments to the BHCA, the Gramm-Leach-Bliley Act of 1999 and the Dodd-Frank Act of 2010 have reaffirmed the separation of banking and commerce. And moratoria on the approval of new ILC deposit insurance applications imposed by the FDIC in 2006 and Congress in 2010 have expired.

While the FDIC has not approved an ILC applicant for deposit insurance since 2006, several recent applications by tech companies raise concerns that can be addressed by closing the loophole once and for all.

Alan Keller ( is ICBA first vice president of legislative policy