The Federal Deposit Insurance Corporation (“FDIC”) released a final rule on December 15, 2020, concerning industrial banks and industrial loan companies (collectively, “ILCs”) and their parent companies (the “Final Rule”). The Final Rule, which takes effect on April 1, 2021, is an important development in the changing regulatory approach to ILCs and should be of interest to those fintech firms and others seeking to provide certain banking services without becoming bank holding companies.
ILCs are state-chartered insured depository institutions that are “banks” for purposes of the Federal Deposit Insurance Act (“FDI Act”) but not the Bank Holding Company Act (the “BHC Act”). As a result, ILC charters have been regarded as highly valuable: there are only 23 currently operating and they have been relatively difficult to establish or acquire, and their parent companies are not regulated and supervised as bank holding companies under the BHC Act.
The Final Rule imposes certain conditions and commitments for a deposit insurance application approval, non-objection to a change in control notice, or merger application approval that would result in an ILC becoming a subsidiary of a “Covered Company.” A Covered Company is any company that (i) is not subject to consolidated supervision by the Federal Reserve Board; and (ii) “controls” an ILC as a result of a change in control under the Change in Bank Control Act, a merger transaction under the Bank Merger Act, or that is granted deposit insurance under the FDI Act, in each case on or after April 1, 2021.
For the purposes of the Final Rule, “control” means the power, directly or indirectly, to direct the management or policies of a company or to vote 25% or more of any class of voting securities of a company and specifically includes the rebuttable presumption of control and the presumptions of acting in concert under the FDIC’s regulations implementing the Change in Bank Control Act.
Innovations in payments in recent years have generated renewed interest in ILC charters, and after a long-running moratorium by the FDIC on approving applications relating to ILCs, the FDIC last March approved deposit insurance applications from Square Financial Services, Inc. (“Square”) and Nelnet, Inc. (“Nelnet”), both of which have established de novo industrial banks in Utah.
The successful applications by Square and Nelnet for ILC charters have been seen by some in the market as an inflection point for fintechs. To date, many fintech companies have relied on partnerships with chartered banks or ILCs to provide loan origination services. Recent efforts by the Office of the Comptroller of the Currency (the “OCC”) to issue so-called “fintech charters” have proved unsuccessful due to regulatory uncertainty and pending litigation between the OCC and various state banking regulators.
The FDIC’s final rule provides (i) transparency to potential future applicants and the broader public as to what the FDIC requires of parent companies of ILCs and (ii) clarity on the FDIC’s practices when making determinations on filings involving ILCs.
The Final Rule specifically prohibits an ILC from becoming a subsidiary of a Covered Company unless the Covered Company enters into one or more written agreements with the FDIC and its ILC subsidiary. If two or more Covered Companies control the ILC, each Covered Company will be required to execute a written agreement. The FDIC may also, on a case-by-case basis, require an individual who is a controlling shareholder of a Covered Company to join as a party to any written agreement. In such case, the controlling shareholder would be required to cause the Covered Company to fulfill its obligations under the written agreements through voting shares, or otherwise, including to maintain the capital and liquidity levels of the ILC subsidiary at or above FDIC-specified levels.
The Covered Company must make eight commitments to the FDIC and the industrial bank:
In addition, the FDIC may require that a Covered Company implement and adhere to a contingency plan subject to the FDIC’s approval. The contingency plan would need to describe, at a minimum, recovery actions to address significant financial or operational stress that could threaten the ILC’s safe and sound operation and strategies for the ILC’s orderly disposition without the need for the appointment of a receiver or conservator.
The Final Rule also imposes certain restrictions on ILCs themselves. Without the FDIC’s prior written approval, an ILC subsidiary of a Covered Company cannot:
 Press Release, Federal Deposit Insurance Corporation, FDIC Approves the Deposit Insurance Application for Square Financial Services, Inc., Salt Lake City, Utah FDIC Approves the Deposit Insurance Application for Square Financial Services, Inc., Salt Lake City, Utah (March 18, 2020); Press Release, Federal Deposit Insurance Corporation, FDIC Approves the Deposit Insurance Application for Nelnet Bank, Salt Lake City, Utah Area FDIC Approves the Deposit Insurance Application for Nelnet Bank, Salt Lake City, Utah Area (March 18, 2020).