FDIC Halts All Decisions Related to Charters of Industrial Loan Corporations

What do GE, GM, Target, Volkswagen, Home Depot, Merrill Lynch and Wal-Mart have in common? Besides being giants of industry, commerce or finance, they all have or want to start subsidiaries known as industrial loan corporations (ILCs), a type of non-bank bank that makes small banks nervous and has the Board of Governors urging congressional action.

In late July, the Federal Deposit Insurance Corp. (FDIC) placed a six-month moratorium on all ILC applications and change of control approvals. Some observers expect congress to review its 1987 law that allows any type of business to own an ILC, but we don't know when that would happen. The Federal Reserve and small banks across the country are hoping that Congress will close what the Fed believes is a loophole in the law that lets commercial companies establish these subsidiaries. ILCs have been around for about 100 years, but they were intended originally to be small, local institutions with limited lending and deposit-taking powers.

"The issue lies with the unrestricted ownership of these ILCs, and the fact that the parent companies may escape federal regulatory oversight," says Bill Emmons, senior economist and manager in supervisor policy analysis at the St. Louis Fed. Many ILCs engage in the same activities as other depository institutions insured by the FDIC—primarily performing financing or finance-processing activities. "So what we have are federally insured banks that aren't subject to consolidated banking supervision. Only the ILC itself is supervised by the chartering state and the FDIC.

"In contrast to other insured institutions, neither the state nor the FDIC have the authority to exercise oversight over an ILC's parent company," says Emmons. "The Fed naturally would prefer to see consolidated supervision of the organization to guard against systemic risk. But if you take that to its logical conclusion, it might mean that the Federal Reserve would wind up supervising the parent company, e.g. Wal-Mart or Volkswagen, which is of course not what the Fed intends."

So instead, the Board of Governors—with the support of many small banks—has taken the position that the law's loophole (as the Board sees it) needs to be closed. In other words, the ILC in its current form needs to change.

FDIC Moratorium

Before Alan Greenspan stepped down as Fed chairman, he argued the need for Fed oversight over ILCs and that the law needed to change. Current Fed Chairman Ben Bernanke's position is no different: without regulatory oversight, there is risk to safety and soundness. In addition, the GAO (Government Accountability Office) did a report for Congress and developed conclusions that was close to the Fed's position. "Small banks have been getting nervous because the way the law is written now, there is a potential for intense competition with large non-financial companies getting into banking. This could tilt the playing field against small banks," says Emmons. "Community bankers don't want to see a Wal-Mart bank branch in every Wal-Mart store."

Until recently, the FDIC didn't see a problem, as the commercial applicants such as Home Depot and Wal-Mart insisted they were looking primarily to handle credit and debt card and electronic check payments, and stay out of branch banking. But this year, the FDIC started thinking differently. According to the FDIC's July 28 press release issuing the six-month moratorium, "The growth of the ILC industry, the trend toward commercial company ownership of ILCs and the nature of some ILC business models have raised questions about the risks of ILCs to the deposit insurance fund, and whether their commercial relationships pose any safety and soundness risks."

"Is the 1987 law as written what congress intended?" asks Emmons. "Or is it a badly written law? Ideally, congress should determine whether the ILC loophole created then was an oversight or whether allowing a non-financial company to own an insured bank via an ILC was the original intent. What the Board of Governors would like to see happen is that the loophole be closed, and perhaps a time-limited grandfather clause be placed on existing commercial ILCs."

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