THE RETURN OF THE INDUSTRIAL LOAN COMPANY, Vol. 2
The Dutch were among the first to develop the modern financial system along with the concept of a joint venture. Up until the second half of the 20th century, joint ventures along with their offspring were allowed to engage in commercial and banking activities. As one author noted, the Bank of Manhattan, now JPMorgan Chase, was formed as a subsidiary of a company charted to supply water to the City of New York. Enter the Bank Holding Company Act of 1956 (BHCA), which puts limitations on companies that control one or more banks. Due to these limitations, it is impractical for companies such as Square Capital and SoFi to acquire bank status, along with many other commercial enterprises. In theory, the BHCA prevents the fusion of commerce and banking. Nevertheless, the definition of a bank under the BHCA excludes entities called industrial loan companies (ILC).
Currently, Square Capital and SoFi are awaiting the result of their ILC application. If granted, Square Capital and SoFi will be among the first financial technology companies to be granted ILC charter status.
The ILC model dates back to the early 20th century when Morris Plan Company of America and the Studebaker Corporation partnered to launch the automotive financing model. Under this model, a parent company controls an ILC, which, in most cases, finances the purchase of the parent company’s consumer goods. The parent company controls an ILC, not a bank, not subject to the BHCA and Federal Reserve Board oversight. Rather, ILC’s are regulated by state regulators and the Federal Deposit Insurance Corp. (FDIC).[1]
According to the head of the lending arm of Square, Square sees itself as a source of financing for its customer base—namely, businesses who use its payment system. Like Ford, Square Capital sees itself as helping its customer base by providing finance. Unlike Ford, Square utilizes customer data collected through its payment system, assess risk and provides appropriate financing to its customer base.[2] The Office of the Comptroller of the Currency (OCC) is the bureau within the Department of the Treasury with the authority to grant ILC charters. In the coming months, the OCC will determine whether to grant an ILC charter to Square and Sofi and we will see if the line between commercial and banking activities is further blurred.
Overall, there is less oversight and fewer requirements for ILCs. Specifically, bank holding companies under the BHCA are subject to strict restrictions on their investments and activities, among other prudential requirements meant to mitigate systemic risk in the financial system. These banks subject to the BHCA and its strict requirements argue that federal insurance funds assume more risk because ILC’s bring more risk to the federal insurance fund. The benefits of ILCs include preemption of state licensing requirements, preemption of state interest rate caps, access to the fed payment system, including FDIC insurance, and lower variable costs due to the need for transacting with banks under rent-a-charter models would not be necessary.[3] We look to the coming weeks to see if SoFi and Square Capital will be able to open shop as an ILC or be limited to only engaging in partnerships with banks.
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