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.
New Regime for ILC Holding Companies Going Forward
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.
Summary of the Final Rule
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:
- Submit to the FDIC an initial listing of all of the Covered Company's subsidiaries, with annual updates thereafter;
- Consent to FDIC examination over the Covered Company and each of its subsidiaries to permit the FDIC to assess compliance with the provisions of any written agreement, commitment, or condition imposed; the FDI Act; any other federal law for which the FDIC has specific enforcement jurisdiction against the Covered Company or its subsidiaries; and all relevant laws and regulations;
- Submit to the FDIC an annual report describing the Covered
Company's operations and activities and such other reports as
may be requested by the FDIC to inform the FDIC as to the Covered
- financial condition;
- systems for identifying, measuring, monitoring, and controlling financial and operational risks;
- transactions with depository institution subsidiaries of the Covered Company;
- systems for protecting the security, confidentiality, and integrity of consumer and nonpublic personal information; and
- compliance with applicable provisions of the FDI Act and any other law or regulation.
- Maintain such records as the FDIC may deem necessary to assess the risks to the ILC subsidiary or to the Deposit Insurance Fund;
- Cause an annual independent audit of each ILC subsidiary;
- Limit the Covered Company's direct and indirect representation on the board of directors or board of managers, as the case may be, of each ILC subsidiary to less than 50% of the members of such board of directors or board of managers, in the aggregate, and, in the case of an ILC subsidiary that is organized as a member-managed limited liability company, limit the Covered Company's direct and indirect representation as a managing member to less than 50% of the managing member interests of the ILC subsidiary, in the aggregate;
- Maintain the capital and liquidity of the ILC subsidiary at such levels as the FDIC deems appropriate, and take such other actions as the FDIC deems appropriate to provide the ILC subsidiary with a resource for additional capital and liquidity (e.g., pledging assets, obtaining and maintaining a letter of credit from a third-party institution acceptable to the FDIC, and providing indemnification of the ILC subsidiary); and
- Execute a tax allocation agreement with its ILC subsidiary that expressly states that an agency relationship exists between the Covered Company and the ILC subsidiary with respect to tax assets generated by such industrial bank, and that further states that all such tax assets are held in trust by the Covered Company for the benefit of the ILC subsidiary and will be promptly remitted to such industrial bank. The tax allocation agreement also must provide that the amount and timing of any payments or refunds to the ILC subsidiary by the Covered Company should be no less favorable than if the ILC subsidiary were a separate taxpayer.
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:
- Materially change its business plan after becoming a subsidiary of such Covered Company;
- Add or replace its directors or senior executive officers during the first three years after becoming a subsidiary of such Covered Company;
- Employ a senior executive officer who is, or during the past three years has been, associated in any manner (e.g., as a director, officer, employee, agent, owner, partner, or consultant) with an affiliate of the ILC; or
- Enter into any contract for services material to the ILC's operations (for example, loan servicing function) with such Covered Company or any of its other subsidiaries.
1 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).
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