This is the first in a series of articles in our "So, You Want to Be a Bank?" series.
More than 1,000 new banks were formed in the eight years before the Great Recession began in 2008. In comparison, the past 15 years have seen a relative drought of de novo bank formation. The slow pace of new bank formation in recent years has been attributed to the lengthy regulatory process, regulatory inertia, and unclear or unreasonable expectations for business plans and capital levels, among other factors. With the recent change in presidential administration, bank regulators may be more receptive to eliminating or streamlining regulatory barriers that have historically stood in the way of de novo bank formation. Indeed, in a statement issued upon becoming acting chair of the agency, Acting Chairman Travis Hill of the Federal Deposit Insurance Corporation (FDIC) stated that he expected the FDIC to "encourage more de novo activity," among other priorities. This article will address the potential benefits of operating through a bank charter and the types of charters available.
While many bank chartering proposals are likely to originate from groups proposing to conduct a traditional banking business, we have seen increasing interest among nonbank financial services providers — including fintechs engaged in payments, crypto currency, and lending businesses — in operating through a depository institution charter.
We focus here on chartering or acquiring a so-called "full service" depository institution, which can be an appealing option due to access to lower-cost funding sources, access to traditional payment systems, and market credibility. However, a limited-purpose state or federal trust company charter that does not take deposits or make loans may be a more appropriate option for a business involved in asset management or custody activities. The decision to charter or acquire a depository institution involves many important regulatory consequences.
Reasons for Establishing or Acquiring a Depository Institution
While it is possible for nonbank entities to provide a variety of financial services in the United States, there are very significant advantages to operating through a bank charter. For one, only banks are permitted to take deposits insured by the FDIC from the public and have access to deposits as a source of funding.1 This is attractive because deposits typically can be raised at a lower cost than other types of funding.
Operating through a bank charter also provides access to the payment system operated by the Board of Governors of the Federal Reserve System and the Federal Reserve Banks, as well as access to wholesale funding such as the Federal Reserve Discount Window, Federal Home Loan Bank advances, and the federal funds market. Further, in many jurisdictions, banks and trust companies are the only types of corporate entities permitted to act as a trustee.
Operating through a bank charter also offers significant advantages to lenders, because insured depository institutions are generally permitted to "export" interest and fees that are components of interest from the state where the bank is located to borrowers in other states, thereby eliminating the need to comply with various state usury laws. Federally chartered depository institutions generally benefit from federal preemption of state banking laws and are not subject to state licensing and compliance requirements that may apply to nonbank lenders or other nonbank financial services businesses, such as money transmitters. State-chartered insured depository institutions are often exempt from such state licensing and compliance requirements as well.
Types of Charters Available
One of the key considerations in forming or acquiring a depository institution is the type of charter through which it is to operate. In the United States, depository institutions may be organized under federal law or state law, and within each system there are various types of charters available, including commercial banks, savings banks, and trust companies.
Any group considering forming or acquiring a bank should review the available charter options — taking into account variations in the formation process (including initial capital requirements) and the authorized activities and powers of the charter and any associated limitations, including limitations on the types or concentrations of permissible assets.
Under federal law, it is possible to charter either a national bank or a federal savings association. The national bank charter provides a great deal of flexibility in terms of authorized commercial banking powers. The federal savings association charter, however, is subject to qualified thrift lender requirements and other limitations that make it more appropriate for a business that will focus on mortgage lending. A savings association charter historically provided certain advantages, such as a savings and loan holding company not being subject to any restrictions on its activities if it controlled only one savings association that met certain requirements. However, this advantage was eliminated for all but certain grandfathered companies by the Gramm-Leach-Bliley Act in 1999, and the Dodd-Frank Act in 2010 (as subsequently amended) imposed additional limitations on activities of certain companies that control an insured depository institution, including a savings association.
An important advantage of depository institutions chartered under federal law, such as a national bank or a federal savings association, is preemption of state law. Federally chartered depository institutions are generally not subject to state laws that conflict with their powers authorized under federal law. As a consequence, federally chartered institutions are not subject to state licensing and certain other regulations, which allows them to avoid complying with a patchwork of state financial regulation laws and operate more uniformly on a nationwide basis.
While preemption of state law is an important advantage of operating through a federal charter, it may be less significant in the context of a community-based or regional institution that plans to operate in only one or a few states. Further, state regulators are known for fostering strong relationships with the institutions they supervise — many of which are significant economic contributors in the states where they do business — and operating through a state charter can mean easier access to regulators.
In addition, some states, such as Utah and California, offer an industrial bank or industrial loan company charter that is not treated as a bank under the Bank Holding Company Act if it meets certain requirements. As a result, if an organization or its investors are engaged in activities that are not permissible for a bank holding company, it may make sense to consider operating through this type of charter. After a significant lull, the FDIC recently approved a de novo deposit insurance application for an industrial bank.
Finally, both federally chartered institutions and FDIC-insured state-chartered institutions are generally permitted to "export" interest from the state where they are located to borrowers in other states.
De Novo Formation vs. Acquiring an Existing Charter
Any party considering operating through a depository institution charter should consider whether to form the charter de novo or acquire an existing institution. In some respects, formation of a de novo institution is more complex than acquiring an existing institution and involves an application to a chartering authority such as the Office of the Comptroller of the Currency or a state regulator, to the FDIC seeking approval of deposit insurance and, often, to the Federal Reserve seeking approval of any bank holding company or savings and loan holding company that will control the new institution. This process can take at least a year to complete and is preceded by one or more prefiling discussions with regulators.
In contrast, groups seeking to acquire an existing institution can often complete the transaction after obtaining Federal Reserve approval of any holding company that will be formed to acquire the target institution, or they can receive Change in Bank Control Act clearance and similar change-in-control approvals required under state law. The time required to obtain approval to acquire an existing institution, absent any significant supervisory concerns, is typically shorter — often as short as a few months. In some cases, groups seeking to acquire a bank may be interested in maintaining the bank's existing management team or its existing business. In the context of an acquisition transaction, it is typically possible to convert the target institution to another charter type (for example, from state to federal) if desired.
That said, there are some advantages to forming a depository institution on a de novo basis, chief among them that organizers of a new institution need not spend time or effort performing diligence on an existing business, negotiating and closing a transaction, or conforming or disposing of unwanted assets, businesses, systems, or vendors after the deal has been completed. And the capital required to be raised to acquire and operate an existing target bank may significantly exceed the capital required to form a de novo bank.
Operating through a bank charter can offer significant benefits. It is also important to understand the consequences of, and processes for, forming or acquiring a depository institution. Additional installments in this series will address these topics.
Footnote
1. Nonbank competitors of banks offer a variety of products that are not deposits but function like them, such as cash management accounts tied to mutual funds or part of a brokerage account. Certain states offer uninsured bank charters that are permitted to accept deposits, but these charters are typically limited to accepting wholesale (and not retail) deposits.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
