The FDIC has issued a proposed rule setting forth the conditions it would impose and the commitments it would require to approve a deposit insurance application from an industrial bank or industrial loan company (collectively, ILC) whose parent company is not subject to consolidated supervision by the Federal Reserve Board (FRB).  The proposal is a significant development for fintech companies and other commercial companies seeking to establish ILCs.

As a general matter, the proposal would codify the FDIC’s current supervisory processes and policies for ILCs that would not be subject to consolidated FRB supervision and “add additional safeguards the FDIC believes are appropriate based on its experience.”  Part IV of the Supplementary Information accompanying the proposed rule contains a section-by-section description of the proposal with a series of questions for each section on which the FDIC seeks comment (17 questions in total).  Comments on the proposal will be due no later than 60 days after the date of publication in the Federal Register.

The proposal would apply to an ILC that, after the effective date of a final rule, becomes a subsidiary of a “Covered Company.”  A “Covered Company” is defined as any company that is not subject to federal consolidated supervision by the FRB and that after the effective date of the final rule, directly or indirectly, controls an ILC (1) as a result of change in control under Section 7(j) of the FDI Act or a merger pursuant to Section 18(c) of the FDI Act, or (2) that is granted deposit insurance under Section 6 of the FDI Act.  A company would “control” an ILC if it has the power, directly or indirectly, to vote 25 percent or more of any class of voting shares of any ILC or any company that controls the ILC, or to direct the management or policies of any industrial bank or parent company.  (The FDIC would also apply certain rebuttable presumptions of control.)  Grandfathered ILCs (i.e. an ILC that is a subsidiary of a company not subject to consolidated FRB supervision on or before the effective date) could become subject to the proposed rule following a change in control, merger, or grant of deposit insurance that occurs after the final rule’s effective date in which the resulting institution is an ILC that is a subsidiary of a Covered Company.

Commitments by Covered Company.  The proposal would prohibit 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 the ILC in which the Covered Company (or each Covered Company) makes the eight commitments listed below.  Compliance with the commitments would be a condition of the FDIC’s grant of deposit insurance, issuance of a nonobjection to a change in control, and approval of a merger.  The proposal would also allow the FDIC, at its sole discretion, to require a controlling shareholder of a Covered Company to join as a party to the written agreement among the FDIC, ILC, and Covered Company as a condition of granting deposit insurance, issuing a nonobjection to a change in control, or approving a merger.

A Covered Company must commit to:

  • Give the FDIC an initial listing, with annual updates, of the Covered Company’s subsidiaries
  • Consent to the FDIC’s examination of the Covered Company and its subsidiaries
  • Submit an annual report to the FDIC on the Covered Company and its subsidiaries and such other reports as requested by the FDIC regarding specified information such as the Covered Company’s financial condition
  • Maintain such records as deemed necessary by the FDIC to assess risks to the ILC or the deposit insurance fund
  • Cause an annual independent audit of each subsidiary ILC
  • Limit the Covered Company’s representation on the ILC’s board of directors or managers to 25%
  • Maintain an ILC’s capital and liquidity at such levels as the FDIC deems appropriate and take such other actions as the FDIC deems appropriate to provide the ILC with a resource for additional capital and liquidity, including, for example, pledging assets, obtaining and maintaining a letter of credit from a third-party institution acceptable to the FDIC, and providing indemnification of the ILC
  • Enter into a tax allocation agreement with the ILC that includes certain provisions, including an express statement that an agency relationship exists between the Covered Company and the ILC with respect to tax assets generated by the ILC

In addition to these eight commitments, the FDIC could require a Covered Company and ILC to commit to provide to the FDIC and implement “a contingency plan subject to the FDIC’s approval that sets forth, at a minimum, recovery actions to address significant financial or operational stress that could threaten the safe and sound operation of the [ILC] and one or more strategies for the orderly disposition of the [ILC] without the need for the appointment of a receiver or conservator.”  The FDIC could also, “at its sole discretion, require additional commitments by a Covered Company, or by an individual who is a controlling shareholder of a Covered Company.”

Restrictions on Covered Company’s ILC Subsidiary.  The proposal would prohibit an ILC from taking certain actions without the FDIC’s prior written approval after it becomes a subsidiary of a Covered Company.  An ILC must obtain such approval to:

  • Make a material change in its business plan
  • Add or replace a member of its board of directors, board of managers, or a managing member
  • Add or replace a senior executive officer
  • Employ a senior executive officer who is associated in any matter (e.g., as a director, officer, employer, agent, partner, or consultant) with an affiliate of the ILC
  • Enter into any contract for services material to the ILC’s operations (e.g., loan servicing function) with the Covered Company or any of its subsidiaries

At its sole discretion, in addition to denying approval for any of the above actions, the FDIC could impose restrictions on the activities or operations of an ILC that is controlled by a Covered Company.

The proposed rule, together with the FDIC’s recent approvals of deposit insurance applications for Nelnet Bank and Square Financial Services, Inc., suggest the ILC charter as a viable alternative to the OCC’s fintech charter, which has been stalled by litigation.  Importantly for a parent company the controls an ILC that is exempt from the Bank Holding Company Act (BHCA) definition of a “bank,” such parent company will not be subject to restrictions in the BHCA and Federal Reserve Board Regulation Y on nonbanking activities imposed on a bank holding company or a financial holding company.  To be eligible for the “bank” exemption, an ILC must have received a charter from a state eligible to issue ILC charters and the law of the chartering state must have required federal deposit insurance as of March 5, 1987.  In addition, an ILC must meet one of the following criteria: it must (1) not accept demand deposits, (2) have total assets of less than $100 million, or (3) have been acquired before August 10, 1987.