The FDIC has issued a final rule setting forth the conditions it will impose and the commitments it will 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).  Along with the FDIC’s final rule regarding brokered deposits, the adoption of the final rule represents a significant development for fintech companies and other commercial companies seeking to establish ILCs.

The final rule is effective on April 1, 2021 and substantially adopts the FDIC’s proposal.  The final rule makes the following substantive changes to the proposal:

• Scope. The final rule will apply only to an ILC that, on or after the effective date of the 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 on or after April 1, 2021, 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 will apply certain rebuttable presumptions of control.)  The final rule did not adopt the proposal’s treatment of 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).  If the proposal’s treatment had been adopted, a grandfathered ILC could have become subject to the final rule if there was a change in control, merger, or grant of deposit insurance on or after the final rule’s effective date in which the resulting institution was an ILC that was a subsidiary of a Covered Company.
• Commitments by Covered Company.  The final rule prohibits an ILC from becoming a subsidiary of a Covered Company unless the Covered Company enters into a written agreement with both the FDIC and the ILC in which the Covered Company makes eight commitments specified in the rule.   Such commitments include:
  • A commitment to submit an annual report to the FDIC on the Covered Company’s operations and activities that contains specified information.  In response to concerns expressed by commenters that a Covered Company that is not engaged in financial services would not be covered by the Gramm Leach Bliley Act, the FDIC revised this commitment in the final rule to require a Covered Company to include in the annual report information about its “systems for protecting the security, confidentiality, and the integrity of consumer and nonpublic personal information.”
  • A commitment to limit the Covered Company’s representation on the ILC’s board of directors or managers to 25% of the board members.  In response to concerns of commenters, including “the potential numeric challenges that could confront industrial banks whose boards are comprised of a comparatively small number of directors,” the FDIC revised this commitment in the final rule to establish a less than 50% threshold.
  • A commitment to maintain the capital and liquidity of the subsidiary industrial bank at such levels as the FDIC deems appropriate, and take such other actions as the FDIC deems appropriate to provide the subsidiary industrial bank 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 subsidiary industrial bank.
• Restrictions on ILC’s appointment of directors and senior executives.  The final rule prohibits a Covered Company’s ILC subsidiary from taking certain actions without the FDIC’s prior written approval.  The actions for which an ILC must obtain such approval include (1) the addition or replacement of a senior executive officer or a member of its board of directors, board of managers, or a managing member, and (2) the employment of a senior executive officer who is or has been associated in any matter (e.g., as a director, officer, employer, agent, partner, or consultant) with an affiliate of the ILC.  Under the proposal, prior FDIC approval for the addition or replacement of a board member or senior executive officer would have been required if such action was taken at any time after an ILC became a subsidiary.  For hiring a senior executive officer associated with an affiliate of the ILC, prior FDIC approval would have been required regardless of when the officer was associated with the affiliate.  Under the final rule, prior written FDIC approval is required for (1) the addition or replacement of a board member or senior executive officer only during the first three years after the ILC becomes a subsidiary of a Covered Company, and (2) the employment of a senior executive office if he or she is currently associated with an affiliate of the ILC or was associated in the three years preceding employment.

As suggested by the FDIC’s recent approvals of deposit insurance applications for Nelnet Bank and Square Financial Services, Inc., an ILC charter can be a viable alternative to the OCC’s fintech charter, which has been stalled by litigation.  Importantly for a parent company that 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.  Although we believe the ILC charter remains attractive to fintech companies and other entities that seek to avoid BHCA restrictions on nonbanking activities, it will have to be determined what resources for additional capital a parent company is required to provide for the subsidiary industrial bank.

It should be noted that the FDIC’s final rule was quickly met with criticism.  In a joint statement, the Center for Responsible Lending, Bank Policy Institute, and the Independent Community Bankers of America challenged the FDIC’s position that the rule will formalize and strengthen the existing supervisory processes and policies that apply to parent companies of ILCs that are not subject to Federal consolidated supervision.  According to these groups, the rule’s actual effect “will be to signal that this charter is a viable back-door option for entering the business of banking without the obligations of consolidated supervision by the Federal Reserve.”  They also assert that the rule “cuts against the grain of the long-established separation of banking and commerce, embodied in the [BHCA]” and “will encourage companies, including Big Tech firms, to acquire ILC charters that will receive the benefits of a bank license, without the federal oversight of the parent company required for traditional banks — posing both consumer protection and systemic risks.”  Finally, they claim that because of the final rule’s April 2021 effective date, “firms may attempt to secure their charter in the next few months in order to avoid being subject to this rule” and call upon Congress “to close the statutory loophole that permits commercial firms to own ILCs without being subject to Federal Reserve supervision.”