Are fintechs better off taking the ILC route to banking?

WASHINGTON — Growing uncertainty about a new federal charter offered by the Office of the Comptroller of the Currency is magnifying a different option for fintech firms seeking a way into the banking sphere: the industrial loan company.

ILCs are state charters most popular in Utah that get deposit backing and supervision from the Federal Deposit Insurance Corp. ILCs have faced their own set of questions over the years, but unlike other types of licenses they are popular with companies not typically thought of as banks.

And with the Federal Reserve Board speculated to be a complicating factor in whether the new OCC charter takes off, observers say firms could give the ILC another look. The Fed is said to be resisting the idea that fintech firms receiving the new OCC charter should gain entry to the payments system or have the same access as banks to the Fed's discount window.

Andrew Harrer/Bloomberg

“The lack of certainty on where the Fed stands on key issues — like the application of the Bank Holding Company Act or what it might charge a fintech to become a bank — could drive fintechs to explore the ILC charter,” said Sam Taussig, head of global policy at Kabbage, an online small-business lending platform. “Certainly, the ILC charter has its own challenges, but it may be an attractive option depending on the fintech’s business model.”

The difficulty for fintech firms trying to avoid 50 state chartering regimes is how to avoid the full set of regulatory hassles of being a commercial bank but still enjoy certain benefits of a federal charter.

Despite state regulators' legal challenge of the OCC's special-purpose charter, the new license is viewed by the industry as a potential happy medium. But if the Fed ultimately decides not to allow OCC-licensed companies into the payments system, it could undermine one of the perceived advantages, observers say.

In contrast, ILCs — for all the controversy that has surrounded them since Walmart's failed attempt to own one — might offer more certainty. While they are supervised like banks, ILC parents are exempt from bank holding rules (meaning nonfinancial firms can own them). And their access to the federal safety net — including federal deposit insurance and the payments system — is unquestioned.

“The markets embrace certainty and predictability, and their absence makes decisions difficult for executives” when considering a charter, Scott Talbott, senior vice president of government relations at the Electronic Transactions Association, said of questions surrounding the OCC charter. “The good news is fintech and financial companies have multiple charter options to best suit their business models, like the ILC option. More choices are always better.”

During a meeting with reporters, Comptroller of the Currency Joseph Otting said it was “still my expectation” to have an applicant for the new OCC charter announced in the first quarter. He also dismissed the Fed as a potential stumbling block, saying that fintech firms could still process payment transactions even if they lack direct access to the payments system.

Still, recent media reports that certain top Fed officials remain resistant to fintechs entering the banking system may have a chilling effect on those considering charter bids.

To be sure, the ILC charter has had its own set of issues. FDIC approvals have been rare and numerous applicants interested in an ILC — including fintech firms — have recently withdrawn their bids to bolser their applications. The Fed and community banks have historically resisted nonbank companies using the ILC as a way into the banking system.

Critics of the charter say it blurs the line between commerce and banking and gives loopholes to firms because the charter does not subject ILCs to Bank Holding Company Act requirements.

“It’s only a matter of time before a really big tech company uses this loophole and that also presents an unlevel playing field with community banks,” said Christopher Cole, executive vice president and senior regulatory counsel at the Independent Community Bankers of America.

But in a notable sign, Square — the payments company led by CEO Jack Dorsey — recently refiled its ILC application after having previously withdrawn, indicating the fintech is serious about obtaining the FDIC's approval. And ever since she was questioned by senators in her nomination hearing, FDIC Chair Jelena McWilliams has shown openness to ruling on new ILC charters.

The Square bid could be a bellwether; if it is successful, it could lead other firms to pursue the ILC charter.

“There’s a number of other folks preparing ILC applications and assembling teams. ... So we anticipate some activity in that regard,” said Howard Headlee, president of the Utah Bankers Association. He added that access to FDIC deposit insurance has been noted as a benefit of the ILC over the OCC charter. “All those that I’ve talked to said insured deposits are a critical part of business plan.”

Otting said a lack of access to the payments system for firms receiving the OCC charter should not be seen as a roadblock.

“I can tell you of the hundreds of meeting I’ve had with fintechs, not one has brought that issue up as an impediment,” he said.

“Most of these entities that today would apply to be a bank, many of them are operating today as a state-chartered or state-licensed lender. And virtually all of them have a correspondent banking relationship with a large bank that gives them the ability to process checks and send wires.”

However, many firms that offer money transfer services say it’s far more costly to do so through a banking relationship than if they had direct access to the Fed payment system.

"Eliminating a dependency on banks as an access point lowers systematic risk, in the case of bank failure or de-risking,” Andrew Boyajian, head of banking for North America at TransferWise, said in an emailed statement. “And, in turn, it lowers the cost of financial services offered by fintechs.”

The Fed has so far not directly addressed whether it will allow fintechs into it payments system, its discount window or to become a Fed member bank — all critical components in helping a fintech determine exactly how much it will cost, or save them, in becoming a bank.

During an American Bar Association conference in Washington Jan. 12 in which the audience questioned other regulators about the Fed’s position, an OCC official remained vague but said the Fed will eventually be forced to respond.

“Quite honestly . . . and this is my opinion, once we start having some of these charters approved and we go to the Fed membership and the issue about what services are offered, the Fed will be put in position to start opining on those things,” said Stephen Lybarger, deputy comptroller of licensing at the OCC. “And that will be further guidance to the industry and even to us.”

Fed staff have indicated that they will make a decision on an individual basis as applicants file with the OCC.

“The Federal Reserve staff has been coordinating closely with the OCC on this charter issue. And we’re trying to follow all the related developments,” said Jeff Ernst, senior fintech risk manager at the Fed, during a Sept. 6 fintech conference in Washington.

When asked about ILCs, Otting said he was open to them if they steered consumers to better options within the banking system, noting how people were forced into “bad” payday loans the last time regulators clamped down on banks in the small-dollar lending space. (As a member of the FDIC board of directors, Otting could potentially have a say on ILC applications.)

“I would be very much interested in pursuing" ILCs "if I thought that they would bring more choice to consumers and small businesses,” Otting said.