On March 18, Square Inc. received approval from the Federal Deposit Insurance Corporation (FDIC) and the State of Utah to open an Industrial Bank (IB), which is big news for the U.S. fintech industry. It has been more than a decade since the FDIC has approved deposit insurance for an IB. For context on this news, we caught up with well-known lobbyist Frank Pignanelli.
Frank first became involved with IBs in 1998, when his lobbying firm was approached to do work for AT&T, which had an IB at the time. Subsequently Frank became executive director of the National Association of Industrial Bankers (NAIB) in 2004, a position he has held since.
First – some background
An industrial bank (also known as an Industrial Loan Company or ILC) is a state-chartered depository institution. IBs have been on the scene since 1910. IBs are eligible for FDIC insurance and are generally subject to the same banking laws and regulations as other bank charter types.
Corporate owners of IBs do not necessarily have to be bank holding companies. This enables non-bank companies, such as fintechs, to own and operate an IB.
Historically, this class of institution has been available in Utah and only a handful of other states. Utah leads the nation both in terms of IB numbers and assets. With 15 IBs, Utah accounts for 60% of the total number and, with $143 billion, 94% of the IB industry’s total assets (01Q2017). According to NAIB, IBs enjoy a better average Return on Equity than non-IBs. [Ed. Note - Utah IB charters are listed below.]
What was the process Square went through?
FP: Square first filed with the federal government to open an IB in 2017. Prior to the application, the company had contracted with a Utah IB,Celtic Bank, to provide loans for Square’s customers.
From 2008 to 2017, the FDIC approved only four state-chartered banks of any kind, let alone any IBs. With the change of administrations and the appointment of Jelena McWilliams as Chair of the FDIC, the Square application started to gain traction.
Square underwent a rigorous federal and state process to receive approval of FDIC insurance and a charter from the Department of Financial Institutions. The solid reputation this company established from the help it supplied to thousands of American businesses was an advantage.
What does the Square approval signal from the FDIC?
This successful application sends a signal to the market that applications will be reviewed and acted upon in a timely manner.
Chair McWilliams has changed the process to speed up the review of applications. The existing regulatory framework and safety and soundness standards are already in place and she is asking regulators to remain vigilant. She is open to new IBs and reaffirmed repeatedly that de novo [new] banks are a key source of new capital, talent, ideas, and ways to serve customers.
All we ask is for the FDIC to consider applications within the existing rules and not to leave applications in limbo. That appears to be the policy of the FDIC under the leadership of McWilliams.
The applicant still has to document a strong business plan and to commit to safe and sound banking. It still may take an applicant a year or more to win approval, but if all the pieces are in place – such as capitalization – it could be worth it for a fintech with a solid business plan to apply.
Is a bank charter a good thing for most fintechs?
Most fintechs are not ready to become banks. It’s a rigorous state and federal application process.
There’s a viable alternative, which is to partner with an industrial bank, such as Square did with Celtic Bank. I encourage successful fintechs to reach out to the Utah and Nevada IBs in our association. There is a wealth of talent and experience in Utah’s financial services industry, and the IBs here can be very innovative. A number of them are really good at lending to small business. They understand the changing market. Also the state regulators here get it and are very supportive of these partnerships. I should note that Utah IB and EDCUtah investor WebBank is one of those institutions interested in partnering.
What overall trends does this development illuminate?
For one thing, the U.S. is actually underbanked. This condition arose out of the Great Recession and the Dodd-Frank legislation.
Larger banks were able to endure the added expenses created by Dodd-Frank, but many smaller banks were forced to consolidate and limit lending to consumers. During the recovery, technology options for financial services exploded. Yet, the FDIC forced state banks to adhere to an outdated 1950s model that could not answer this challenge.
The fintech market exploded in part because small businesses wanted access to capital and big banks were not always responsive, and the FDIC was making it hard for state-chartered banks to be reactive too. Fintechs stepped in to loan money to individuals and companies, but did so outside of the traditional banking system. They have neither the capitalization requirements of banks, nor consumer lending protections. So anything that makes it easier for fintechs to participate in the traditional banking system is a good thing.
Another trend is that IBs are well poised to take advantage of new technology. From the start, IBs were limited in branches. It forced them to be innovative. Now banking without branches is becoming the norm in the entire industry.
Fortunately for the country, Chairman McWilliams understands the incredible opportunities technology offers in financial services, thereby expanding safe credit for Americans. Her vision and knowledge are changing the FDIC and the nation.
Lastly, California is signaling that it’s more open to expanding banking charters. Governor Newsome and his economic development team have stated as much. It’s a positive reflection on the IB model. It will take them awhile, but that’s another development worth watching.
What are the biggest misperceptions about IBs?
I’ve heard everything from “They’re not regulated” to “They’re some weird Utah thing.”
IBs are chartered by the state and regulated its Department ofFinancial Institutions. The FDIC provides deposit insurance and also regulates IB operations. For decades, IBs have had higher capitalization than other types of banks and have been the safest and soundest institutions in the entire banking industry. They withstood the Depression and the financial crisis of2008. During the Great Recession, only one closed. All the other Utah IBs were slightly less profitable but otherwise fine in that period.
IBs are one of the most successful financial experiments this country has ever had. Most Utahns don’t even know they exist. We can thank our former senators Garn, Bennett, and Hatch and former and current Congress members Jim Matheson, Mia Love and Ben McAdams for protecting the IB industry in Utah. Also, we owe much to Commissioner Ed Leary of the Utah Department of Financial Institutions for having the vision and fighting for a strong IB Charter. The Governor’s Office of Economic Development also promoted the industry. In fact, both the Utah and Nevada economic development departments were instrumental in protecting IBs during the tough years after the Great Recession.
So, it is no surprise that Utah has the lion’s share of IBs in the country.
Another asset is the Utah Bankers Association, which represents national and state-chartered financial institutions, including community banks, regional banks, money center banks and industrial banks. UBA President Howard Headlee has a unique perspective and is a strong proponent of industrial banks. He has remarked, “Industrial Banks are regulated just like every other type of bank, and in Utah we have come to understand that even though at times we are tough competitors, we are stronger when we stand together.”
Bonus question - When EDCUtah talks to out-of-state fintechs, what’s the message?
What I would convey is that IBs have contributed to the overall success of Utah’s financial services industry, which is the largest strategic cluster in the state. IBs have generated a base of talent and have – in financial circles – created a level of respect for Utah across the entire banking industry.
Howard Headlee concurs: “Utah is already at the forefront of innovation in financial services. We welcome new ideas, collaboration, and partnerships - they thrive here. Key to that is having one of the strongest, most experienced and respected state regulators. When states talk about creating a financial services sandbox, I smile, because Utah has been a sandbox for the past three decades.”
One last point - Goldman Sachs originally had an IB in Utah years ago. The Federal Reserve forced them to sell it, for reasons having nothing to do with the bank. The chairman of Goldman Sachs called me, and said, “Frank, I hate to close this bank. It’s making money, and we love Utah.”
Well, they did have to close the charter, but that experience with Utah – along with their tech operations presence in Research Park – led the company to open other operations here. It employs about 3,000 people in Salt Lake City now. The IB was key to the Goldman Sachs success story in Utah.
For more information, visit http://industrialbankers.org
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And on the same day as Square’s approval, the FDIC also approved an IB charter for Nelnet, an educational lender: https://www.fdic.gov/news/news/press/2020/pr20034.html
Video on the financial services “sandbox”: https://youtu.be/HRfv0G_-zW0
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