EDITOR NOTE: The FDIC finalized a rule allowing non-financial companies to operate as lenders. Not only does this open the banking industry to competition, it also forces banks to ramp up their innovation efforts, focusing less on new products and more on designing tech processes that may make banking easier for clients. In short, less profit-oriented and more customer-centric. To date, the three big companies entering this new arena are Amazon, Facebook, and Walmart (companies whose massive size has everything to do with their customer-centric innovations). More companies are likely to follow in their footsteps. Any competition in the banking space is welcome, as that can only bring more choices to customers. And because these non-bank entities are not handling customer deposits, in addition to having a much more diversified portfolio and revenue stream, customers may find such companies less risky and perhaps even more trustworthy than their banking counterparts.
The Federal Deposit Insurance Corporation (“FDIC”) recently passed the final rule concerning parent companies of industrial banks (IB). Notably, the same is expected to trigger certain nonbank companies into applying for an IB charter.
Per the rule, effective Apr 1, 2021, an industrial loan company will be able to become a subsidiary of any another company, which is not under the Federal Reserve’s supervision, after all the concerned parties sign written agreements with the FDIC.
In layman’s terms, an industrial loan company (ILC) lends money and their deposits are insured by FDIC. Also, these may be owned by non-financial institutions. Thus, this major change is expected to make traditional banks face competition from other the FinTechs and corporate giants such as Amazon.com AMZN, Facebook FB, Walmart WMT and others.
Non-banking companies will be able to engage in limited banking activities, despite not being subject to the strict regulation and supervision faced by banks.
Nevertheless, in the rule passed, the regulator has mandated the parent companies to maintain significantly higher capital than other insured banks and sign agreement on capital and liquidity maintenance, consent to FDIC examinations and annual external audits. The companies will also need to maintain appropriate records and reporting requirements.
The rule approved is similar to what had been proposed in March 2020. The only changes being certain additional reporting requirements, and that ILC's board of directors may consist of less than 50% (up from 25%) representation from parent company. Also, certain restrictions have been imposed on ILC subsidiaries related to appointment of directors and senior executive officers during the first three years after becoming a subsidiary.
FDIC Chairman Jelena McWilliams said, “This rule addresses two important supervisory goals: it provides transparency by codifying FDIC’s long-standing practice, while ensuring that all industrial bank applicants for deposit insurance and their parent companies understand regulatory expectations before they commence the application process.”
Per an article by Banking Dive, FDIC is said to have received 12 deposit insurance applications from proposed ILCs since 2012. Of those, two have been approved, eight have been withdrawn and two are pending.
Notably, the applications of a FinTech firm, Square SQ, and student loan servicer Nelnet's were approved in March, which faced widespread criticism from banking organizations and democrats.
Further, McWilliams is willing to consider Japanese online services provider, Rakuten’s RKUNY charter to set up its own bank. If this charter gets approval there would be nothing stopping the non-banking giants from entering the banking industry with considerably lesser supervision.
Banks to Feel Threatened?
Though entry of corporate giants and FinTechs into traditional banking domain will definitely have an adverse impact on banks’ market share, it will not be so easy as several mandates and regulatory institutions continue to prevent the same.
However, as consumers are getting more comfortable with the use of digital technology (online and mobile banking), banks must gear up and improve their digital offerings to counter tech firms’ growing popularity. While banks have started making efforts on this front, those initiatives are still at a developing stage.
Therefore, to counter tech giants, banks need to catch up and fill the lag at a faster pace. Instead of pushing products to the clients, banks need to put customers first and make major changes about how to carter to requirements of millennials.
Originally posted on Nasdaq