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A new US bill, introduced by a top Democratic senator, would close a legal loophole that allows companies to operate banks without proper oversight, addressing fears that bigtechs may exploit it to expand their financial services.
The Close the Shadow Banking Loophole Act would end a long-standing technicality which allows commercial companies to own banks while escaping stringent federal oversight.
So-called industrial loan companies (ILCs) are state-chartered banking institutions whose holding companies are not subject to consolidated supervision by the Federal Reserve, as all other bank holding companies are, due to a loophole in the Bank Holding Company Act.
The result is that ILCs owned by technology companies, such as Square/Block, have an advantage over traditional banks with regulatory safeguards.
“Letting bigtech and commercial companies operate banks without proper oversight will only open doors for predatory lending, invasions of consumer privacy, and broader financial instability,” said Senator Sherrod Brown (D-OH), chair of the Senate banking committee and main sponsor of the bill.
“To protect consumers’ pocketbooks and ensure a strong banking system for Main Street, we need to ensure all banking institutions play by the same rules,” he added.
An outstanding loophole
Generally, US law prohibits commercial enterprises from operating banks. The separation between commercial and banking activities has been a long-standing US policy which is intended to ensure that no company can offer both a product and the loan to purchase that product.
An outstanding exception to the rule are ILCs, which are financial institutions chartered in six states, including the economic powerhouse California. These companies function much like typical banks but they can be owned by commercial firms.
The 50-year-old Bank Holding Company Act exempts ILCs from the definition of a bank and, therefore, from federal banking oversight. Meanwhile, another piece of legislation, the FDIC Act, treats ILCs as state banks allowing them to obtain deposit insurance.
In practice, it means that ILCs can benefit from all of the privileges of being an insured commercial bank, including deposit insurance, access to the payments system and nationwide operations, without their holding companies being subject to the consolidated supervision by the Federal Reserve.
Bigtech foray into financial services
ILCs have traditionally been used by small loan companies but have increasingly become a preferred way for commercial firms to start offering banking services.
In 2005, retail giant Walmart, and later Home Depot, sought to set up an ILC. However, public and congressional backlash forced the companies to drop their plans.
Subsequently, Congress placed temporary moratoriums on ILCs and it was not until 2020 that the Federal Deposit Insurance Corporation (FDIC) approved new applications by two ILCs — payments giant Square/Block and student loan servicer Nelnet.
Policymakers now fear that bigtech companies could use the charter to expand their financial offerings, which currently rely on partnerships with traditional financial institutions.
These worries seem to be supported by the fact that Japanese e-commerce giant Rakuten is in the process of seeking an ILC charter and Google’s scrapped plans to offer online checking and savings accounts.
Google announced the launch of a banking service, called Plex, in 2020 but eventually dropped the project last October. Certain media and industry reports suggested at the time that the bigtech took that decision to avoid the appearance that it was competing with banks, which are large customers of Google’s cloud service.
Alternative solutions, such as an ILC, could enable bigtechs to both avoid direct competition with banks and be subject to less strict scrutiny by regulators.
Meanwhile, CNBC speculates that the introduction of the bill could have been accelerated by Elon Musk’s grandiose plans to turn Twitter into a super app, which could potentially involve an application for an ILC charter.
"History has shown us the consequences of allowing companies to operate like banks without the necessary safeguards," said Renita Marcellin, advocacy and legislative director at Americans for Financial Reform, one of the 22 industry associations endorsing the proposal.
"ILCs are a part of that history, as seen during the 2008 financial crisis. Congress should act to close this loophole that allows tech conglomerates and other commercial companies to skirt our banking laws," she added.
Brown first introduced legislation to close the ILC loophole in 2007.
The version filed this week with Congress requires companies that acquire an ILC to be subject to the same supervision by the Federal Reserve as any other bank holding company under the Bank Holding Company Act.
It would also establish a process for pending ILC applications.
The company did not reply to a request for comment by the time of publication.
A similar bill, called Close the ILC Loophole Act, was introduced in the House by Congressman Jesús “Chuy” García (D-IL) in June.
