Dodd-Frank Moratorium Ends on Bank Charters for Commercial Firms

The following post comes to us from Arthur S. Long, partner in the Financial Institutions and Securities Regulation practice groups at Gibson, Dunn & Crutcher LLP, and is based on a Gibson Dunn publication by Mr. Long, Alexander G. Acree, Kimble C. Cannon, C.F. Muckenfuss III, and Colin C. Richard.

This post addresses the end of the Dodd-Frank Act moratorium on the ability of “commercial firms” to acquire FDIC-insured banks that are excluded from the definition of “bank” in the Bank Holding Company Act: industrial banks (or “ILCs,” as they are commonly labeled) and credit card banks. The moratorium, set forth in section 603 of the Dodd-Frank Act, ended on July 21, 2013, and it is now again legally permissible for any type of company—retailer, manufacturer, or any type of nonfinancial firm—to seek to acquire or establish such an FDIC-insured bank.

Federal law has contained provisions expressly permitting any type of company to control an ILC or credit card bank for decades, but the Federal Reserve Board and, more recently, the FDIC have expressed policy concerns with the control of insured banks by commercial firms. The Dodd-Frank moratorium followed a similar moratorium on approvals for an ILC to be controlled by a non-financial firm, which the FDIC implemented in 2006-2008 and then continued de facto after it formally ended. We understand that at least three applications filed before the beginning of the FDIC moratorium were not acted on even though the moratorium did not apply to them. Section 603 of Dodd-Frank reflected the same policy concerns, but it has now expired, and the underlying provisions of law permitting control by commercial firms remain in effect.

Owning an ILC or credit card bank can benefit a commercial firm. Current examples of commercial firms that own such institutions are Pitney Bowes and BMW, which received FDIC approval and established their banks before the 2006 moratorium. The benefit comes from controlling an affiliated financing vehicle that may make loans—credit card and otherwise—to consumers, and that also has the advantage of lower-cost FDIC-insured deposit funding.

An ILC is a state-chartered banking institution that functions in almost every way like a commercial bank; the only meaningful difference is that if an ILC has more than $100 million in assets, it may not accept demand deposits. Such plus-$100 million ILCs may, however, offer NOW accounts, MMDAs, and time deposits (CDs), and so the limitation is not a meaningful constraint on their activities. ILCs may make all types of loans. They are most often chartered in Utah, which has a developed scheme of supervision and regulation for such institutions, but also in Nevada and California.

A limited-purpose credit card bank may be chartered by either the Office of the Comptroller of the Currency or a state. Such banks are more restricted in their activities than ILCs. On the asset side of their balance sheet, they are generally restricted to making credit card loans, including to small businesses. Such banks may maintain only one office that accepts deposits, may not accept demand deposits or transaction accounts, and may not accept savings or time deposits of less than $100,000 except as collateral for credit card loans. As a result, they generally may need to rely to some degree on parent company funding, either through loans, wholesale savings and time deposits, or purchases of credit card receivables.

In addition to imposing the recently ended moratorium, the Dodd-Frank Act required a study by the Government Accountability Office (GAO) on the regulatory implications of limited-purpose bank charters. The GAO released its report in January 2012 and did not recommend that Congress repeal the federal law provisions that allow ownership of ILCs and limited-purpose credit card banks by commercial firms; Congress has taken no further action. The Report found that ILCs had declined in number and size since 2006—from 58 to 34, with the assets of such institutions dropping from $212.7 billion to $102.4 billion—and that currently 10 limited-purpose credit card banks are operating.

The GAO also noted that the bank regulators have a difference of opinion regarding the adequacy of regulation of these two types of limited-purpose institutions. The regulators with primary authority over the institutions, the OCC in the case of most credit card banks, and the FDIC in the case of ILCs, told the GAO they believe that current law as implemented provides effective regulation and supervision of these banks and their affiliates. The Federal Reserve and the Treasury Department took a different view, contending that the BHC Act exemptions represent gaps in the current regulatory structure and pose risk; in particular, that no supervisor has the authority to oversee the entire corporate structure where the limited-purpose bank is a subsidiary of a holding company or commercial company. The GAO report did not endorse any new supervisory requirements. Knowledgeable outside commentators, including former banking agency leaders, however, have previously testified that the FDIC and OCC have ample authority to regulate and supervise insured banks and their affiliates even if controlled by a commercial firm.

The regulators that have the power to approve applications by commercial firms to acquire ILCs and limited-purpose credit card banks, or to establish them de novo, are the FDIC and the OCC, not the Federal Reserve or the Treasury. As noted above, there is no longer any statutory impediment to the approval of such applications, and indeed, Dodd-Frank evidences a congressional policy that such applications should be considered under applicable federal standards and may be approved. We would note that since the onset of the financial crisis in 2008, the economic environment for start-up banks of any type has not been very favorable, and the banking agencies have enhanced the rigor with which they scrutinize the business plans, financial projections, and proposed activities of all banks, including the degree to which they rely on brokered deposits, which the FDIC has seen as potentially increasing a bank’s risk profile. As between the two charters, a limited-purpose credit card bank charter is likely to draw less regulatory scrutiny than an ILC charter due to the more restricted nature of its activities.

An additional provision of Dodd-Frank to be considered requires a company that owns an ILC or limited-purpose credit card bank to serve as a “source of strength” to the institution. The U.S. bank regulators are required to issue regulations interpreting this requirement, but no regulations have yet been proposed, let alone finalized. Under prior Federal Reserve practice with respect to banks not exempt from the Bank Holding Company Act, the term “source of strength” means that the company owning the bank may be required to downstream capital into the bank if the bank becomes undercapitalized, although the Federal Reserve has not consistently applied this requirement. For a number of years, regulatory approvals of acquisitions of ILCs and limited-purpose credit card banks have been conditioned on capital maintenance agreements with the acquiring company, under which the acquiring company consents to keep the bank “well-capitalized.” In addition, a company acquiring an FDIC-insured ILC or limited-purpose credit card bank will become subject to the Dodd-Frank “Volcker Rule” ban on proprietary trading and sponsoring or owning hedge funds and private equity funds.

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