According to the FDIC, 8.4 million U.S. households lacked a bank account as of 2017, putting America behind other rich countries. Minorities and the young are heavily overrepresented among the unbanked, so addressing this problem is a matter of both financial inclusion and equal opportunity. Fortunately, the FDIC can use its authority over an obscure banking charter to help, and it recently proposed to do just that. But if it goes ahead, it can expect stiff opposition from industry incumbents and their champions in Congress.
Many blame the unbanked problem on the recent decline in the number of U.S. banks. But that decline has been more than offset by the 24 percent growth of bank branch networks since 1995. Because the share of unbanked households is also often higher in urban areas, where bank branches are easiest to come by, than elsewhere, proximity to a bank office doesn't seem to be a strong driver of account ownership. Instead, the unbanked themselves generally blame their predicament on either the high cost of keeping bank accounts or their distrust of ordinary banks or both.
Slimming down the ranks of the unbanked is therefore likely to necessitate a different kind of bank—one that inspires unbanked Americans' confidence without busting their budgets. Many large commercial firms, such as retailers, grocery stores, online marketplaces, and other businesses that the unbanked regularly patronize would seem well-placed to fill such a gap. The hitch is that the 1956 Bank Holding Company Act (BHCA) generally forbids mingling commerce and banking, an American anomaly that subsequent financial legislation has only helped to entrench. While Congress got rid of the New Deal-era separation of banking and securities in 1999, it hasn't yet seriously contemplated letting non-financial firms enter the business of banking.
There is, however, an exception in current law: a commercial firm can offer certain types of bank accounts by obtaining an industrial bank charter from a state banking regulator and deposit insurance from the FDIC. Only five states currently host industrial banks, and only Utah and Nevada continue to take charter applications from commercial firms, with Utah accounting for 94 percent of industrial bank assets. All sorts of firms, including carmakers BMW and Toyota, the student loan servicer Sallie Mae, and Swiss investment bank UBS, now own industrial banks.
Owing to their exemption from the BHCA, industrial banks are a bête noire of many regulators and politicians. The Federal Reserve dislikes them because neither they nor their parent companies are subject to its consolidated supervision. Even Alan Greenspan, as close to a free-market luminary as is ever likely to run the Fed, asked Congress to get rid of them toward the end of his tenure, causing some to wonder if he'd gone native. Politicians generally oppose industrial banks because only a few states have them, while community banks, whose lobbying clout remains heavy despite their recent economic decline, give no quarter in their persistent calls to "end the industrial bank loophole." Owing partly to such strong opposition, industrial banks are a small part of the U.S. banking system, accounting for 0.8 percent ($150 billion) of total FDIC-insured assets ($18 trillion).
Yet industrial banks' safety and soundness record is actually comparably good: They fail less, hold more capital, and are more profitable than ordinary banks. Nor is there much evidence to support the accusation that they're insufficiently regulated. Like ordinary banks, they face strict limits on the amount and terms of their lending to affiliated companies. Just like bank holding companies, industrial bank parent companies must be ready to serve as a "source of strength" in times of stress. But the FDIC imposes additional standards, often requiring that industrial banks hold capital well above the statutory minimum. For example, Square, a payments firm that recently gained FDIC approval for its industrial bank, must not let its capital drop below 20 percent of assets. Ordinary banks, on the other hand, usually get a pass with 9 percent and may temporarily hold just 8 percent under the CARES Act.
Yet despite their good prudential record, industrial banks' prospects have become somewhat dimmer in the last two decades. A series of moratoria—first by the FDIC, then by the Dodd-Frank Act—kept a lid on new industrial bank charters until 2013. One event more than any other served to galvanize industrial bank opponents: Wal-Mart's July 2005 charter application. Nearly 14,000 mostly critical responses pushed the FDIC to enact its moratorium and gave Greenspan an opportunity to advocate pulling the plug on industrial banks altogether. Community bankers joined the fray, of course, arguing that a Wal-Mart bank would put them out of business, usher in monopoly, and increase risk in the system. In March 2007, the retail giant, exhausted from nearly two years of "manufactured controversy," withdrew its application. The Wal-Mart fiasco marked the start of a 15-year-long hiatus in industrial bank approvals, contributing to a dearth of new bank charters of all kinds since the 2008 financial crisis.
This March, however, the FDIC released plans that could give the industrial bank model a new lease on life. A notice of proposed rulemaking (NPR) laid out the written commitments that charter applicants must make to gain approval. Paradoxically, the new requirements may actually improve applicants' odds of success: In the past, they were left in the dark about precisely what it took to gain the FDIC's approval, with many withdrawing their applications after years-long delays. By codifying its expectations, the FDIC's proposed rule should make applicants' prospects less uncertain, thereby encouraging new applications, while increasing the speed and rate of approvals. As if to signal its good faith, the day after introducing its proposal, the FDIC approved Square's application, along with that of the loan servicer Nelnet.
But the FDIC's battle has only just begun. While its Chairman Jelena McWilliams deserves praise for tackling an issue that is sure to bring controversy, both new charters were awarded to financial sector parents and were therefore less likely to raise opposition from ordinary banks. The real test will come with applications from commercial firms. Unless the FDIC can eschew political pressure, and focus instead, as it is supposed to, on these applicants' prudential commitments and prospects for serving community needs, their applications may meet the same fate as Wal-Mart's. Much will depend on whether McWilliams keeps the vow she made in the NPR's release to "implement the law as it exists today." No doubt reassured by this promise, Japanese e-commerce firm Rakuten last week announced that it will make a second bid to establish an industrial bank, just three months after ending its first attempt.
The circumstances of Rakuten's bid will make it a crucial test case for the FDIC's new policy. Incumbents large and small yowled when Rakuten first applied for an industrial bank charter in July 2019; and they will no doubt resume their warnings that granting it will open the floodgates to other tech and commercial firms. While these incumbents' motives may be questionable, their concerns are not entirely illegitimate. For example, provisions in the current law exempting banks from disclosing their data-sharing with affiliates may have to change if commercial firms take up a bigger role in banking. This is because commercial firms, unlike standalone banks, might conceivably use financial data from their industrial bank to tailor product offerings to their customers, which would contravene the spirit if not the letter of arm's length restrictions on affiliate transactions.
But the responsibility for making such a revision belongs to Congress, as part of its larger efforts on data privacy. In the meantime, the FDIC should charter industrial banks in line with its statutory mandate, allowing them to help bank the unbanked and increase the range of options to which consumers have access. After 15 years of moratoria and delays, action to increase entry into banking is long overdue.