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Square, Nelnet receive approvals to build banking arms after regulatory changes

Brian Cheung
MELBOURNE, AUSTRALIA - APRIL 11: (AUSTRALIA OUT) Jack Dorsey, co-founder and CEO of Square and Twitter, is interviewed at Five & Dime Bagel on April 11, 2016 in Melbourne, Australia. Dorsey is visiting Australia for the first time. (Photo by Louis Ascui/Fairfax Media via Getty Images via Getty Images)

Payments processor Square (SQ) and educational services company Nelnet (NNI) will soon have something in common: banking services.

Both companies announced Wednesday that they had obtained conditional approval from the Federal Deposit Insurance Corporation to create “industrial loan company” (ILC) banks that can offer deposit products and loans, just as traditionally chartered banks do. 

The announcements were made one day after the FDIC clarified its stance on allowing non-financial companies to operate banks with full deposit insurance, re-opening the door for large retailers and fintech companies to compete in the industry.

The FDIC was facing pending applications from Square, Nelnet, and Japanese e-commerce company Rakuten to build their own financing arms.

Square said in statement that it plans on offering small business loans and deposit products, while the coming Nelnet Bank hopes to provide private student loans. Both approvals are conditional on providing capital adequacy and proper liquidity management.

ILCs have existed for decades, many within companies that should be familiar to most households: BMW, Toyota (TM), and Harley-Davidson (HOG). Large and expensive purchases like a car often require financing so offering bank-like products was a natural evolution. 

Companies were free to apply for an ILC charter with the FDIC until 2005, when Wal-Mart (WMT) attempted to build its own financing arm. But public backlash pushed the regulator to freeze ILC charters and the ensuing financial crisis ultimately pushed Wal-Mart to withdraw its application.

Since then, few companies have attempted to ask for an ILC even though the FDIC’s self-imposed moratorium expired in 2013.

The next generation of ILCs

But over the last few years, a whole new cohort of business models like Square and Nelnet sought to expand deeper into the financial services industry via an ILC.

FDIC staff say the proposed rule Tuesday is a codification of the existing ILC application and regulatory process. A noticeable change is a “financial strength” requirement where the parent company is forced to set aside a standing pool of money to pay down to the ILC in the event that the financing arm falters in its capital levels.

The banking industry has been vocally opposed to the FDIC making the change. The Independent Community Bankers of America have expressed concern over the ILC structure allowing banks to avoid oversight from the Federal Reserve, which normally supervises bank holding companies. 

Bank holding companies will often be regulated by both the Fed and the FDIC (in some cases the Office of the Comptroller of the Currency).

The ICBA has said in the past that allowing ILC parent companies to avoid the Fed leaves “a dangerous gap in safety and soundness oversight.”

BEVERLY HILLS, CA - APRIL 29: Jelena McWilliams, Chairman, Federal Deposit Insurance Corporation, participates in a panel discussion during the annual Milken Institute Global Conference at The Beverly Hilton Hotel on April 29, 2019 in Beverly Hills, California. (Photo by Michael Kovac/Getty Images)

FDIC Chair Jelena McWilliams said in a statement that the “proposal would ensure that parent companies serve as a source of strength for their industrial bank subsidiaries.”

The proposal was unanimously approved by the FDIC board on Tuesday in a 4-0 vote.

Brian Cheung is a reporter covering the Fed, economics, and banking for Yahoo Finance. You can follow him on Twitter @bcheungz.

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