The FDIC Issues Proposed Rule for Parent Companies of Insured Industrial Banks on the Eve of Approving Deposit Insurance Applications for Two De Novo ILCs
On March 17, 2020, the Federal Deposit Insurance Corporation announced a proposed rule (Proposed Rule) for the supervision of commercial firms (referred to herein as parent companies) that control an industrial loan company, industrial bank or a similar institution (collectively referred to herein as "industrial banks") that are not otherwise subject to consolidated supervision by the Board of Governors of the Federal Reserve System (Federal Reserve).1 The Proposed Rule was introduced a day prior to the FDIC's announcement approving the deposit insurance applications of two de novo industrial banks2—which will allow for the establishment of the first de novo insured industrial banks since 2007—and weeks after the FDIC published updated guidance to its Deposit Insurance Application Procedures Manual, including a new supplement focused on the processing of deposit insurance applications from nonbanks and nontraditional banks.3 While the FDIC affirms that the Proposed Rule is essentially a codification of existing practices, policies and procedures of the agency, the notice of proposed rulemaking (NPR) provides much needed transparency on the considerations the FDIC will apply in reviewing deposit insurance applications, change in control notices and merger applications involving industrial banks.
This Advisory provides a high-level summary of the Proposed Rule, including questions of great significance to the FDIC's supervision of commercial firms that are parent companies of an industrial bank. The comment period for the NPR is scheduled to end on June 1, 2020.
II. Overview of Proposed Rule
In the NPR, the FDIC discusses in depth the history of industrial banks, as well as the FDIC's role as the primary federal regulator of all industrial banks currently in existence. An industrial bank is generally an insured state-chartered financial institution that is organized in one of the seven states with chartering authority over such entities and limits its activities to those that allow it to qualify for an exemption to the definition of "bank" under the Bank Holding Company Act of 1956, as amended (BHC Act).4 The Competitive Equality in Banking Act amended the BHC Act to exclude from the definition of "bank," insured industrial banks that meet certain criteria, including (i) being chartered in one of the seven states that had an industrial bank charter enacted or contemplated as of March 5, 1987,5 and (ii) not accepting demand deposits or maintaining less than $100 million in total consolidated assets.6
An industrial bank is a "bank" under the Federal Deposit Insurance Act (FDI Act),7 and the FDIC generally applies the same regulatory and supervisory requirements to industrial banks as it does for state-chartered nonmember banks. The FDIC does not have consolidated supervisory authority over the parent company of an industrial bank; however, it does have limited supervisory authority, including limited examination authority and the ability to require the parent company to serve as a source of strength to its subsidiary industrial bank(s).8
According to the FDIC, its decision to codify its existing practices, policies and procedures related to applications and notices involving industrial banks with a parent company not subject to consolidated supervision by the Federal Reserve is driven by (i) the continuing evolution in the use of the industrial bank charter, (ii) the unique nature of applicants seeking to establish de novo industrial banks, (iii) legitimate considerations raised by interested parties both in support of and opposed to the industrial bank charter, and (iv) a desire to ensure that the parent company of an industrial bank serves as a source of strength to its subsidiary industrial bank.9
Below is further discussion of the Proposed Rule, including (i) the proposed scope of applicability, (ii) mandatory written agreements and conditions of a Covered Company (as defined in the Proposed Rule), (iii) restrictions on the activities of industrial banks that are subsidiaries of a Covered Company, and (iv) the FDIC's request for comment regarding certain aspects of the proposal.
A. Proposed Scope of Applicability
The Proposed Rule would apply to any "Covered Company," to be defined as a company that "controls" an industrial bank that is not a "grandfathered industrial bank" (i.e., an industrial bank that exists prior to the effective date of the final rule) and that is not otherwise subject to consolidated supervision by the Federal Reserve. "Control" would be defined as having "the power, directly or indirectly, to direct the management or policies of a company, or to vote 25 percent or more of any class of voting securities of a company" and would include the rebuttable presumptions of control under the FDIC's regulations for the Change in Bank Control Act.10 The FDIC is seeking comment on whether the requirements under the Proposed Rule should apply to any parent company of an industrial bank that is not otherwise subject to consolidated supervision (which would include grandfathered industrial banks). In addition to this question, listed below are several other questions and requests for comment from the FDIC related to the scope of applicability of the Proposed Rule.
- Should the Proposed Rule apply to an industrial bank that is controlled by an individual rather than a company?
- Should the Proposed Rule apply to the parent companies of other nonbank insured depository institutions that are excluded from the definition of "bank" under the BHC Act11 or "savings association" under the Home Owners' Loan Act,12 such as credit card banks and trust companies?
B. Written Agreements, Commitments, Conditions, and Other Requirements
The FDIC routinely requires a parent company of an industrial bank to enter into a capital and liquidity maintenance agreement (CALMA), under which the parent company is responsible for ensuring compliance with the capital and liquidity requirements applicable to its subsidiary industrial bank. The FDIC also requires a parent company of an industrial bank to enter into other written agreements with the FDIC that allow it to assess the ability of the parent company to ensure compliance with any FDIC-imposed commitments or conditions. Under the Proposed Rule, the FDIC would require a "Covered Company" to enter into a written agreement with the agency with, at a minimum, the following eight standard commitments prior to obtaining control of an industrial bank:
- Provide the FDIC with a listing (updated annually) of all of the Covered Company's subsidiaries;
- Consent to the FDIC's examination of the Covered Company, and each of its subsidiaries, to allow for the FDIC to assess compliance with any commitment or condition imposed by the FDIC, the FDI Act, and any other law or regulation;
- Provide the FDIC with an annual report and any other reports requested by the FDIC on the Covered Company' and its subsidiaries' (i) financial condition, (ii) systems for identifying, measuring, monitoring, and controlling financial and operational risks, (iii) transactions with depository institution subsidiaries of the Covered Company, and (iv) compliance with applicable provisions of the FDI Act and any other law or regulation;
- Maintain any records that the FDIC deems necessary to assess the Covered Company' and its subsidiaries' risks to the industrial bank and to the Deposit Insurance Fund;
- Arrange annual independent audits of each subsidiary industrial bank of the Covered Company;
- Limit the Covered Company's direct or indirect representation on the governing body of each subsidiary industrial bank of the Covered Company to no more than 25 percent of the governing body of the industrial bank;
- Maintain the capital and liquidity of each of the Covered Company's subsidiary industrial banks at such levels as the FDIC deems necessary for the safe and sound operation of the industrial banks,13 and take any other actions deemed appropriate by the FDIC to provide each subsidiary industrial bank with the resources for additional capital or liquidity; and
- Enter into a tax allocation agreement that expressly recognizes an agency relationship between the Covered Company and each of its subsidiary industrial banks with respect to tax assets generated by the respective industrial bank, and states that all such tax assets are held in trust by the Covered Company for the benefit of the subsidiary industrial bank(s) and promptly remitted to the respective industrial bank.
The FDIC may also require a Covered Company to submit a contingency plan that reflects strategies for the orderly disposition of the industrial bank without the need for the appointment of a receiver or conservator.14 According to the FDIC, the contingency plan would not be a resolution plan, but, rather, an explanation of the steps the industrial bank and Covered Company could take to mitigate the impacts of financial and operational stress outside of the receivership process.
Certain questions and requests for comment in the NPR relevant to the written agreement requirements of a Covered Company are as follows:
- If there is an individual who is the dominant shareholder of a Covered Company, should that individual be responsible for the maintenance of the industrial bank's capital and liquidity at or above FDIC-specified levels?
- Should a dominant shareholder of a Covered Company be responsible for causing the Covered Company to comply with the written agreements, commitments and restrictions imposed on the industrial bank?
- For purposes of transparency and identifying any potential risks to the industrial bank, the FDIC included proposed commitments requiring examination and reporting. Is this approach the best way to gain that transparency, or is there a better way? To what extent, if any, is the FDIC's supervision enhanced by requiring a Covered Company to consent to examination of the Covered Company and each of its subsidiaries as proposed? Is there another way to identify any potential risks?
- With respect to a Covered Company's representation on the board of its subsidiary industrial bank, the FDIC chose the 25 percent threshold to align with the percent threshold for control. Is another threshold more appropriate?
- Should the Proposed Rule require a Covered Company to disclose to the FDIC certain affiliates or portfolio companies of the Covered Company in addition to subsidiaries, given that such entities could engage in transactions with, or otherwise impact, the subsidiary industrial bank?
- In order to ensure that each Covered Company can serve as a source of financial strength to its industrial bank subsidiary and fulfill its obligations under a capital maintenance agreement, should the FDIC include a commitment that the parent company will maintain its own capital at some defined level on a consolidated basis in all circumstances? How should the FDIC determine the level?
C. Restrictions on Industrial Bank Subsidiaries of Covered Companies: FDIC Prior Approval Needed for these Actions
Due to the perceived higher risks of industrial bank subsidiaries of companies that are not subject to consolidated supervision by the Federal Reserve, and in accordance with the FDIC's supervisory authority over industrial banks, the FDIC is proposing to require industrial banks controlled by a Covered Company to seek prior approval from the FDIC for the following actions:
- To make a material change in the industrial bank's business plan after becoming a subsidiary of a Covered Company;
- To add or replace a member of the board of directors, board of managers, or a managing member of the governing body of the industrial bank after becoming a subsidiary of a Covered Company;
- To add or replace a "senior executive officer" (as defined in the Proposed Rule) after becoming a subsidiary of a Covered Company;
- To employ a senior executive officer who is associated in any manner (as a director, officer, employee, agent, owner, partner, or consultant) with an affiliate of the industrial bank; or
- To enter into any contract for services material to the operations of the industrial bank (for example, loan servicing function) with such Covered Company or any subsidiary thereof; and
- Any other requirements imposed by the FDIC on the industrial bank on a case-by-case basis.
The FDIC is seeking comment on whether any of these restrictions should be temporarily limited, for example, to the first three years after an industrial bank becomes a subsidiary of a Covered Company.
D. Other Questions and Requests for Comments
In addition to the questions noted above, the FDIC requests comments on the following:
- Would there be any benefit in having or requiring a Covered Company that conducts activities other than financial activities to conduct some or all of its financial activities (including ownership and control of an industrial bank) through an intermediate holding company similar to what a grandfathered unitary savings and loan holding company may be required to do pursuant to section 626 of the Dodd-Frank Wall Street Reform and Consumer Protection Act? What other approaches may be appropriate?
- In evaluating the statutory factors under section 6 of the FDI Act for deposit insurance applications, should the FDIC consider an evaluation of the competitive effects of the parent company's or the parent company's affiliates' provision of consumer products aggregated with the activities of the industrial bank?
- The current Interagency Charter and Federal Deposit Insurance Application requests information related to two broad categories, Market Characteristics and Community Reinvestment Act Plan, to assist the FDIC in determining whether the convenience and needs of the community to be served by an industrial bank will be met with the overall purpose of maintaining a sound and effective banking system. Are there any other categories of information that the FDIC should consider in evaluating an industrial bank's ability to meet the convenience and needs of the community to be served by such an industrial bank where the industrial bank will have a limited physical presence or will rely heavily on technology to deliver products and services?
- The FDIC has typically required, as conditions for approval, several additional commitments when considering applications involving foreign ownership of a proposed insured depository institution. These conditions address matters regarding service of process and access to information on the operations and activities of the parent company and its subsidiaries. Are there additional safeguards, commitments or restrictions the FDIC should consider for a foreign Covered Company? Should additional capital or liquidity levels be considered?
- The Gramm-Leach-Bliley Act of 1999 imposed certain restrictions on the extent to which a federal banking agency may regulate and supervise a functionally regulated affiliate of an insured depository institution. Conversely, the federal banking agencies, including the Federal Reserve, impose various periodic reporting requirements on depository institutions and their parent companies. In view of these restrictions and requirements, are the commitments and requirements appropriately tailored to carry out the purpose and intent of the proposed rule adequately?
III. Additional Considerations
The FDIC believes that the Proposed Rule would accomplish two important goals: (i) ensure that a Covered Company, as the parent of an industrial bank approved for deposit insurance, serves as a source of strength for its subsidiary industrial bank and (ii) provide transparency to future applicants and the broader public as to what the FDIC requires of a Covered Company as a parent of an industrial bank. The Proposed Rule may be touted as merely a codification of the existing practices and procedures of the FDIC in reviewing and approving deposit insurance applications, merger applications and change-in-control notices involving industrial banks. However, this rulemaking also gives the public the opportunity to provide their opinion and be involved in the review and revision of the FDIC's practices, policies and procedures for applications and notices for industrial banks. One of the greatest obstacles for the FDIC in advancing the Proposed Rule to final will likely be the policy considerations that led to the moratorium on deposit insurance applications of industrial banks beginning in 2007 and extending through 2013. However, FDIC Chairman Jelena McWilliams has stated that she wants the agency under her leadership to "lay the foundation for the next change of banking by encouraging innovation that meets consumer demand, promotes community banking, reduces compliance burdens, and modernizes our supervision."15 With the FDIC's announcement of the approval of deposit insurance applications for two de novo industrial bank applications a day after announcing the Proposed Rule, it appears that the FDIC is prepared to move this NPR along in accordance with its statutory authority, notwithstanding regulatory, public or political opposition.
Financial institutions, commercial companies or others that would like to comment on or have questions about the FDIC's Proposed Rule, or that have questions about industrial banks generally, are encouraged to contact any of the authors or their Arnold & Porter contact. The firm's Financial Services group would be pleased to assist with any questions you may have.
© Arnold & Porter Kaye Scholer LLP 2020 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.
See, "FDIC Seeks Comment on Proposal to Ensure Safety and Soundness of Industrial Banks," March 17, 2020.
See, "FDIC Approves the Deposit Insurance Application for Nelnet Bank, Salt Lake City, Utah Area," March 18, 2020; see also, "FDIC Approves the Deposit Insurance Application for Square Financial Services, Inc., Salt Lake City, Utah," March 18, 2020.
12 USC § 1831o-1(b) ("If an insured depository institution is not the subsidiary of a bank holding company or a savings and loan holding company, the appropriate Federal banking agency for the insured depository institution shall require any company that directly or indirectly controls the insured depository institution to serve as a source of financial strength for such institution.").
In 2007, the FDIC proposed a rule for the industrial bank subsidiaries of financial companies, but for several reasons, including the onset of the financial crisis, did not advance the rule to final. See, "Industrial Bank Subsidiaries of Financial Companies," 72 Fed. Reg. 23 (February 5, 2007). According to the FDIC, after allowing its practices, policies and procedures to be tested during the 2008 financial crisis, and finding that its supervision is effective, the agency is more comfortable with introducing and moving forward on this NPR.
The Fact Sheet that was released with the Proposed Rule suggests that Covered Companies will be expected to maintain high levels of capital and liquidity at a subsidiary bank. According to the FDIC, "By codifying the requirement that a covered parent company maintain high levels of capital and liquidity at a subsidiary industrial bank, the proposed rule would ensure the safety and soundness of these institutions and protect the Deposit Insurance Fund." There are no specific thresholds noted in the Proposed Rule, and therefore it is expected that the amount required will be determined on a case-by-case basis.
See, Release of the FDIC’s innovation lab, FDiTech. See also, "FDIC Chairman McWilliams: The Future of Banking," Prepared Remarks for FDIC Chair Jelena McWilliams delivered at the CSBS FDIC Community Bank Research Conference (October 1, 2019).