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Thursday, June 24, 2010

Industrial Loan Companies/Banks and the Separation of Banking and Commerce: Legislative and Regulatory Perspectives

N. Eric Weiss
Specialist in Financial Economics

Industrial Loan Companies (ILCs) are state-chartered and state-regulated depository institutions. The Federal Deposit Insurance Corporation (FDIC) may insure them. Their owners include nonfinancial companies that cannot own (hold stock of) a bank under the Bank Holding Company Act (i.e., cannot be a bank or financial holding company). Their primary federal regulator is not the Federal Reserve, which regulates bank holding companies, but the FDIC. Although prominent large ILCs include subsidiaries of securities firms, their owners also include automotive and retailing companies. The ILC form reflects a persistent tendency to combine the financing of a business with its operations. While this practice is standard in many countries, notably Germany and Japan, it has been in disfavor in America. ILCs, therefore, have developed against a long U.S. two-way tradition of the separation of banking and commerce: (1) Ownership interests that nonfinancial firms may have in banks are generally 25% or less. (2) Commercial banks may generally hold only nominal amounts of corporate stock.

As part of its proposals for financial regulatory reform, the Obama Administration has proposed shifting regulation of ILCs from the FDIC to the Federal Reserve. Opponents of the change have stated that during the current recession, ILCs have not created problems for the financial system.

ILCs evoke at least two policy issues. First, could the combination of state and FDIC regulation provide oversight comparable to that for nationwide banks, especially for bank holding companies? Second, should Congress grant ILCs powers that would allow them to be nationwide banks while in competition with community banks? Arguments over the separation of banking and commerce go back to the Glass-Steagall Act as revised by a series of laws, including the Gramm-Leach-Bliley Act.

Previously, interest shown by Wal-Mart and Home Depot in controlling an ILC with nationwide potential heightened industry and congressional interest in these issues.

The conference committee for H.R. 4173, the Restoring American Financial Stability Act of 2010, has released text that it intends to use as the basis for negotiation. In general the text follows the language adopted by the Senate concerning ILCs. Specifically, the base text would create a three-year moratorium on the FDIC's approval of new ILCs controlled by commercial firms and prohibit transferring control of ILCs except to prevent default; the bill would direct the Government Accountability Office (GAO) to study the implications of eliminating ILCs (and also credit card banks and trust banks). The House language for H.R. 4173 (and the earlier H.R. 3996) would require ILCs to be owned by bank holding companies that are regulated by the Federal Reserve; the Obama Administration has made a similar proposal.

This report (1) provides an historical overview of the separation of banking and commerce; (2) examines the nature of ILCs and their regulation; and (3) identifies and analyzes the relevant legislation in Congress.

Date of Report: June 17, 2010
Number of Pages: 13
Order Number: RL32767
Price: $29.95

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