ILCs, Brokered Deposits, Robinhood in Trouble
Introducing: Reg Briefs
Hey all, Jason here.
Wait, what? On a Thursday?! Given the sheer volume of banking- and fintech-related news, I’ve decided to try a second edition, which I’m dubbing “Reg Briefs,” focused on regulatory and legislative developments impacting the sector. Also, Netherlands is on lockdown until at least January 19, so I need to keep busy!
As I told one of my favorite former colleagues, I’m not a lawyer, but I love playing one on the internet.
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Why is Everyone Talking About ILCs?
Quick reminder on why Industrial Loan Companies (ILCs) are such a hot topic: they are not subject to the Bank Holding Company Act, meaning they can be owned by a firm engaged in non-financial commercial activities - like Google, Amazon, Facebook (or Walmart).
ILCs also represent a potentially easier path to a bank charter for fintech companies (Square and Nelnet recently secured charters) - though they still require FDIC approval, which is typically a lengthy process.
An ILC (like a state chartered bank,) enables a firm to avoid state-by-state licensing requirements, export state interest rates (hello, Utah!), hold deposits, make loans, access Fed payment systems and the discount window, but are not regulated by the FRB (rather, their respective state regulator and the FDIC). Popular fintech partner banks WebBank and Celtic Bank are chartered as ILCs.
What actually happened: the FDIC approved a rule establishing criteria and supervisory rules for the parent companies of ILCs (more relevant for the Google/Amazon/Walmart angle than fintechs).
The final rule is largely the same as what was proposed this March (eg, this isn’t a surprise). The FDIC’s fact sheet states that the rule will:
Ensure that the parent of a covered industrial bank approved for deposit insurance serves as the source of strength for the industrial bank; and
Provide transparency to future applicants and the broader public as to what the FDIC requires of parent companies of covered industrial banks.
What it does: a key function of this rule is to codify existing practices (eg, reduce uncertainty for companies considering pursuing an ILC). The proposed rule states:
The purpose of the proposed rule is to codify existing practices utilized by the FDIC to supervise industrial banks and their parent companies, to mitigate undue risk to the DIF [Deposit Insurance Fund] that may otherwise be presented in the absence of Federal consolidated supervision of an industrial bank and its parent company, and to ensure that the parent company that owns or controls an industrial bank serves as a source of financial strength for the industrial bank
What it means: many news headlines characterized this as making it easier for Amazon, Facebook, Google, or Walmart to “become a bank” (Walmart did try to get an ILC in 2006, driving huge pushback from the incumbent banking sector).
I view companies like Google or Facebook offering a full suite of banking services as very unlikely (Amazon, who knows) - especially while facing various anti-trust investigations, which are likely to ramp up under a Biden administration.
While an ILC charter does allow a commercial parent company to own an entity that holds deposits and make loans, these conventional banking services aren’t the type of scalable/high margin offering that earn tech companies high valuation multiples.
Rather, there are some specific benefits that may be interesting to tech companies, including direct access to payment rails (something Walmart actually specified when withdrawing its 2006 ILC application).
For fintechs, the ILC route may make sense (vs. national OCC charter), depending on their product offerings and business model. SoFI started down this path before withdrawing its application, and Square’s ILC should begin operating next year.
Brokered Deposits Rule: Good News for Fintech (and Banks)
What actually happened: The FDIC finalized revisions to its regulations around “brokered deposits.”
What it does: Acknowledging that the technology and business landscape has and is evolving, the FDIC undertook rulemaking to bring regulations governing brokered deposits in line with current industry practices and the marketplace.
Acting Comptroller of the Currency Brian Brooks said in a statement (emphasis added):
“The rule regarding brokered deposits approved today by the FDIC Board helps modernize the concept of brokered deposits in ways that give consumers more choices and control over their financial decisions and promote innovation between commercial banks and the financial technology industry.
Under the previous status quo, the broad definition of brokered deposits discouraged bank and fintech partnerships by imposing unnecessary burden and costs—specifically, by deeming app-based fintech services that facilitate consumer savings accounts potential deposit-brokering activity.
This rule recognizes that fintech partnerships help banks reach new customers and extend their services to previously unbanked and underserved populations without triggering onerous regulatory requirements.”
What it means: by updating the definition of “brokered deposits,” this regulatory change provides more flexibility in banks’ funding sources (as banks considered less than “well capitalized” are prohibited from accepting brokered deposits). Specifically:
fintechs that partner with a single deposit platform won’t be considered broker-deposit arrangements
companies that facilitate customers’ deposits (but don’t take possession) will no longer be deemed broker-deposit arrangements
companies that accept deposits but are focused on consumer lending will not be considered deposit brokers under the new “primary purpose” exception
This rule change should facilitate more fintech-bank partnerships and new approaches to deposit-gathering.
Massachusetts Goes After Robinhood
Robinhood just paid $65 million to settle charges from the SEC for misleading investors, but now it faces a new complaint from the Massachusetts Securities Division.
What actually happened: Yesterday, the Wall Street Journal reported that the Massachusetts securities regulator filed a complaint against Robinhood for exposing investors to “unnecessary trading risks” by “falling far short of the fiduciary standard.”
Note that while the federal fiduciary rule for broker-dealers was struck down, Massachusetts passed its own version.
Key elements of the complaint:
aggressive tactics to attract “new, often inexperienced” investors
failure to prevent outages and disruptions on its platform (as many as 70 this year)
use of “gamification to encourage and entice continuous and repetitive use” (the complaint alleges one MA-based Robinhood user with no investment experience made over 12,700 trades in six months)
breach of fiduciary conduct
Robinhood, whose mission is to “democratize finance for all,” earns most of its revenue from payment for order flow, and thus has a clear incentive to encourage active trading (even when that isn’t in its users’ best interests).
William Galvin, the Massachusetts Secretary of the Commonwealth, said:
“Treating this like a game and luring young and inexperienced customers to make more and more trades is not only unethical, but also falls far short of the standards we require in Massachusetts.”
What it means: while likely little more than a speed bump for $11 billion-valued Robinhood, as it only applies to Robinhood investors in Massachusetts, it’s potentially a regulatory shot across the bow.
With a Biden regulatory regime expected to be more active and focused on customer harm, Robinhood could be in for increased scrutiny, and not just at the state level.
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