After implosions in ’08, Industrial Loan Company designations or ILCs are back in style — a tempting, less-regulated pathway to banking for commercial cos and fintechs
With vestiges of the Biden regulatory interregnum fed into the woodchipper, fintechs, neobanks, and commercial businesses have set their sights on Trumpian banking policy, gauging the feasibility therein to secure banking and pseudo-banking charters in an effort to maximize consumer LTV and, in some cases, further whittle the long-standing boundary between commerce and banking.
If we’re playing it straight, the Banking-as-a-Service (BaaS) world wasn’t exactly a regulatory darling during the Biden years: on the receiving end of enforcement actions and consent orders alleging violations to the Bank Secrecy Act as well as inadequate banking and anti-money laundering (AML) practices.
One entity subject to such scrutiny was B2 Bank (f.k.a. The First National Bank of Buhl), which, in addition to operating two retail branches in Northern Minnesota, functions as the BaaS partner to M1, the Chicago-based personal finance platform backed by SoftBank, Left Lane, Coatue, and others. Purchased in 2021 by M1’s Founder and CEO Brian Barnes as an individual — not as a subsidiary of M1 or of a holding company — B2 furnishes M1’s high-yield savings accounts and personal loans.
B2 has operated under an agreement with the Office of the Comptroller of the Currency (OCC) since November 2023; the regulator cited “unsafe or unsound practices including those relating to internal controls and less than satisfactory management,” compelled the bank to draft a comprehensive affiliate risk management program (reading between the lines: demarcating church-and-state boundaries between M1 and B2, given their operational and leadership overlaps as affiliate businesses), and concluded that B2 must receive OCC “non-objection” for all changes to its strategic plan.
But, unlike many BaaS players who have exited the space following regulatory intervention, B2 expects to grow its BaaS-focused book of business, according to Barnes. He told Fintech Nexus the bank thinks its OCC order will be lifted in the next month. “That has made a scenario where we would have probably signed Clients Two, Three, and Four starting last year, and we’re trying to sign Clients Two, Three, and Four now,” he said.
One potential conduit for new forays into banking activity is the Industrial Loan Company (ILC) designation. Crucially, ILCs are not defined as banks under the Bank Holding Company Act, enabling parent companies to engage in commerce while de facto operating as a full bank and sustaining controlling stakes from investors who engage in non-bank activity (think VCs); they also are not supervised by the Federal Reserve, but are subject to state laws and Federal Deposit Insurance Corporation (FDIC) supervision.
Some ILCs have come and gone — General Motors’ (NYSE: GM) and Morgan Stanley’s (NYSE: MS) ILCs, for instance, were converted into commercial banks after imploding during the financial crisis — and there are fewer than ILCs in existence, making up less than 1% of all FDIC-insured institutions’ assets. Efforts to close the ILC “loophole,” such as the Eliminating Corporate Shadow Banking Act of 2019 sponsored by Sen. John Kennedy (R-LA), have failed over the years — Sen. Kennedy’s office did not respond to a request for comment. There have also been moratoria on ILC approvals, the most recent of which followed Walmart’s (NYSE: WMT) application for an ILC charter in 2005 (withdrawn by 2007), and lasted until 2020, when Square/Block (NYSE: XYZ) and Nelnet (NYSE: NNI) received the FDIC’s greenlight for ILC charters under Chair Jelena McWilliams.
During the McWilliams years of the first Trump administration, the FDIC amended its rulemaking so ILC applicant holding companies would “serve as a source of strength for an industrial bank,” requiring “a parent company to inject capital or liquidity if the bank’s capital or liquidity falls below a certain threshold,” as McWilliams put it in March 2020.
Those guidelines enabled fintechs of a certain size to secure ILC charters, according to banking/fintech advisor and commentator Todd Baker. Square (now named Block) and Nelnet were large enough that they could buoy ILC banks through volatility, making their ILCs “fintech banks associated with large corporations,” Baker says.
At the time of these approvals, McWilliams said “questions about the mixing of banking and commerce, and the ability of banks to affiliate with nonfinancial firms, involve complicated policy trade-offs that are best addressed by Congress”: legislative action represented the best path forward to address “applications from groups seeking to establish new banks owned by commercial parents.”
Well, following Donald Trump’s election to a second term in the White House, “commercial parents” and car manufacturers General Motors, Ford, and Stellantis submitted ILC charter applications. Securing these charters would shore up the ranks of carmakers possessing ILC charters, as Toyota and BMW already have them, and would give GM another shot at ILC operation.
While a spokesperson for the OCC told Fintech Nexus that the Board “has not yet acted upon the next step in this rulemaking process,” Michele Alt, Partner at advisory and investment firm Klaros Group and a veteran of the OCC’s Law Department, predicts a litigious double bind if Congress fails to clarify the legal status or process for ILCs. Especially after the Supreme Court threw out the “Chevron decision,” which told courts to follow federal agencies’ interpretations of ambiguous laws, incumbent industry groups (such as the Bank Policy Institute and American Bankers Association) could sue the FDIC if ILC approvals see an uptick on one side, and from rejected ILC applicants on the other side for a lack of regulatory and rulemaking clarity. “Unless there is legislation that will actually eliminate the ILC charter, we’re seeing this super interesting lining up of incumbents against insurgents,” Alt said, anticipating an “opening of the floodgates” for other entities, namely fintechs, if this first wave of ILC applicants are approved.
But would those other entities really be fintechs of all stripes — obviating or minimizing the value of BaaS tie-ups? Probably not by biblical proportions. Baker says it’s unlikely that fintechs will surge through such a loophole to secure charters of their own, in part for purely quantitative reasons. If banking activities become a large enough slice of a fintech’s corporate pie, then a fintech’s valuation will be quantified the way a bank’s is — a far smaller figure that would minimize a founder’s equity and throw a wrench in investors’ “rocketship-emoji” returns. This is a valuation concern that Barnes of M1 and B2 said his board has discussed. At the very least, coupled with the FDIC’s requirements for holding companies (assuming these stipulations stick around and aren’t fed into the woodchipper too), that prevents early- and mid-stage fintechs from eyeing ILCs as the way to free themselves from the Green Dots and Coastal Community Banks of the world.
There are also costs involved. Barnes said the de novo process was “10 to 20 times more expensive than purchasing an existing bank, and so it didn’t feel like it was the right economic calculus.” Securing a de novo charter was also a longer process, and could lead to a rejection, while the acquisition of B2 as an individual was a more surefire approach to arrive at a similar goal. Though, Barnes admits, the bank purchase “probably wouldn’t have happened” if it hadn’t happened “towards the end of the first Trump administration.
The ongoing state of the BaaS landscape has compelled some fintech CEOs to contemplate buying banks like Barnes has.
“But I don’t know if they know what they’re signing up for,” Barnes said. “Man, it’s pushed me to the limits. Knowing some of the other people that don’t have the temperament, I think they would not enjoy themselves.”
