The OCC’s and FDIC’s Attempts to Confer Banking Privileges on Nonbanks and Commercial Firms Are Unlawful and Threaten to “Bankify” Our Economy

The Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) have adopted several recent measures that attempt to confer benefits and privileges of banks on nonbank providers of financial services and commercial firms.  Those initiatives are unlawful and dangerous because they will enable nonbanks and commercial firms to undermine vitally important federal policies governing banks and bank holding companies.

In 2018, the OCC announced its intention to grant national bank charters to “fintech” firms that provide lending and payment services but do not accept deposits.  The New York Department of Financial Services sued the OCC, and a federal district court ruled in 2019 that the OCC’s nondepository national bank charter was unlawful.  However, in August 2020, Acting Comptroller of the Currency Brian Brooks ignored that ruling and encouraged payments companies to apply for nondepository national bank charters.  Major technology firms responded with enthusiasm to Mr. Brooks’ invitation.  A trade group representing Amazon, Apple, Google, Intuit, PayPal, and other technology companies issued a public statement praising the “leadership and vision” of Mr. Brooks.

On December 15, 2020, the FDIC adopted a rule that will allow all types of commercial firms – including the largest technology firms – to acquire FDIC-insured industrial banks and industrial loan companies (hereinafter collectively referred to as “ILCs”).  ILCs are FDIC-insured consumer banks that are chartered by Utah and several other states.  The FDIC’s ILC rule could potentially transform our financial system and economy.  Unlike the OCC’s nondepository national bank charter, the FDIC’s ILC rule will permit Big Tech giants and other commercial firms to own FDIC-insured, deposit-taking institutions.

The OCC and FDIC have approved additional measures that confer banking privileges on nonbank providers of financial services.  In June 2020, the OCC adopted a rule authorizing national banks to transfer their federal preemptive immunity from state usury laws to nonbanks that are purchasers, assignees, or transferees of their loans.  The OCC’s usury preemption transfer rule seeks to shield those nonbanks from the application of all state usury laws except usury laws of the state where the national bank that transferred the loans is “located.”  Most national banks “locate” their lending operations in states that have few, if any, usury limits.  Consequently, the OCC’s rule effectively grants blanket immunity from state usury laws to nonbanks that acquire loans from national banks.  The FDIC subsequently issued a similar rule, which allows FDIC-insured state banks to transfer their federal preemptive immunity from state usury laws to purchasers, assignees, or transferees of their loans.

In October 2020, the OCC adopted a rule that (1) allows national banks to form partnerships with nonbank lenders, (2) designates national banks as the “true lenders” for all loans produced by such partnerships if the banks are named as the lenders in the loan agreements or fund the loans, and (3) permits national banks to retain their status as “true lenders” even if they sell their entire interest in those loans to their nonbank partners one day after the loans are made.  The OCC’s “true lender” rule enables national banks to establish “rent-a-charter” schemes with payday lenders, auto title lenders, and other high-cost nonbank lenders.  Under “rent-a-charter” schemes, banks earn fees by selling their federal preemptive immunity from state laws to their nonbank partners, while the nonbanks assume all or most of the economic benefits and risks of the loans produced by such partnerships.  The FDIC has not yet proposed a regulation similar to the OCC’s “true lender” rule.

I recently published an article and an op-ed criticizing the OCC’s and FDIC’s initiatives.[*] Part 1 of my article contends that the OCC’s nondepository fintech national bank charter and the FDIC’s proposed ILC rule are contrary to federal statutes and policies governing banks and bank holding companies.  Part 2 of my article argues that the OCC’s and FDIC’s attempts to confer on nonbanks the preemptive immunities granted by Congress to banks violate federal laws and threaten to inflict serious injuries on states, consumers, and small businesses.

The OCC’s and FDIC’s initiatives are the most recent examples of a very dangerous trend toward “bankification” of our financial system and our nonfinancial economy.  Actions taken by regulators and Congress from the 1970s through the 1990s – including Congress’ repeal of the Glass-Steagall Act in 1999 – permitted the formation of “universal banks” (banks that engage in securities activities) and “shadow banks” (nonbanks that offer bank-like services).  Universal banks and shadow banks were leading participants in the toxic subprime lending boom that led to the global financial crisis of 2007–09.

During the financial crisis, the Treasury Department and the Federal Reserve bailed out big universal banks (including Citigroup and Bank of America) as well as large shadow banks (including AIG, Morgan Stanley, and Goldman Sachs).  Federal agencies also protected short-term financial instruments that functioned as substitutes for bank deposits, such as money market mutual funds, commercial paper, and securities repurchase agreements (“repos”).  Federal authorities effectively wrapped the federal “safety net” for banks and bank deposits around our entire financial system.  By doing so, they “bankified” our financial markets.

The Dodd-Frank Act and other financial reforms adopted after the global financial crisis did not change the basic structure of our financial system.  Congress did not break up universal banks and shadow banks, despite their central roles in precipitating the crisis of 2007-09.  In March 2020, when the Covid-19 pandemic ignited another financial crisis, the federal government arranged a new series of bailouts that protected universal banks, shadow banks, and short-term financial markets from collapsing.  In addition, federal authorities took the extraordinary step of backstopping the corporate bond market.  That unprecedented measure was made necessary by the reckless conduct of universal banks and shadow banks, which underwrote a massive expansion of risky corporate debt during the past decade.

The federal government’s response to the pandemic has once again revealed the unhealthy “bankification” of our financial system.  The OCC’s and FDIC’s recent actions threaten to “bankify” the rest of our economy.  Those initiatives will allow technology firms and other commercial enterprises to obtain banking privileges and benefits—including access to the federal “safety net”—without complying with many important requirements governing FDIC-insured full-service banks.

For example, commercial firms that acquire nondepository national banks and ILCs will not have to comply with the Bank Holding Company Act (BHC Act), which prohibits affiliations between FDIC-insured full-service banks and commercial firms.  That prohibition is a cornerstone of our nation’s longstanding policy of separating banking and commerce.  The BHC Act separates banking and commerce to prevent undue concentrations of financial and economic power and to stop commercial firms from gaining access to the subsidies provided by the federal “safety net” for banks.

If the OCC’s and FDIC’s initiatives are allowed to stand, Congress will face intense pressure to repeal the statutory barriers separating banking from commerce.  Big Tech firms will lobby for permission to acquire full-service banks, and big banks will push for authority to acquire technology firms.  If Congress gives in (as it did when it repealed the Glass-Steagall Act), mergers between Big Tech companies and large banks are virtually certain to occur.

The result would be a “bankification” of our entire economy.  Giant banking-and-commercial conglomerates would spread across the nation.  Commercial owners of banks would receive huge benefits from deposit insurance and other subsidies provided by the federal “safety net” for banks.  Large commercial firms that own sizable banks would be considered “too big to fail” and would enjoy enormous advantages over smaller competitors that could not afford to acquire banks.  When the next crisis occurs, the federal government would feel compelled to rescue not only our financial system but also the new class of banking-and-commercial conglomerates.  Market discipline, which has already been greatly weakened in our financial markets, would largely disappear from the rest of our economy.

Congress should adopt two measures to halt the “bankification” of our country.  First, Congress should enact a new Glass-Steagall Act to reestablish a strict separation between our banking system and our capital markets.  Congress should prohibit banks from underwriting and trading in securities and other capital market instruments, except for government bonds.  Congress should also prohibit nonbanks from offering short-term financial instruments that function as deposit substitutes.  Only banks should be allowed to issue money market mutual funds and short-term commercial paper and repos.  Requiring nonbanks to fund their operations with longer-term securities would eliminate the shadow bank business model, improve market discipline, and enhance the stability of our financial markets.

Second, Congress should reaffirm the separation of banking and commerce by overruling the OCC’s and FDIC’s attempts to permit commercial enterprises to own banks.  Both measures would return banks to their traditional roles as objective providers of deposit, credit, payment, and fiduciary services.  The “too big to fail” problem would be greatly diminished, as universal banks would be broken up and shadow banks would largely disappear.  Banks and commercial firms would be barred from exercising any type of control over each other.

Banks and the capital markets would once again become independent sectors.  Both sectors would have strong incentives to serve the needs of our nonfinancial economy, including consumers, communities, and Main Street businesses.  Our financial system and our economy would become more stable, more competitive, and more prosperous.

 

Art Wilmarth is a Professor Emeritus of Law at George Washington University. This blog post is based on his publications cited in the footnote, as well as his recently published book, Taming the Megabanks: Why We Need a New Glass-Steagall Act (Oxford Univ. Press, 2020), and his testimony before the House Financial Services Committee’s Task Force on Financial Technology on September 29, 2020.

 

[*] Arthur E. Wilmarth, Jr., “The OCC’s and FDIC’s Attempts to Confer Banking Privileges on Nonbanks and Commercial Firms Violate Federal Laws and Are Contrary to Public Policy,” 39 Banking & Financial Services Policy Report No. 10, at 1-25 (Oct. 2020), available at http://ssrn.com/abstract=3750964; Arthur E. Wilmarth, Jr., “Why it would be a huge mistake to allow Big Tech firms to acquire banks,” Fortune (Nov. 26, 2020), available at https://fortune.com/2020/11/26/big-tech-banking-glass-steagall-act-financial-crisis/.

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