FDIC Proposes To Expand the Scope of Its Regulation for Parent Companies of Industrial Banks

On July 30, 2024, the Board of Directors of the Federal Deposit Insurance Corporation (FDIC) approved a proposal to amend its existing regulations governing parent companies of industrial banks and industrial loan companies (collectively, industrial banks). In December 2020, the FDIC formalized its framework for supervising industrial banks in part 354 of the FDIC Rules and Regulations (Part 354). The proposed amendments to Part 354 would modify that framework in certain notable respects, including by:

• Establishing additional criteria that the FDIC would consider when assessing the risks presented to an industrial bank by its parent company and evaluating the industrial bank’s ability to function independently of the parent company
• Clarifying the relationship between written commitments and the FDIC’s evaluation of the statutory factors applicable to an industrial bank filing
• Revising the definition of “Covered Company” to (1) include conversions involving a proposed industrial bank under Section 5 of the Home Owners’ Loan Act (HOLA), (2) apply Part 354 to parent companies of industrial banks if there is a change of control or merger involving the parent company, and (3) give regulatory authority to the FDIC to apply Part 354 to other situations where an industrial bank would become a subsidiary of a company not subject to federal consolidated supervision

The comment period ends on October 11, 2024. If adopted as proposed, the FDIC’s proposed rule would apply prospectively. This Advisory provides a high-level summary of the proposed rule, including questions and requests for comment from the FDIC, and discusses key takeaways for financial institutions.

Overview of Proposed Rule

Under its current regulations, after April 1, 2021, no industrial bank may become a subsidiary of any company (or otherwise become controlled by any company) that is not subject to federal consolidated supervision by the Federal Reserve Board unless the company agrees to certain commitments in the form of one or more written agreements with the FDIC and the subsidiary bank. The commitments and written agreements result in the parent company being subject to “light” supervision by the FDIC. The FDIC is the responsible federal banking agency for industrial banks that are not state member banks, and as noted in the adopting release for the regulation, “[a] key part of [the FDIC’s] supervision is evaluating and mitigating the risks arising from the activities of the control parties and owners of insured industrial banks to ensure they do not threaten the safe and sound operations of those industrial banks or pose undue risk to the Deposit Insurance Fund (DIF).”¹

Additional Criteria in Evaluation of Industrial Bank Proposal

If adopted as proposed, the FDIC’s proposed rule would incorporate additional considerations that the FDIC will undertake to determine the degree of risk presented to the industrial bank from the parent company and its affiliates. These considerations address the business purpose for establishing or acquiring control of the industrial bank, intercompany relationships, the regulatory and consumer compliance history and supervisory record of each relevant entity, the novelty of the parent company’s primary businesses (including any new or innovative processes), accessibility of information, and any plans or processes that mitigate risks presented by the parent company. In addition, under the proposed rule, the FDIC would consider the industrial bank’s ability to function independently of the parent organization.

Importantly, the proposed rule would create a rebuttable presumption that an industrial bank is a “shell or captive” institution if it (1) could not function independently of the parent company, (2) is significantly or materially reliant on the parent company or its affiliates, or (3) serves only as a funding channel for an existing parent company or affiliate business line. Further, the proposed rule provides that the FDIC will presume that the shell or captive nature of an industrial bank involved in an application weighs heavily against favorably resolving one or more of the applicable statutory factors.²

While the proposed rule contains a provision that would permit a company to submit a rebuttal of the presumption that a proposed industrial bank is a shell or captive institution or that such a shell or captive nature is consistent with the statutory factors, the proposed rule does not explain the standards of review that would be used by the FDIC to evaluate rebuttal requests, nor does the proposed rule discuss which statutory factors the staff may view as being negatively affected by the shell or captive nature of an industrial bank.

Written Commitments and Statutory Factors

In the preamble of the proposed rule, the FDIC expresses its concern that applicants may be misinterpreting the effects of the written commitments required under Part 354 as they relate to the FDIC’s assessment of the applicable statutory factors. Part 354 permits the FDIC to condition the approval of an application or non-objection on the industrial bank and its parent company entering into written agreements and making required commitments. However, such agreements and commitments do not replace any statutory factors applicable to the application.

To this end, the proposed rule clarifies that written agreements will be taken into account as part of the FDIC’s consideration of the underlying filing, but do not replace any statutory factor applicable to the filing and will not necessarily lead to the favorable resolution of any statutory factor where the facts and circumstances are otherwise unfavorable. This proposed amendment is consistent with the application processing policy of the FDIC and does not create any new requirements or expectations.

Covered Company

The proposed rule would make three amendments to the definition of “Covered Company” to clarify the scope and applicability of Part 354. First, the revised definition of “Covered Company” would include conversions involving a proposed industrial bank under Section 5 of the HOLA. Under the current version of Part 354, a company that controls an industrial bank that has converted from a federal savings association charter is not considered a Covered Company, and this amendment is intended to ensure that such a company is subject to Part 354. The FDIC is proposing a second amendment to the definition of Covered Company to ensure that a parent company of an industrial bank subject to a change of control, or a parent company of an industrial bank subject to a merger in which it is the resulting entity, would be subject to Part 354. The last proposed amendment gives regulatory authority to the FDIC to apply Part 354 to other situations where an industrial bank would become a subsidiary of a company not subject to federal consolidated supervision.

Request for Comments

The FDIC is soliciting public comments on various aspects of the proposed rule. Questions include the following:

1. What situations (other than change in bank control, merger, and conversion pursuant to Section 5(i)(5) of the HOLA) present similar risks such that they should also subject the industrial bank and its parent company to Part 354?
2. What other clarifications, if any, to Part 354 and its relationship to the FDIC’s evaluation of the applicable statutory factors should the FDIC consider?
3. What features or aspects of a shell or captive bank business model should affect the FDIC’s evaluation of industrial bank filings?
4. Should the FDIC assess the potential risks posed to safety and soundness, consumer protection, and the DIF differently for shell or captive bank business models involving significant or material reliance on the parent organization?
5. Are there other issues or facts that the FDIC should consider in determining whether to strengthen its supervisory framework with respect to industrial banks and in how the FDIC evaluates potential risks and concerns presented in an industrial bank filing?
6. How should the FDIC assess the “convenience” and “needs” of the “community” served by dependent bank business models?

As noted above, comments will be accepted until October 11, 2024.

Takeaways

Industrial bank charters have long been a source of controversy. Their numbers remain small and, until this year, the last approval was in 2020. In March 2024, a bipartisan group of 12 U.S. senators urged the FDIC to give fair consideration to industrial banks without an inherent disadvantage for an industrial bank charter.

The FDIC has taken steps to address the processing of industrial bank applications. Most recently, on June 21, 2024, the FDIC approved its first industrial bank charter since 2020 in connection with the reorganization of a credit union, the subsidiary of Thrivent Financial Holdings. In this transaction, the FDIC approved deposit insurance for the new industrial bank and the merger of the credit union into the industrial bank. The applications had been pending since 2021. The FDIC also recently adopted a resolution that requires FDIC staff to provide full Federal Reserve Board briefings for merger and deposit insurance applications that have been outstanding for more than 270 days. For more information about the recent FDIC resolution on merger and insurance applications, please see our July 2024 Advisory.

The proposed rule seeks to provide transparency regarding how the FDIC evaluates potential risks and concerns presented in an industrial bank charter application filing. At the same time, the proposed rule would impose stricter standards on industrial banks and their parent companies, so it does not seem to suggest an era of new openness to industrial banks. Among other things, the proposed rule includes considerations aimed at identifying shell or captive business models and presumptions the FDIC will apply as a consequence of such identification. Coupled with the FDIC’s clarification under the proposed rule that written agreements will not necessarily lead to the favorable resolution of any statutory factor where the facts and circumstances are otherwise unfavorable, the proposed rule, if adopted as proposed, would result in increased scrutiny of the application filings, particularly with respect to the industrial bank’s ability to function independently of the parent company.

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 2024 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.