Square wants to be a bank, sort of
Mobile point-of-sale pioneer Square is applying for an Industrial Loan Company (ILC) charter to support the expansion of its lending business, the volume of which grew 68 percent year-over-year in Q2 to $318 million.
The news was met with immediate rancor by at least one community banking group, which also lodged complaints about blurring the lines between commerce and banking when online lender SoFI applied for the same charter in June. But proponents say, the move makes a lot of sense and could be good for underserved businesses and consumers that have trouble accessing credit through traditional banks.
“If there ever was a case for a fintech [company] to receive an ILC charter, Square would be its poster child,” says Michael Moeser, director of the payments practice at Javelin Strategy & Research. Although critics like to point to Walmart’s failed attempt at gaining such a charter in 2006, Moeser says that Square is “a very different company.”
“Square is a financial services company. They process credit cards and provide small business cash advance loans through a partner,” he notes.
What’s more, Moeser points out than an ILC is a “very limited charter” that permits its owner to deal in only specific financial products. “It’s not like Square is going to start opening up branches, underwriting mortgages, doing auto loans, etc., with an ILC,” Moeser says. “The term Industrial Loan Company denotes it is not a bank holding company.”
Bank holding companies, which are able to offer a larger array of financial products, face more federal regulatory requirements and supervision, and are barred from pursuing lines of business that fall outside of financial services.
For its part, Square, via a spokesperson, says, “The primary purpose of the bank will be to offer business loans to small businesses, similar to the existing business of Square Capital, and to offer deposit products.”
Turf wars
Before Square made its move, the Independent Community Bankers of America (ICBA) wrote in an August blog post that it would fight “tooth and nail” against attempts to remove the “historic separation of banking and commerce in federal law and regulation.” It reiterated that sentiment in news reports about Square’s plans on Sept. 7.
The group says that “allowing nonbank corporate conglomerates to own banks not only violates the U.S. policy of maintaining the separation of banking and commerce. It also jeopardizes the impartial allocation of credit, creates egregious conflicts of interest, and results in a dangerous concentration of commercial and economic power.”
ILC charters require companies to be supervised by the state in which they apply for the charter—in Square’s case, likely Utah—and the FDIC, so there’s no oversight or supervision from the Federal Reserve or the Office of the Comptroller of the Currency (OCC). That’s a sticking point for critics like the ICBA, which say the nonbank companies are taking advantage of a “loophole” that enables them to engage in nonbanking commercial activities and not be subject to consolidated supervision.
“Square’s bid for an ILC is just the latest evidence that our current system is inadequate for the 21st century, tech-driven marketplace,” says Jennifer Tescher, president and CEO of the Center for Financial Services Innovation (CFSI). “Square didn’t really have a lot of good options,” she adds, pointing to an expensive, costly and complex state-by-state licensing regime or the stalled OCC fintech charter. States, including New York, are suing the regulator over its proposal to offer a special banking charter to fintech companies.
“From where I sit, I think we should be doing everything possible to help Square innovate and compete in the marketplace—assuming the loan products are high quality,” Tescher says.
For more than a decade, CFSI has been conducting research and bringing various stakeholders—industry, regulators, consumer advocates—together around using technology to increase access to financial services. Its 2016 research estimates the size of the financially underserved market in the U.S. to be $140.7 billion.
“The very same banks who are crying foul over Square’s ILC application are the same ones who are shutting their doors on small businesses,” adds Javelin’s Moeser. “If these small merchants were able to get loans and have their credit cards processed, Square would have no business model. The reality is that banks don’t want to lend to small businesses because they are risky and don’t want to process their credit cards because the volume is too low and profits are thin. If Square were to go away, there would be little incentive for banks to compete for small merchants. They only reluctantly do so because they fear they would lose small business deposit and payroll accounts.”
A new day for non-banks?
Online lender SoFi was the first to apply for an ILC in many years. The Dodd-Frank Act had placed a moratorium on such charters that ended in 2013, but the FDIC has been “gun-shy” since Walmart’s failed attempt to secure an ILC charter in 2006, Moeser notes.
Varo Money, a start-up from San Francisco, said opting for an ILC was likely adding “fuel to the fire” in the debate over ILCs.
Debate notwithstanding, Square is probably not going to be the last fintech company to try to become an ILC.
“Our purpose is to empower small businesses and the underserved to participate in the economy,” says the Square spokesperson. “Square Capital is uniquely positioned to build a bridge between the financial system and the underserved, and further expand access to capital.”
