Capital a Key Element of Square’s Industrial Bank Charter Review

Payment processor Square, Inc.’s bid to start a bank in Utah could hinge on capital. The San Francisco-based company will have to make a strong case that its banking business model and the underlying financials are solid, particularly during the nascent stage of operations, Utah’s financial services regulator said Jan. 9.

“Institutions are usually not profitable during the first three years of their existence,” Utah Department of Financial Institutions Deputy Commissioner R. Paul Allred said Jan. 9.

Square is seeking an industrial loan company (ILC) charter in Utah backed by the Federal Deposit Insurance Corp. If the application is granted, it could prove a tipping point for more fintech companies to file their own bank charter applications.

Companies like Square will have to prove their capital is commensurate with the risk they’re taking on and sufficient to weather “the rough patches” of starting up operations, Allred told the American Bar Association’s Consumer Financial Services conference in Park City, Utah.

Nearly two decades ago, capital requirements for ILCs were generally around $10 million to $15 million, Allred said. Now, “there’s a new normal, and we don’t know what that is,” he said.

Square’s market cap is approximately $16 billion with multiple business verticals, including small-business lending, retail software and hardware sales and support, and payments processing.

“They need to be well capitalized and they have to be able to support the conclusion on what they think is an adequate capital level based on assets,” Allred said of companies seeking an ILC charter.

ILCs or industrial banks are financial institutions that may be owned by nonbank holding companies. State-charted institutions that obtain deposit insurance from the FDIC are exempt from extensive regulations of the Bank Holding Company Act (BHCA), including supervision by the Federal Reserve.

Square’s bank subsidiary would offer small-business loans and deposit products similar to traditional banks. For now, the industry is in a wait-and-see period while the company’s application is under review by Utah, which is home to about 15 ILCs, and ultimately the FDIC.

Allred said Utah doesn’t have a deadline for deciding on a state charter.

Utah Residence

If Utah’s DFI does approve Square’s bank charter application, that means senior executives for Square’s banking subsidiary would have to take up residence in the Beehive State.

“What the commissioner wants is local management. We’re not interested in mail drop or post office box banks,” Allred said. Having executives located in the state makes the department’s oversight and regulatory activities easier, he said.

FDIC: Open Question

While Utah’s regulators are expected to stay mum on Square’s application until they make a final determination on it, the FDIC’s role in the future of fintech ILCs, and Square in particular, is a much larger question mark.

No company has received an ILC since 2009. The FDIC’s reticence to provide deposit insurance for industrial loan companies is seen by many as one of the primary reasons for the lack of interest.

The FDIC’s cautious approach to granting deposit insurance for new entities with state bank charters is holding back innovation in the financial sector, Frank Pignanelli, executive director of the National Association of Industrial Bankers and a Salt Lake City-based attorney, told Bloomberg Law during the conference.

But the NAIB and other proponents of ILC charters are encouraged by the nomination of Fifth Third Bancorp’s chief legal officer, Jelena McWilliams, to lead the FDIC. They’re hopeful that McWilliams, if confirmed by the Senate, could be open to considering new fintech entrants like Square into the banking world.

To contact the reporter on this story: Lydia Beyoud in Washington at lbeyoud@bloomberglaw.com

To contact the editor responsible for this story: Michael Ferullo at mferullo@bloomberglaw.com