Academic journal article Economic Review - Federal Reserve Bank of Kansas City

Industrial Loan Companies: A Growing Industry Sparks a Public Policy Debate

Academic journal article Economic Review - Federal Reserve Bank of Kansas City

Industrial Loan Companies: A Growing Industry Sparks a Public Policy Debate

Article excerpt

Industrial loan companies, or ILCs, are a small, but rapidly growing part of the financial industry. These state-chartered institutions operate in seven states and have nearly all of the same powers as commercial banks. However, ILCs differ greatly from banks in one characteristic-the type of companies that may own them. ILCs meeting certain conditions may be owned and operated by firms engaged in commercial activities, thus skirting the prohibitions on mixing banking and commerce that apply to virtually all other depository institutions.

Commercial ownership is now a prominent topic in banking with Wal-Mart's recent attempt to open an ILC and Home Depot's efforts to acquire an existing ILC. At the center of this controversy are such questions as whether commercial firms-retailers, manufacturers, and others -should be allowed to use ILCs to get into banking and what would be the public policy implications of such entry.

Those opposing the Wal-Mart and Home Depot proposals, for instance, contend that ILCs owned by commercial entities would face significant conflicts of interest. Such ILCs, it is argued, would have strong incentives to lend to customers of the parent company on a favorable basis and without due regard for standards of creditworthiness. These conflicts might thus be resolved to the detriment of the ILC, its customers, or the deposit insurance system and other elements of the federal safety net. Another common argument is that Wal-Mart and others might be able to exploit their size and existing customer relationships in a manner that would give them a dominant role in banking markets, thereby reducing financial competition. To allow Congress to consider such issues, the Federal Deposit Insurance Corporation (FDIC) placed a moratorium until January 2008 on commercial firms opening or acquiring insured ILCs.1

While the Wal-Mart and Home Depot proposals are behind much of the ILC debate, the public policy issues are much broader than these two proposals. Financial and commercial firms have made significant inroads into the ILC industry, mosdy within the last decade or so. In fact, among the most recognizable owners of ILCs are Merrill Lynch, Morgan Stanley, American Express, General Electric, General Motors, Toyota, BMW, Volkswagen, Target, and Harley-Davidson. Consequendy, many of the issues surrounding broader ownership of ILCs are far from hypothetical. Considerable information already exists on how financial and commercial firms use ILCs and what are the associated issues and benefits.

This article uses this broader ownership experience with ILCs as a starting point to examine the public policy issues that arise from mixing banking and commerce. The first section reviews the history of ILCs and the basic legal and supervisory frameworks under which they operate. The second section looks at the reemergence of ILCs under their new forms of ownership. The third section focuses on the ILCs owned by financial and commercial firms, taking a close look at individual ILCs and the types of business they conduct. The fourth section explores the public policy issues.


ILCs, also known as industrial banks, first emerged in the early 1900s to provide small loans to industrial workers. This market developed because commercial banks were generally unwilling to offer uncollateralized loans to factory workers and other wage earners with moderate incomes. Much of the early success of industrial banks can be attributed to Arthur J. Morris, who chartered the first ILC in 1910 and established the basic framework for Morris Plan banks.2 Morris Plan banks spread to over 140 cities by the early 1930s and became the leading providers of consumer credit to lower-income workers.

Since then, commercial banks and other institutions have largely taken over the role of providing small consumer loans, thus leaving traditional ILCs with only a small segment of the consumer lending business. …

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