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

By Spong, Kenneth; Robbins, Eric | Economic Review (Kansas City, MO), Fall 2007 | Go to article overview

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


Spong, Kenneth, Robbins, Eric, Economic Review (Kansas City, MO)


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.

Critics contend that ILCs owned by commercial entities may 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. Another common argument is that the parent company 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.

Spong and Robbins examine the public policy issues that arise from mixing banking and commerce. First, they review the history of ILCs and the basic legal and supervisory frameworks under which they operate. Next, they look at the reemergence of ILCs under their new forms of ownership and take a close look at individual ILCs and the types of business they conduct. Finally, they explore the public policy issues.

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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, mostly within the last decade or so. In fact, among the most recognizable owners of ILCs are Merrill Lynch, Morgan Stanley, American Express, General Hectric, General Motors, Toyota, BMW, Volkswagen, Target, and Harley-Davidson. Consequently, 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. …

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