Senator Sherrod Brown (D‑OH) has just introduced the “Close the Shadow Banking Loophole Act,” a bill he claims will prevent “Big Tech and commercial companies” from operating banks “without proper oversight.” While the title–and the reasoning–might sound ominous, this bill does virtually nothing to ensure the safety and soundness of the banking sector. (The shadow banking theme is flawed too, but let’s leave that aside for now.)
It’s also strange that Senator Brown, someone known to stick up for the little guy, is behind a bill that undoubtedly protects large financial institutions from competition. Back in 2020, the Bank Policy Institute (BPI), the lobbying organization for some of the United States’ largest banks, released a report calling for the same thing. (BPI used nearly identical language.)
So, while Brown’s bill is new, this issue is not.
According to Brown–and BPI and other bank lobbyists–the issue is that anyone engaged in the same banking activity should be regulated in the same manner. The banks–and Brown–say that they do not want industrial loan companies (ILCs) to “get away” with being less regulated than “regular” commercial banks. While that premise seems fair, it’s more of a technical problem than anything else, and it only exists because the U.S. regulatory framework is a total mess.
The issue really amounts to a complaint that the parent companies of nonbanks (such as ILCs) will not be regulated by the Federal Reserve, something that the parent companies of banks cannot avoid. In other words, these regulations have nothing to do with the actual company dealing with the customers’ money. Simply put, the Federal Reserve regulates all holding companies that own banks, but not holding companies that own nonbank financial companies such as ILCs.
This issue blew up in the early 2000s when Walmart applied for an ILC charter. Walmart figured it could profitably provide banking services to low‐income customers, something that progressive politicians say they want more of, but the political resistance was so fierce that Walmart gave up.
Again, it is not the case that Walmart’s bank–the one that would have been dealing with customers’ money–would have been exempt from the regulations faced by every other commercial bank. Walmart’s bank would have been required to abide by the same rules and regulations as all other banks.
The problem–because of the quirky U.S. banking law–is that Walmart itself would not have been regulated by the Federal Reserve, unlike the parent companies of regular commercial banks. This quirk exists primarily because of the Bank Holding Company Act (BHCA) of 1956. Funny enough, the BHCA was a legislative response to what had become an unworkable feature of the U.S. regulatory framework: a prohibition against branch banking.
While banks were generally prohibited from opening multiple branches, a separate holding company could own multiple banks. Congress could have just permitted branch banking. Instead, the BHCA codified the holding company process and restricted the ability of bank holding companies to be involved in nonbanking commercial activity. This feature, often referred to as the “separation of commerce and banking,” is essentially unique to the United States.
Nobody would design a system like the American one, and it’s very easy to see why:
- The only thing that really matters for bank solvency is the safety and soundness of the bank itself, not the legal entity that owns the bank.
- If federal officials want to force the parent company of a bank to serve as a financial backstop to the bank itself, something which remains controversial (see chapter 4), then it would be much easier to impose higher capital or liquidity requirements on the bank itself.
- There is no objective economic reason to separate banking from other types of commerce, and other sections of the U.S. banking code prohibit shady transactions between affiliated companies.
- Any well‐funded and well‐capitalized firm that wants to start a bank or provide financial services should be allowed to do so. A convoluted regulatory system that prevents competition, discourages innovation, and minimizes financial diversity imposes higher costs on consumers. (It sure doesn’t help the little guy.)
- A system that provides federally backed deposit insurance for accounts up to $250,000 goes well beyond helping the typical American (the average deposit account is only about $5,000), crowds out private investment and job opportunities, and creates a banking constituency that depends on taxpayer backing. (Again, it’s tough to argue that $250,000 in coverage has much to do with the little guy.)
- There is no objective economic reason that nonbank firms should be prevented from providing payment services.
- Although the Federal Reserve has regulated bank holding companies for decades, the United States has experienced banking crises during the 1970s, 1980s, and 2000s, all on the Fed’s watch. It might seem comforting to think that federal regulation can maintain stability, but that’s a false sense of security.
If Brown and his senate colleagues want to help U.S. businesses provide more banking services to the little guys, or anyone else, they’ll craft legislation to make the existing regulatory framework less burdensome, opening up competition in financial services. The existing regulatory framework is expensive, inadequate, anticompetitive, and harmful.
My Cato colleagues and I have a great set of recommendations Congress can start with. And I even have a short book that will help Senator Brown pick a better bill title next time.
