Guest post by Professor Lawrence J. White, NYU Stern School of Business
Overshadowed by the media attention to the proposed repeal of Obamacare, the House Financial Services Committee recently approved substantial changes in financial regulation. The House of Representatives may soon consider the proposed bill—the Financial CHOICE Act—which would make major changes in the Dodd-Frank Act.
However, when financial regulation is being discussed, there is a large elephant that isn’t in the room, but really should be: Walmart. Starting in the mid-1990s, Walmart made two separate efforts to enter banking in the United States, but was repelled both times. After its second effort was rebuffed in 2007, Walmart gave up this effort in the United States (but has since entered banking in Canada and in Mexico).
One question to ask might be, “Why should Walmart be allowed to enter banking?” But a more relevant question would be, “Why shouldn’t Walmart be allowed to enter banking?”
After all, the U.S. economy is generally market-oriented, and entry is generally recognized as potentially beneficial for consumers, as entrants can bring new ideas, innovations, and efficiencies to the market. Of course, incumbents usually don’t like the idea of entrants’ disrupting the status quo; and often those incumbents lobby for regulation and/or legislation that creates barriers to entry. But, for most markets, the presumption in broad U.S. economic policy is that entry should be encouraged—or at least, that policy should be neutral between incumbents and entrants—so that the benefits of entry can be enjoyed by consumers.
Of course, banking is special—as the regular readers of this blog are well aware. And how the specialness of banking and the presence of Walmart in banking can be reconciled must be addressed, and will be addressed below.
But first, consider what the entry of Walmart into banking might well achieve: Walmart is well known for providing reasonably priced goods to low- and moderate-income households. Its position as the largest company in the United States—as measured by sales and by employment—is a testament to that reputation.
But it is exactly this demographic group—low- and moderate-income households—that is most in need of reasonably priced financial services. The percentage of U.S. households that are unbanked (i.e., do not have a bank account) or underbanked (i.e., have an account but rely on non-bank providers for some financial services and products) has been a longstanding policy concern. The most recent data (from a FDIC report that covers 2015) in this regard—based on a survey of more than 36,000 households nationwide—show that 7% of all households were unbanked and an additional 20% of all households were underbanked. Unsurprisingly, the percentages are substantially larger for low- and moderate-income households (see table).
Unbanked and underbanked households (Percent of total), 2015
Further, since 2009 (when the FDIC first began reporting these data), the percentage of unbanked households has declined only modestly, while the percentage of underbanked households has actually increased.
It is worth remembering that these percentages are present in a financial system where (as of year-end 2016) there were over 5,100 commercial banks, another 800 savings institutions, and an additional 5,900 credit unions! And the total number of branch offices of all of these financial institutions exceeded 90,000!
So, given Walmart’s general business strategy, it seems likely that the entry of Walmart into banking would lead it to extend more financial services to its primary clientele—and thus improve financial access for an underserved group.
It is also important to remember what Walmart is not known for. There have been few (if any) media stories of abusive sales practices toward its customers. And, Walmart has never been accused of predatory pricing: maintaining super-low prices until other retailers go out of business, and then raising its prices to monopoly levels.
Accordingly, it seems quite unlikely that the Walmart Bank would engage in such practices in the financial sphere. Given the recent revelations of unsavory practices at Wells Fargo (as well as the continued concerns over practices at payday lenders and mortgage servicers), this is a nontrivial claim.
But, as I noted above, banking is special. We expect banks to be operated in a safe-and-sound manner, such that the likelihood that they would fail—and cause losses to their creditor-depositors (or to the deposit insurer that backs them)—should be quite small. And the elaborate system of prudential regulation for banks is a reflection of that expectation.
So, how would the entry of Walmart—and, presumably, other non-financial companies that are interested in entering banking—fit into that system of prudential regulation?
The crucial concept is that the “Walmart Bank” that would provide banking services to the public would be organized as a separate subsidiary of the parent Walmart company. In essence, the parent Walmart company would be a bank holding company (BHC), which is a common ownership structure for U.S. banks. The Walmart Bank subsidiary would be expected to abide by all prudential regulations—including adequate net worth (capital) requirements—that apply to banks.
At the same time, from the perspective of prudential regulation, it makes good sense for the Walmart Bank to be a subsidiary and thus for banking services to not be provided by the parent company. Bank regulators’ prudential tasks would be much harder if they had to assess the overall financial health of the Walmart company and its extensive retail operations alongside its banking activities, rather than focusing specifically on the financial services operations of the Walmart Bank subsidiary.
In essence, the assets and activities of a prudentially regulated bank should be “examinable and supervisable.” Bank supervisors should be able to understand these assets and activities and judge whether the bank is well managed and well capitalized. The farther afield from financial services the bank’s activities stray, the harder the task of the prudential regulator. Hence, there is a sensible argument for keeping the financial services of the bank separate (as a subsidiary) from the non-financial activities of the rest of the company.
However, because it is relatively easy for the owners (including BHCs) of a bank to drain the bank of its assets—for example, by paying excessive dividends to its owners, or by making loans to the owners that are not repaid, or even by paying excessive prices for any materials that it buys from the owners—it is essential that any transactions between the bank and its owners be on arm’s-length terms. U.S. bank regulators have long been aware of this danger of the draining of a bank by its owners and have rules in place (which are embodied in Sections 23A and 23B of the Federal Reserve Act) that insist on this arm’s-length standard.
Current U.S. banking policy has much of this story right. But where policy has gone “off the rails” is the insistence that a BHC cannot be engaged in commerce—that is, in non-financial services activities. This restriction on scope was embodied in the Bank Holding Company Acts of 1956 and 1970 and remains established policy for banks and banking in 2017. Its persistence as policy is more a testament to the lobbying strength of the incumbent bankers (who clearly prefer less competition) rather than to a concern about the economic welfare of consumers. It also yields the economically absurd result that it is okay for a local car dealer to own a bank (so long as the dealer doesn’t form a BHC that involves the car dealership); but it is not okay for AutoNation (a publicly traded company that operates hundreds of car dealerships) to own a bank.
Until 1999 there was a potential way around this no-commerce restriction on the activities of a holding company: the holding company of a savings and loan (S&L or thrift) institution faced no such restriction, and at various times companies such as the Ford Motor Company, Fuqua Industries, Weyerhaeuser, ITT, Gulf & Western, Household International, and Sears, Roebuck have owned S&Ls via the formation of thrift holding companies.
In the middle of the 1990s, Walmart decided to try to enter banking by becoming a thrift holding company. However, before Walmart was able to become a thrift holding company, the Gramm-Leach-Bliley Act of 1999 (which was primarily focused on allowing commercial banks—via BHCs—to enter investment banking) forbade the creation of any new thrift holding companies that could engage in commerce. It also restricted the sale of an existing thrift holding company to a non-financial company, such as Walmart.
There was a second, more limited way around the “no commercial owner” restriction: a few states—most notably Utah—offered “industrial loan company” (ILC) charters that allowed a commercial firm to own a financial institution that could issue deposits and make loans and thus could function as a bank. But in order to operate, the ILC would need to obtain deposit insurance from the FDIC.
Walmart duly obtained a Utah ILC charter and in 2005 applied for FDIC deposit insurance. In 2007 Walmart withdrew its application after it was clear that the FDIC would not grant it deposit insurance. Further, the Dodd-Frank Act of 2010 placed a three-year moratorium on the granting of deposit insurance to any new (or newly acquired) ILC. Although the moratorium expired in 2013, bank regulators appear to have “gotten the message” that the commerce-finance barrier should remain intact.
If this issue of commercial companies’ owning banks were to be re-opened—with Walmart being the “poster child”—incumbent banks would be fiercely opposed (as they were in 2005 to Walmart’s FDIC application). They would make loud claims of “unfair competition,” but the argument above for the examinable-and-supervisable separate subsidiary, supported by Sections 23A and 23B, undercuts such assertions. Further, if it were thought that Walmart would be the beneficiary, the forces of and sympathizers with organized labor, which has never been happy with Walmart’s wages and benefits policies, could again be expected to oppose the granting of such bank charters (as they did in 2005).
But—perhaps—the advocates of the Financial CHOICE Act would be able to see the benefits to the wider provision of banking services to businesses and to consumers from the loosening or elimination of this commerce-finance restriction. And this would be a direct way to bring real financial benefits to low- and moderate-income households without any direct (or indirect) Congressional appropriations.
A revisiting of the commerce-finance restriction is surely a worthwhile topic for debate when the full House of Representatives begins its consideration of the Financial CHOICE Act.
Acknowledgment: We are honored to have as our first guest author our distinguished friend and NYU Stern colleague, Larry White, the Robert Kavesh Professor in Economics.