Should Walmart be allowed to get into banking?

Prof Lawrence White of Stern School has a piece on Walmart entry into banking. He says we should actually ask the following question: Why shouldn’t Walmart get into banking?

By the way I also learnt from the article that the retail giant entered banking in Canada and Mexico. In Mexico it sold off its banking business in 2014. The one in Canada continues. The issue is whether it should be allowed in America as well.

Prof White says:

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)

Hmmm.

The post also has a interesting discussion on the complex financial regulation setup in US:

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.

…..

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.

Another example of how despite best intentions, regulations leave many gaps to be filled.

But overall a good discussion about many aspects of economics and finance..

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