Don’t Wall Off Innovative Tech Firms from Banking

Washington politicians may disagree on what to do at the U.S. border, but when it comes to technology firms entering banking, it seems many from both parties want to build a wall. Ironically, this virtual barrier would primarily keep out not foreign financial firms, but American non-bank innovators with new financial products that could greatly benefit American consumers. For these politicians, ever since it announced plans for a cryptocurrency called Libra, Facebook has become the number-one figurative barbarian at the financial gate.

In a tweetstorm on July 11th, President Donald Trump proclaimed, “If Facebook and other companies want to become a bank, they must seek a new Banking Charter and become subject to all Banking Regulations.”

Later that week  Democrats on the House Financial Services Committee circulated draft legislation that would prevent large tech firms from offering many financial services if they decided to seek a charter. The billis bluntly titled the “Keep Big Tech Out of Finance Act.”

These politicos seem to dismiss Libra, which would be jointly managed by Facebook and dozens of members of the Libra Association, without giving any mind to the benefits it could offer in expanding access to capital, credit, and basic banking services. The Libra white paperintroducing the cryptocurrency points out that particularly for lower-income consumers, “hard-earned income is eroded by fees,” and “blockchains and cryptocurrencies have a number of unique properties that can potentially address some of the problems of accessibility.”

We have yet to see if blockchain and cryptocurrency can live up to this promise, and even if they do, whether it will be Libra that will come out on top. Indeed, one of the ironies of Libra’s launch was that it boosted the price of rival cryptocurrencies such as bitcoin, which crossed the $10,000 threshold for the first time in almost two years. But none of the cryptocurrencies will likely reach their full potential in aiding consumers if well-managed companies are barred from entering this sector.

Ironically, although the technology envisioned by Facebook and other backers of the Libra currency is new, U.S. policymakers have a long history of telling innovative firms to “keep out” of finance. These restrictions have demonstrably harmed American consumers, savers, and entrepreneurs.

Let’s go back to 2005 when Facebook was barely two years old and only available at certain college campuses. Then, the firm that was seen as a mortal danger to the U.S. financial system was giant discount retailer Walmart, which had just applied to the Federal Deposit Insurance Corporation (FDIC) to form a limited-purpose bank called an industrial loan corporation, or ILC. Though Walmart wanted the bank primarily to reduce its costs of processing the debit and credit card transactions of its customers, its application brought massive opposition from existing banks and their regulators.

Missing the mortgage crisis by established banks and the government-sponsored housing entities Fannie Mae and Freddie Mac that was only two years away, the outgoing and incoming Federal Reserve chairmen

Facebook's entry into the sector with Libra boosted the price of other cryptocurrencies, particularly that of bitcoin.

Facebook’s entry into the sector with Libra boosted the price of other cryptocurrencies, particularly that of bitcoin.


proclaimed that Walmart’s entry into banking would be a grave threat to the financial system. Just before stepping down as Fed chairman, Alan Greenspan warned in a letter to then-Rep. Jim Leach (R-IA) that ILCs “are undermining the prudential framework that Congress has carefully crafted and developed” and “threaten to remove Congress’ ability to determine the direction of our nation’s financial system with regard to the mixing of banking and commerce.” In 2006, shortly after taking the helm of the Fed as chairman, Ben Bernanke declared, “We’ve been concerned about the ownership of ILCs by non-financial institutions and whether or not that poses risk to the safety net.”

The controversy resulted in the FDIC, during George W. Bush’s presidency, putting a moratorium on ILCs that froze the application from Walmart, as well as those pending from Home Depot and a subsidiary of Warren Buffett’s Berkshire Hathaway. This moratorium was written into the Dodd-Frank financial overhaul of 2010. Though the moratorium officially expired in 2013, FDIC officials during the Obama administration indicated they would still not approve any ILC for a non-financial firm.

Greenspan, Bernanke, and others invoked “the separation of banking and commerce,” a principle that to some U.S. banking regulators seems as important as the constitutional doctrine of separation of church and state. This phrase was again uttered by some at last week’s Congressional hearings on Libra with the justification of keeping tech companies out of financial services. Once again, the “separation” precept was invoked with an aura of reverence, but not a lot of analysis.

The supposed wall of separation between banking and commerce rests on a very shaky foundation. As I documented in a 2015 Competitive Enterprise Institute study, the history shows that Congress blocked non-financial firms from going into banking at the behest of the politically powerful bank lobby, and the theory for restricting this competition came later.

Furthermore, the U.S. is virtually the only industrialized country that broadly bans nonfinancial firms from establishing banking units.  As financial analysts James R. Barth and Tong Li note in a report for the Milken Institute, the U.S. is the “only G20 country opposed to the ‘mixing of banking and commerce.’”

In the United Kingdom, for example, one out of every eight British pounds withdrawn from ATMs are taken from the cash machines of Tesco Bank, a division of retail giant Tesco. In 1997, Tesco entered into a joint venture with Royal Bank of Scotland (RBS) to form Tesco Personal Finance. In 2008, when RBS was hit hard by the financial crisis, Tesco bought out its partner’s stake and became sole owner of the renamed Tesco Bank. As of 2013, Tesco Bank held more than £5.57 billion ($8.6 billion) in outstanding mortgages, personal loans, and credit-card debt of British residents.

Remarkably, in a country with sharp divisions on Brexit and many policy issues, there is no political controversy regarding Tesco’s place in the banking sector. In 2009, Alistair Darling, then chancellor for the exchequer in Prime Minister Gordon Brown’s Labour government, praised Tesco’s works and made the competitive case for new types of banks. “We need more competition in the banking sector,” he said. “It is therefore very important that we do everything we can to encourage new entrants into this sector.”

The story is similar with new entrants in the banking sector in Canada and Mexico. And ironically, one of the most powerful entrants of recent years in those countries is Walmart, which operates a bank that issues credit cards in Canada and ran a full-service bank in Mexico. By 2014, when it was sold to Grupo Financiero Inbursa, the financial conglomerate controlled by Mexican billionaire Carlos Slim, the banking unit of Walmart de Mexico had 5.43 billion pesos ($355.8 million) in deposits and 1.79 billion pesos ($117.3 million) in loans on its books.

Counterfactuals can never be proven completely, but imagine if Walmart, Home Depot, and Berkshire Hathaway had been allowed to enter the U.S. banking sector before the housing bust. At the very least, given the stellar performance of the Walmart and Tesco in other countries during the same time period, the crisis could have been mitigated. Americans would have had more alternatives to faltering banks, which would have meant that there would have been more access to credit and capital and possibly less need to bail out failing financial institutions. As I pointed out in my CEI paper, “for large firms to fail in any industry without significant disruption elsewhere, there must be new competing firms ready to provide the product or service.”

Fortunately, Jelena McWilliams, current chair of the FDIC appointed by President Trump, has stated a desire to clear the regulatory barriers for new ILCs. The president and Congress should allow her to make desperately needed reforms to the process and not build new walls to keep Facebook or other non-bank firms out of the financial sector. The rest of the world has already opened its gates to innovative firms that want to enter banking. It’s time for the U.S. to eliminate the barriers between America’s middle-class consumers, savers and entrepreneurs and better and cheaper banking services.

Disclosure: I own shares in Facebook and Walmart. I shop at Walmart, but am not on Facebook.