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Is Wal-Mart Leaving the Money Business? Don’t Bank on It

Monday, March 19, 2007

The company’s capitulation to federal regulators is less significant than you think.

Wal-Mart announced at the end of last week that it would withdraw its application, filed with the Federal Deposit Insurance Corporation (FDIC), to acquire or establish an industrial loan company (known as an ILC) in Utah. An ILC is a special kind of bank that is eligible for deposit insurance from the FDIC but is not subject to the restrictions on ownership by nonfinancial companies such as retailers and manufacturers, as most banks are. The announcement came immediately after statements on Capitol Hill and articles in the Wall Street Journal and New York Times suggesting that Wal-Mart was considering the possibility of making mortgage loans to its customers triggered an outcry that the company—despite earlier denials—was really planning to use its ILC to enter the consumer banking business. Although on its face Wal-Mart’s withdrawal seems to be a victory for the banks, which want to prevent it from competing for their business, there is more here than meets the eye. This may ultimately be seen as the beginning of the end of the current restrictions on affiliations between banks and nonfinancial firms.

Wal-Mart’s ILC application was never intended as a banking or deposit-taking enterprise, only another way that the company could cut its costs.

Let’s get down to basics. Making loans, including mortgage loans, is not banking. Anyone can make loans, and in general no government license or approval is required to do so. The largest mortgage lender in the United States, Countrywide Financial Corporation, is not a bank, and there are literally thousands of nonbank mortgage lenders and finance companies that make loans of all kinds to homebuyers and consumers at every income level. Banking is distinguished from other financial activities by the fact that banks take deposits, most of which are withdrawable on demand or through the use of instruments of transfer such as checks.

Wal-Mart had never applied for the authority to take deposits—it left that out of its application to reduce controversy. It wanted an ILC because these institutions, like ordinary banks, have access to the U.S. payment system. This system—operated by the Federal Reserve—is the means through which funds are transferred from buyers to sellers, and access to it would have given Wal-Mart an opportunity to reduce costs for paying its suppliers and collecting the credit card charges of its customers. So Wal-Mart’s ILC application was never intended as a banking or deposit-taking enterprise, but only another way that the company could cut its costs. If it could have gained access to the payment system it would not have had to pay one or more banks for funds transfer services, and as with all of Wal-Mart’s cost-saving efforts these benefits would eventually have been passed on to its customers.

Thus, for all the supposed sympathy on Capitol Hill for American consumers—and especially “working families”—they don’t count for much when an organized pressure group like the banking industry comes calling. Then, our representatives in Congress become very concerned about such fallacious and unintelligible principles as “the separation of banking and commerce” and are perfectly happy to leave working families behind. From its inception, the “separation of banking and commerce” has been nothing more than a means for banks to protect themselves from competition, and it was invoked again, by people who should (and probably do) know better, to oppose the Wal-Mart application to acquire an ILC. The withdrawal of that application means America’s working families, who are Wal-Mart’s principal customers, will have to pay more for what they buy at Wal-Mart, and should thank their representatives in Congress for this privilege.

Making loans, including mortgage loans, is not banking. Anyone can make loans, and in general no government license or approval is required to do so.

Ironically, though, the withdrawal of the Wal-Mart application will not stop Wal-Mart from competing with the banks in mortgage lending and consumer finance. Freed of the distraction of fighting over its FDIC application, Wal-Mart can now accelerate its entry into the finance business, where its low-cost style will force banks and other lenders to lower their charges if they want to keep America’s working families as customers.

And Wal-Mart’s withdrawal may also have one more deliciously ironic effect. Almost 60 companies, some of them direct retail competitors of Wal-Mart, already own ILCs, and through this mechanism have access to the payment system. With Wal-Mart now out of the way, the zeal in Congress to stop nonfinancial companies from acquiring ILCs  may now dissipate. If so, the FDIC will eventually have to start approving the applications of many more nonfinancial companies that want to gain access to the payment system—and in some cases to take insured deposits—by acquiring an ILC. At some point, the number of such companies will be so substantial that Congress will be required to ratify reality by repealing the current restrictions on affiliations between nonfinancial firms and banks.

This is exactly the process that resulted in the repeal of the Glass-Steagall Act, a Depression-era law that prohibited affiliations between commercial banks and securities firms. Despite the law’s overall purpose, the courts recognized exceptions in the law that permitted banking organizations to get into the business of underwriting and selling securities. So many banks made use of these exceptions that Congress eventually had to ratify the reality in the market and repeal Glass-Steagall’s affiliation restrictions. Thus, while bankers are expressing satisfaction that they have now driven Wal-Mart from the ILC scene, in the long run it is likely be a pyrrhic victory.

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