Niche Banks Fight Back at Tighter Regulation

Generations ago, industrialists and financiers extracted fortunes from the copper and gold mines dug into the canyons near here. Now, their modern-day counterparts are resisting a government proposal that could shut down what has become another gold mine of sorts.

Utah is the nation’s unlikely capital of industrial banks — niche institutions that primarily make loans to businesses. Corporations like Goldman Sachs , Target and General Electric have been attracted to the state to set up such institutions. While they have brought billions of dollars in deposits, thousands of jobs and millions in charitable donations to Salt Lake City, the banks have also drawn fire from Washington.


The Obama administration argues that the banks pose a threat to the economy because their parent companies can engage in risky practices but are often exempt from routine scrutiny by the Federal Reserve. Treasury officials want to require the corporate owners of the nation’s 41 industrial banks to accept more rigorous regulation or be forced to sell or shut them down. “The president’s regulatory reform plan is not about fighting the last crisis, but trying to avoid the next one,” said Michael S. Barr, assistant Treasury secretary for financial institutions. “If we preserve known loopholes in consolidated oversight, then we will just be inviting the next Bear Stearns or A.I.G.”

But the banks are fighting back. “We are talking about survival here,” said Louise P. Kelly, president of EnerBankUSA in Salt Lake City.

Defending the institutions as safe and profitable, she and others have mounted a campaign to not only block the administration’s plan, but to expand the number of such banks. The industry is deploying lobbyists, jawboning lawmakers, doling out campaign contributions and trying to persuade Treasury and banking officials.

So far, they appear to be winning some concessions. Sheila Bair, the chairwoman of the Federal Deposit Insurance Corporation, and Barney Frank, the chairman of the House Financial Services Committee, have both said they would favor allowing owners of existing industrial banks to maintain their banking operations. “They told me that divestiture would be very disruptive, and I agreed,” Mr. Frank, Democrat of Massachusetts, said in an interview, referring to Jeffrey R. Immelt, the chief executive at General Electric, and other G.E. executives who met with him in July. “It is not a matter of them wreaking havoc.”

Treasury Secretary Timothy F. Geithner and other officials are pressing ahead with their proposal to require the institutions to submit to Federal Reserve oversight, part of a sweeping package of regulatory reforms. But the battle over the banks, expected to intensify now that Congress is back in session, demonstrates how difficult enacting tougher regulation can be.

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The nation’s industrial banks hold $130 billion, only about 1 percent of federally insured bank deposits. They trace their history to the early 1900s when small lending houses sprang up to offer loans to factory workers who otherwise could not get credit. Today, the banks — almost all are in Utah, Nevada and California — do all manner of lending.

Unlike commercial banks, though, all but the smallest industrial banks are barred from offering checking accounts, so most have no retail branches. And they are not supervised by the Federal Reserve nor are their parent companies required to set aside capital reserves that could be used if a bank gets into trouble.

While no industrial bank has failed in the last year, Capmark Bank and Marlin Business Bank sustained losses that are forcing them to curtail operations. The F.D.I.C. recently ordered another, Advanta Bank Corporation, to stop taking new customers because it was in peril.

Utah became a haven for industrial banks in the last decade, relaxing laws to lure them there after Congress prohibited them in states that did not already have them. Companies like BMW and Pitney Bowes , and major investment banks, including Lehman Brothers, Morgan Stanley and Merrill Lynch, soon set up shop. Assets at such banks in Utah skyrocketed from $3 billion in 1995 to $243 billion last year, although the numbers have since dropped to $106 billion, largely as a result of a rush to convert to commercial bank status to qualify for government bailout money.

In Salt Lake City, the banks have been a welcome presence. They created an estimated 15,000 jobs at the banks and related service companies, and their executives have sprinkled money around to everything from the Utah Symphony Orchestra to housing for the poor.

The Obama administration plan, though, presents a double threat to the state. If the Treasury department prevails in insisting on Federal Reserve oversight for industrial banks, there is no reason for those owned by national financial services companies to be headquartered in Utah. And terminating the industrial bank charter, along with other new requirements, could force manufacturing giants like G.E. to sell their financial arms because of federal prohibitions against commercial companies operating banks.

Indeed, perhaps no company has more at stake in the debate than G.E., which operates its $10 billion industrial bank, GE Capital Financial, at the foot of the Wasatch Mountains, 15 miles south of downtown Salt Lake City.

Located in a new office complex, it hardly seems like a bank at all: it has no branches, no A.T.M.’s and hardly any walk-in customers. But it lends to businesses across the nation. It has financed loans to more than 5,000 fast-food restaurants, helped equip about 4,000 dentists’ offices and allowed small businesses to buy tens of thousands of forklifts, delivery vans and other equipment. “This is boring — forklifts, grills at Burger King,” said Russell Wilkerson, a G.E. executive who was visiting his company’s Utah offices last month. “It is middle-market America.”

Those loans may be boring, but they have proven to be lucrative. G.E.’s industrial bank ranked as the nation’s 46th most profitable bank earlier this year.

If General Electric had to sell off GE Capital — the large financial unit of which the industrial bank is a subsidiary — it would cost shareholders $40 billion in lost market capitalization, or 22 percent of current market capitalization, according to an estimate by a Goldman Sachs analyst, because of higher taxes, lower net income and higher capital overall requirements. “It is first unnecessary because it did not contribute to the crisis, and second it would be disruptive to the economy and lending,” Brackett B. Denniston, G.E.’s general counsel, said in an interview.

Like other industrial banks here, G.E.’s is regulated by Utah’s Department of Financial Institutions, as well as the F.D.I.C. State officials resent any suggestion that they are lax in their oversight. “We have proven there is a way to manage these institutions,” said Darryle P. Rude, Utah’s chief industrial bank supervisor. “So why would you want to eliminate a system that has not been a threat?”

But critics tick off a list of complaints about the banks, including assertions that owning them gives their corporate parents an unfair advantage and encourages risky practices.

Companies that own industrial banks can finance lending operations more cheaply than their competitors by relying on federally insured deposits at their banks, instead of going to the more costly bond market, said Matthew Anderson, a consultant who studies bank industry earnings.

In addition, he and others point out, state regulators and the F.D.I.C. do not have the same powers as the Federal Reserve to demand changes in risky business practices by parent companies that might indirectly threaten their industrial banks.

Treasury officials have not blamed industrial banks for a role in the financial crisis, but they do argue that the regulatory loophole permitted abusive actions by some of their parent companies that fed the problems. “This is not about picking on anyone, but they contributed to risk in the system,” said a Treasury official, who spoke on condition of anonymity because he was not authorized to comment on the issue.

A few industry observers go further in their complaints. Some companies intentionally chose an industrial bank charter — where they could raise money through brokered C.D.’s, investor funds in cash accounts and funds from business clients — so that they could take riskier bets and have higher leverage in their other business units, argued Raj Date, who leads a nonprofit industry research group, Cambridge Winter.

He said that parent companies of eight of what had been the top 12 Utah industrial banks filed for bankruptcy protection or received large allotments of federal bailout funds or other federal financial support in the last year. Those companies — including Merrill Lynch, GMAC, Morgan Stanley and CIT — consumed $70 billion, according to Mr. Date’s analysis. (Those institutions have all closed their industrial banks, in most cases a condition of accepting the money.) “The United States of America has lost billions of dollars based on inadequate regulation,” said James A. Leach, a former Republican congressman from Iowa and longtime critic of industrial banks. “Once you set up an exception like the industrial bank charter, the smart and the big are not dumb. They will exploit it. And that is just what they did.”

Executives at industrial banks, including those operated by Harley Davidson , Toyota , Pitney Bowes and G.E., reject criticism they were a factor in the financial crisis, a position shared by Ms. Bair, the F.D.I.C. chairwoman.

The bankers said that many financial institutions without industrial banks also turned to the federal government for a bailout. They added that industrial banks have nearly twice the capital reserves of a typical commercial bank. “For the last ten years the industrial banks have been the strongest, best capitalized, most profitable, least likely to fail banks in the country,” said George Sutton, a former Utah bank regulator who has helped set up several industrial banks.

The de facto headquarters for the industry’s lobbyists is a small office building a few blocks from the Utah capitol, where Douglas S. Foxley and Frank R. Pignanelli are based. The partners, one a Democrat and the other a Republican, have tried to persuade skeptics in Washington that the industrial banks are part of the solution to the economic crisis, not a cause.

They have appealed to Utah’s Congressional delegation, the home state delegations of the banks’ parent companies, and Congressional and committee leaders. The banks’ parent companies have made campaign contributions to some lawmakers.

For example, G.E., which has a variety of issues before Congress having to do with its role as a defense contractor, manufacturer and financial powerhouse, made $500,000 in donations to legislators since January, including the Senate majority leader, Harry Reid, Democrat of Nevada; Senator Christopher Dodd, Democrat of Connecticut, the chairman of the Senate Banking committee, and Senator Bob Bennett, Republican of Utah. “What it comes down to is a lot of blocking and tackling,” said Mr. Foxley, the lobbyist. “We have to stop this.”