United States Government Accountability Office

GAO Testimony 

Before the Subcommittee on Financial 

Institutions and Consumer Credit, 

Committee on Financial Services, House 

of Representatives

INDUSTRIAL LOAN 

CORPORATIONS 

Recent Asset Growth and 

Commercial Interest 

Highlight Differences in 

Regulatory Authority 

Statement of Richard J. Hillman, Managing Director 

Financial Markets and Community Investment 

For Release on Delivery

Expected at 10:00 a.m. EDT 

Wednesday, July 12, 2006

 

GAO-06-961T 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

July 12, 2006

INDUSTRIAL LOAN CORPORATIONS

Recent Asset Growth and Commercial 

Interest Highlight Differences in 

Regulatory Authority 

Highlights of GAO-06-961T, testimony 

before the Subcommittee on Financial 

Institutions and Consumer Credit,

Committee on Financial Services, House 

of Representatives 

Since their origin in the early 1900s, 

industrial loan corporations (ILCs)

have grown significantly in size, 

and some have expressed concern 

that ILCs may have expanded 

beyond the original scope and 

purpose intended by Congress.

Others have questioned whether

the current regulatory structure for 

overseeing ILCs is adequate. 

This testimony is based on our 

September 2005 report that, among 

other things, (1) described the 

growth and permissible activities of 

the ILC industry, (2) compared the 

supervisory authority of the 

FDIC—the current federal 

regulator for ILCs—with

consolidated supervisors, and (3) 

described the extent to which ILC 

parents could mix banking and 

commerce. 

 

In this testimony GAO is reiterating

that Congress should (1) consider

options for strengthening the

regulatory oversight of ILCs and (2) 

more broadly consider whether 

allowing ILCs a greater degree of

mixing banking and commerce is 

warranted or whether other entities 

should be permitted to engage in

this level of activity. 

The ILC industry has experienced significant asset growth and has evolved 

from once small, limited-purpose institutions to a diverse industry that 

includes some of the nation’s largest and more complex financial 

institutions. Between 1987 and 2006, ILC assets grew over 3,900 percent 

from $3.8 billion to over $155 billion. In most respects, ILCs may engage in 

the same activities as other depository institutions insured by the FDIC and 

are subject to the same federal safety and soundness safeguards and 

consumer protection laws. Therefore, from an operations standpoint, ILCs 

pose similar risks to the bank insurance fund as other types of insured 

depository institutions. 

Parents of insured depository institutions that present similar risks to the 

bank insurance fund are not, however, being overseen by bank supervisors 

that possess similar powers. ILCs typically are owned or controlled by a 

holding company that may also own or control other entities. Although FDIC

has supervisory authority over an insured ILC, this authority does not 

explicitly extend to ILC holding companies and, therefore, is less extensive 

than the authority consolidated supervisors have over bank and thrift 

holding companies. Therefore, from a regulatory standpoint, these ILCs may 

pose more risk of loss to the bank insurance fund than other insured 

depository institutions operating in a holding company. For example, FDIC’s

authority to examine ILC affiliates is more limited than a consolidated 

supervisor. While FDIC asserted that its authority may achieve many of the 

same results as consolidated supervision, and that its supervisory model has 

mitigated losses to the bank insurance fund in some instances, FDIC’s 

authority is limited to a particular set of circumstances and may not be used 

at all times. Further, FDIC’s authority has not been tested by a large ILC 

parent during times of economic stress. 

Because of an exception in federal banking law, ILC holding companies can 

mix banking and commerce more than the holding companies of most other 

depository institutions. In addition, there are a number of pending 

applications for deposit insurance with FDIC involving commercial firms, 

including one of the largest retail firms. While some industry participants 

assert that mixing banking and commerce may offer benefits from 

operational efficiencies, empirical evidence documenting these benefits is

mixed. Federal policy separating banking and commerce focuses on the 

potential risks from integrating these functions, such as the potential 

expansion of the federal safety net provided for banks to their commercial 

entities. GAO finds it unusual that a limited ILC exemption would be the 

primary means for mixing banking and commerce on a broader scale and 

sees merits in Congress taking a look at whether ILCs or other entities 

should be allowed to engage in this level of activity. www.gao.gov/cgi-bin/getrpt?GAO-06-961T.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Richard J.

Hillman at (202) 512-8678 or 

hillmanr@gao.gov.
Mr. Chairman and Members of the Subcommittee: 

I am pleased to be here today to discuss the results of our 2005 report on 

industrial loan corporations (ILCs).1

 Over the past 10 years, ILCs, 

particularly when included as part of a holding company structure, have 

experienced significant growth, now having over $155 billion in assets; 

these once small niche lenders have evolved into a diverse industry that 

includes some large, complex financial institutions. As a result, some have 

expressed concerns that ILCs may be expanding beyond the original scope 

and purpose intended by Congress. 

The potential entry into banking services by some of the nation’s largest

retailers has also raised concerns. In 2005, one of the world’s largest 

retailer, Wal-Mart, submitted an application with the Federal Deposit 

Insurance Corporation (FDIC) to provide federal insurance of deposits in 

a subsidiary ILC. In May, Home Depot, the nation’s largest home 

improvement retailer, submitted an application for FDIC to approve the 

purchase of an existing ILC. Proponents assert that these operations will 

benefit consumers through lower prices or increased access to financial

services. Critics, however, say that nonfinancial operations of this size 

owning an insured ILC pose unnecessary risks to the deposit insurance 

funds that cannot be adequately addressed under the current regulatory 

authorities. 

My remarks today are primarily based on our 2005 report and focus on 

three of the report’s objectives: the growth and permissible activities of 

the ILC industry, how FDIC’s supervisory authority over ILC holding 

companies and affiliates compares with a consolidated supervisors’ 

authority; and, the extent to which the ILC charter enables commercial 

holding companies to mix banking and commerce.2

In summary: 

ILCs began in the early 1900s as small, state-chartered, loan companies 

that primarily served the borrowing needs of industrial workers unable to 

 1

GAO, Industrial Loan Corporations: Recent Asset Growth and Commercial Interest

Highlight Differences in Regulatory Authority, GAO-05-621 (Washington, D.C.: September

15, 2005). 

2

In preparation for this hearing, we updated our September 2005 report to provide 

information on the number and total assets of ILCs through March 31, 2006.

Page 1 GAO-06-961T 
obtain noncollateralized loans from banks. Since then, the ILC industry 

has experienced significant asset growth and has evolved from small, 

limited-purpose institutions to a diverse industry that includes some of the 

nation’s largest and more complex financial institutions with extensive 

access to the capital markets. For example, from 1987 to March 31, 2006, 

ILC assets have grown over 3,900 percent from $3.8 billion to over $155 

billion. With one exception contained in federal and one state’s banking 

laws, federally insured ILCs in a holding company structure may generally 

engage in the same activities as other FDIC-insured depository 

institutions. Like other FDIC–insured depository institutions, ILCs may 

offer a full range of loans such as consumer, commercial and residential

real estate, and small business loans. As a result, from an operations 

standpoint, ILCs in a holding company structure pose risks to the Deposit 

Insurance Fund (the Fund) similar to those posed by other FDIC-insured 

institutions in holding company structures.3

 

ILCs are state chartered depository institutions. Concerns about them 

presently exist because of a provision in the Bank Holding Company Act 

(BHC Act). Under that act, a company that owns or controls a federally 

insured ILC can conduct banking activities through the ILC without 

becoming subject to the federal supervisory regime that applies to 

companies that own or control banks or thrifts. Because these ILCs have 

federally insured deposits, they are subject to supervision by FDIC as well 

as their respective state regulators.4

 However, FDIC lacks the explicit

authority to regulate ILC parent companies and their activities. Under the 

BHC Act, the Board of Governors of the Federal Reserve (Board) is 

responsible for supervising bank holding companies and has established a 

consolidated supervisory framework for assessing the risks to a 

depository institution that could arise because of their affiliation with 

other entities in a holding company structure.5

 The Office of Thrift 

Supervision has similar authority under the Home Owners Loan Act with 

 3

Under 12 U.S.C. 1831a(a), FDIC-insured state banks, a group that includes ILCs, may not

engage as principal in any activity that is not permissible for a national bank unless the 

FDIC has determined that any additional activity would pose no significant risk to the

deposit insurance fund and the bank is in compliance with applicable federal capital 

standards. 

4

Since ILCs are state-chartered financial institutions, they are subject to supervision and

regulation by both FDIC and the chartering state’s financial regulator. 

5

 The Securities and Exchange Commission has approved the applications of five 

investment banks, including the parent companies of several large ILCs, to be subject to 

consolidated supervision. 

Page 2 GAO-06-961T 
respect to savings and loan holding companies. The Board and OTS each 

take a systemic approach to supervising depository institution holding 

companies and their nonbank subsidiaries and may look across lines of 

business at operations such as risk management, information technology, 

or internal audit in order to determine the risk these operations may pose 

to the insured institution. However, because of an exception under the 

BHC Act, holding companies of ILCs are not subject to consolidated 

supervision. Unlike the Board, FDIC does not have specific consolidated 

supervisory authority over holding companies that conduct banking 

activities only through ILCs. FDIC has, however, employed what some 

term a “bank-centric” supervisory approach that primarily focuses on 

isolating the insured institution from potential risks posed by holding 

companies and affiliates, rather than assessing these potential risks 

systemically across the consolidated holding company structure. While 

FDIC’s cooperative working relationships with state supervisors and ILC 

holding company organizations, combined with its other bank regulatory 

powers, has allowed FDIC, under certain circumstances, to assess and 

address the risks to the insured institution and to achieve other results to 

protect the insurance fund against ILC-related risks, questions remain 

about the extent to which FDIC’s supervisory approach and authority 

address all risks posed to an ILC from its parent holding company and

nonbank affiliates and how well FDIC’s approach would fare for large, 

troubled ILCs during times of stress. 

Another area of potential concern about ILCs is the extent to which they 

can mix banking and commerce through the holding company structure. 

The BHC Act maintains the historical separation of banking from 

commerce by generally restricting bank holding companies to bankingrelated or financial activities. 6

 However, because of the ILC exemption in 

the BHC Act, ILC holding companies, including nonfinancial institutions 

such as retailers and manufacturers, and other institutions are not subject 

to federal activities restrictions. Consequently, they have greater latitude 

to mix banking and commerce than most other financial institutions. While 

some industry participants have stated that mixing banking and commerce 

 6

As amended by the Gramm-Leach-Bliley Act (GLBA), the BHC Act restricts the activities of 

bank holding companies to activities “closely related to banking” that were permitted by

the Federal Reserve Board as of November 11, 1999. However, bank holding companies 

that qualify as financial holding companies can engage in additional activities defined in

GLBA as activities that are “financial in nature,” as well as activities that are incidental to 

or complementary to financial activity. Pub. L. No. 106-102 §§ 102, 103, codified at 12 U.S.C.

§ 1843(c)(8), (k) (2000 & Supp. 2004). 

Page 3 GAO-06-961T 
may offer benefits from operational efficiencies, the policy of separating 

banking and commerce was based primarily on reducing the potential 

adverse consequences that combining these activities may pose. These 

include the potential expansion of the federal safety net provided for 

depository institutions to their commercial holding companies or affiliates, 

increased conflicts of interest within a mixed banking and commercial 

conglomerate, and increased economic power exercised by large 

conglomerate enterprises. We found divergent views about the 

competitive implications of mixing banking and commerce and were 

unable to identify conclusive empirical evidence that documented 

efficiencies attributable to mixing banking and commerce. In addition, we

found it unusual that use of the ILC exemption under the BHC Act would 

be the primary means for mixing banking and commerce across a broader 

scale than afforded to the holding companies of other federally insured 

depository institutions. 

Our report included matters for congressional consideration designed to 

better ensure that insured institutions providing similar risks to the Fund 

are subject to federal supervision overseen by banking supervisors that 

possess similar powers. In this regard, we determined that it would be 

useful for Congress to consider several options such as eliminating the

current BHC Act exception for ILCs and their holding companies from 

consolidated supervision, granting FDIC similar examination and 

enforcement authority as a consolidated supervisor, or leaving the 

oversight responsibility of small, less complex ILCs with the FDIC, and 

transferring oversight of large, more complex ILCs to a consolidated 

supervisor. In addition, we concluded that it would also be beneficial for 

Congress to more broadly consider the advantages and disadvantages of 

mixing banking and commerce to determine whether allowing ILC holding 

companies to engage in this activity more than the holding companies of 

other types of financial institutions is warranted or whether other financial 

or bank holding companies should be permitted to engage in this level of 

activity. 

Before discussing the results of our work more fully, I would like to 

provide a brief overview of the growth of ILCs and compare their 

permissible activities with those of a state nonmember commercial bank.

Page 4 GAO-06-961T 
First, I would like to highlight the significant growth and transformation 

that has taken place in the ILC industry since 1987. ILCs began in the early 

1900s as small, state-chartered loan companies, serving the borrowing 

needs of industrial workers unable to obtain noncollateralized loans from 

commercial banks. Since then, the ILC industry has experienced 

significant asset growth and evolved from small, limited-purpose 

institutions to a diverse group of insured financial institutions with a 

variety of business models. Most notably, as shown in figure 1, from 1987 

to March 31, 2006, ILC assets have grown over 3,900 percent, from $3.8 

billion to over $155 billion, while the number of ILCs declined about 42 

percent from 106 to 61. In March 2006, 9 ILCs were among the 271 largest 

financial institutions in the nation with $3 billion or more in total assets, 

and one institution had over $62 billion in total assets. As of March 31, 

2006, 6 ILCs owned over 80 percent of the total assets for the ILC industry 

with aggregate assets totaling over $125 billion and collectively controlled 

about $68 billion in FDIC-insured deposits. During this time period, most 

of the growth occurred in the state of Utah while the portion of ILC assets 

in other states declined—especially in California. According to Utah 

officials, among the reasons ILCs grew in that state was because its laws 

are “business friendly,” and the state offers a large, well-educated 

workforce for the financial services industry. 

ILCs Have Grown 

Significantly and Are 

No Longer Small, 

Limited-Purpose 

Institutions 

Page 5 GAO-06-961T 
Figure 1: Number and Total Assets of ILCs, 1987 to March 31, 2006 

0

20

40

60

80

100

120

Number of ILCs Assets (Dollars in billions)

Source: GAO analysis of FDIC Call Report data.

Year

0

26

52

78

104

130

156

ILCs

Assets

2006

(3/31)

1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Financial services firms, such as the ILCs owned by Merrill Lynch, USAA 

Savings Bank, and American Express own and operate the majority of the 

61 active ILCs.7

 These ILCs are parts of complex financial institutions with

extensive access to capital markets. Other ILCs are part of a business 

organization that conducts activities within the financial arm of a larger 

corporate organization not necessarily financial in nature. In addition, 

other ILCs directly support the holding company organizations’ 

commercial activities, such as the ILCs owned by BMW and Volkswagen. 

Finally, some ILCs are smaller, community-focused, stand-alone 

institutions such as Golden Security Bank and Tustin Community Bank.

Although the total amount of estimated insured deposits in the ILC 

industry has grown by over 600 percent since 1999, as shown in figure 2,

these deposits represent less than 3 percent of the total estimated insured 

 7

As of March 31, 2006. 

Page 6 GAO-06-961T 
deposits in the bank insurance fund for all banks. The significant increase 

in estimated insured deposits since 1999 was related to the growth of a 

few ILCs owned by financial services firms. For example, as of March 31, 

2006, the largest ILC, owned by Merrill Lynch, held over $43 billion in 

estimated FDIC insured deposits. 

Figure 2: Percentage of Estimated FDIC Insured Deposits Held by ILCs, 1987 – March 31, 2006 

Percentage

Source: GAO analysis of FDIC Call Report data.

Year

0

1

2

3

4

5

2006

(3/31)

1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

ILC Business Lines and 

Regulatory Safeguards Are 

Similar to Other Insured 

Financial Institutions 

Next, I would like to briefly compare the permissible activities of ILCs 

with other insured financial institutions.8

 Federal banking law permits 

FDIC-insured ILCs to engage in the same activities as other insured 

depository institutions. However, in order to qualify for the ILC exception

in the BHC Act, (and also, we found, because of restrictions in California 

state law) most ILCs, which are owned by non-BHC Act holding 

companies, may not accept demand deposits. Other than this exception, 

 8

A full comparison is beyond the scope of this testimony. See our 2005 report for a more 

detailed and comprehensive discussion of ILC lines of business and the regulatory 

safeguards that apply to ILCs and other insured depository institutions. 

Page 7 GAO-06-961T 
banking laws in California, Nevada, and Utah have undergone changes that 

generally place ILCs on par with traditional banks in terms of services 

provided. Thus, as shown in Table 1, like other FDIC-insured depository 

institutions, ILCs may offer a full range of loans such as consumer, 

commercial and residential real estate, and small business loans. Further, 

like a bank, ILCs may “export” their home-state’s interest rates to 

customers residing elsewhere. 9

 In effect, this permits ILCs offering credit

cards to charge their state’s maximum allowable interest rates in other 

states. 10 In addition, ILCs generally are subject to the same federal 

regulatory safeguards that apply to commercial banks and thrifts. For 

example, ILCs are subject to restrictions on transactions between an 

insured institution and its affiliates under sections 23A and 23B of the 

Federal Reserve Act that are designed to protect the insured depository 

institution from adverse transactions with holding companies and 

affiliates. 11 Sections 23A and 23B generally limit the dollar amount of loans 

to affiliates and require transactions to be done on an “arms-length” basis.12

ILCs must also comply with Bank Secrecy Act, Anti-Money Laundering, 

and Community Reinvestment Act requirements and like other insured 

depository institutions comply with consumer protection laws. 

During our review, we did not identify any banking activities that were 

unique to ILCs that other insured depository institutions were not 

permitted to do. The primary difference, as shown in table 1, between ILCs 

and other FDIC-insured depository institutions is that, to remain outside of 

the BHC Act, an ILCs must be chartered in the states described in the the

 9

See 12 U.S.C. § 1831d(a); see also, FDIC General Counsel’s Opinion No. 11, Interest 

Charges by Interstate State Banks, 63 Fed. Reg. 27282 (May 18, 1998). 

10Nevada and Utah do not cap the interest rates credit card companies can charge. Their 

usury laws, similar to Delaware and South Dakota, are considered desirable for credit card

entities. 

11Covered transactions are specifically described in section 23A (b)(7)(A) through (E) but 

generally consist of making loans to an affiliate; purchasing securities issued by an affiliate; 

purchasing nonexempt assets from an affiliate; accepting securities issued by an affiliated 

company as collateral for any loan; and issuing a guarantee, acceptance, or letter of credit 

on behalf of (for the account of) an affiliate. Section 23A also lists several types of 

transactions that are specifically exempted from its provisions. Under the BHC Act, as 

amended by GLBA, a depository institution controlled by a financial holding company is

prohibited from engaging in covered transactions with any affiliate that engages in 

nonfinancial activities under the special 10-year grandfather provisions in the GLBA. 12 

U.S.C. § 1843 (n)(6).

12Section 18(j) of the FDI Act extends the provisions of sections 23A and 23B of the Federal 

Reserve Act to state nonmember banks. 12 U.S.C. § 1828(j). 

Page 8 GAO-06-961T 
ILC exemption and may not accept demand deposits if its total assets are 

$100 million or more.13

Table 1: Comparison of Permissible Activities Between State Nonmember 

Commercial Banks and ILCs in a Holding Company Structure 

Permissible Activities 

State Non-member 

Commercial Bank Industrial Loan Corporation

Ability to offer full range of 

loans, including: 

consumer,

commercial real estate, 

residential real estate, 

small business, and 

subprime. 

Yes Yes

Ability to export interest 

rates. 

Yes Yes

Ability to offer full range of 

deposits including demand

deposits. 

Yes Yes, except in California. 

However, BHC Act-exempt 

ILCs may offer demand 

deposits if either the ILC’s

assets are less than $100 

million or the ILC has not been

acquired after August 10, 

1987.A

Source: FDIC. 

AIILCs can accept NOW accounts which are insured deposits that, in practice, are similar to demand 

deposits. 

Note: This table was adapted from FDIC’s Supervisory Insights, Summer 2004. According to the 

FDIC officials, Supervisory Insights was published in June 2004, by FDIC to provide a forum to 

discuss how bank regulation and policy is put into practice in the field, share best practices, and 

communicate emerging issues that bank supervisors are facing. This inaugural issue described a

number of areas of current supervisory focus at the FDIC, including the ILC charter. According to 

FDIC officials, Supervisory Insights should not be construed as regulatory or supervisory guidance.

Based on an analysis of the permissible activities of ILCs and other insured 

depository institutions, we and FDIC’s Inspector General found that, from

 13The Competitive Equity Banking Act (CEBA) contains the ILC exemption allowing 

entities that own or control ILCs to avoid Board regulations as a bank holding company. 

This exemption applies to ILCs chartered in states that as of March 5, 1987, had in effect or 

under consideration a statute requiring ILCs to be FDIC insured. According to the FDIC, at 

the time of the CEBA exemption, six states – California, Colorado, Hawaii, Minnesota, 

Nevada, and Utah met this requirement. Only ILCs chartered in these “grandfathered” 

states are eligible for the ILC exemption from the BHC Act. 

Page 9 GAO-06-961T 
an operations standpoint, ILCs do not appear to have a greater risk of 

failure than other types of insured depository institutions. FDIC officials 

have reported that, like other insured depository institutions, the risk of 

failure and loss to the Fund from ILCs is not related to the type of charter 

the institution has. Rather, these officials stated that this risk depends on 

the institution’s business plan and the type of business that the entity is 

involved in, management’s competency to run the bank, and the quality of

the institution’s risk-management process. Further, FDIC officials stated 

that their experience does not indicate that the overall risk profile of ILCs 

is different from that of other types of insured depository institutions, and 

ILCs do not engage in more complex transactions than other institutions. 

In our 2005 report we compared the supervisory approaches of FDIC and 

consolidated supervisors, such as the Board and the Office of Thrift 

Supervision (OTS), and described in detail several differences between 

FDIC’s supervisory authority over ILC holding companies and affiliates 

and the authority of these consolidated supervisors. Today, I will highlight 

a few of these differences to illustrate how FDIC’s authority over holding 

companies and affiliates is not as extensive as the authority that these 

consolidated supervisors have over holding companies and affiliates of 

banks and thrifts. 

FDIC’s Supervisory 

Authority Over ILC 

Holding Companies 

and Affiliates Is Not 

Equivalent to 

Consolidated 

Supervisors’ Authority 

FDIC and Consolidated 

Supervisors Use Different 

Supervisory Approaches 

With some exceptions, companies that own or control FDIC insured 

depository institutions are subject to a consolidated—or top-down—

supervisory approach that is aimed at assessing the financial and 

operations risks within the holding company structure that may pose a 

threat to the safety and soundness of the depository institution. 

Organizations in countries throughout the world recognize consolidated 

supervision as an accepted approach to supervising organizations that 

own or control financial institutions and their affiliates. The European 

Union generally requires consolidated supervision for financial institutions 

operating in its member states, and the Basel Committee recognizes this 

Page 10 GAO-06-961T 
approach as an essential element of banking supervision.14 According to 

this committee, consolidated supervision “includes the ability to review 

both banking and nonbanking activities conducted by the banking 

organization, either directly or indirectly (through subsidiaries and 

affiliates), and activities conducted at both domestic and foreign offices. 

Supervisors need to take into account that nonfinancial activities of a bank

or group may pose risks to the bank. In all cases, the banking supervisors 

should be aware of the overall structure of the banking organization or 

group when applying their supervisory methods.” 

In contrast to the top-down approach of bank consolidated supervision, 

which focuses on depository institution holding companies, FDIC’s 

supervision focuses on depository institutions. FDIC’s authority extends to

affiliates of depository institutions under certain circumstances. Thus, 

FDIC describes its approach to examining and taking supervisory actions 

concerning depository institutions and their affiliates (including holding 

companies), as bank-centric or bottom-up. According to FDIC officials, the 

objective of this approach is to ensure that the depository institution is 

insulated and isolated from risks that may be posed by a holding company 

or its subsidiaries. This objective is similar to the objectives of 

consolidated supervision. While FDIC officials assert that the agency’s 

bank-centric approach can go beyond the insured institution, as discussed 

later in this testimony, this approach is not as extensive as the 

consolidated supervisory approach in assessing the risks a depository 

institution faces in a holding company structure. 

Consolidated Supervisors 

Have More Explicit 

Supervisory Authority 

Over Holding Company 

Affiliates than FDIC 

Because most ILCs exist in a holding company structure, they are subject

to risks from the holding company and its subsidiaries, including adverse 

intercompany transactions, operations risk, and reputation risk, similar to 

those faced by banks and thrifts existing in a holding company structure. 

However, FDIC’s authority over the holding companies and affiliates of 

ILCs is not as extensive as the authority that consolidated supervisors 

have over the holding companies and affiliates of banks and thrifts. In our 

 14The Basel Committee on Banking Supervision, established in 1974, is composed of 

representatives from the central banks or supervisory authorities of major industrial 

countries in Europe, North America, and Asia, including the United States. This committee 

has no formal authority but seeks to develop broad supervisory standards and promote 

best practices in the expectation that each country will implement the standards in ways 

most appropriate to its circumstances. Implementation is left to each nation’s regulatory 

authorities. 

Page 11 GAO-06-961T 
2005 report, we described in detail various ways that consolidated 

supervision offered more explicit authority over holding company 

affiliates than FDIC’s bank centric approach. Today, I will summarize two 

of these points to illustrate some of the differences in supervisory 

authority between the FDIC and consolidated supervisors. These two 

points describe differences in FDIC’s and the Board’s authority to examine 

holding companies and their nonbank subsidiaries to assess potential risks 

to the insured depository institution; and the importance of consolidated 

supervision standards designed to ensure that the holding company serves

as a source of strength to the insured depository institution. 

As consolidated supervisors, the Board and OTS have broad authority to 

examine bank and thrift holding companies (including their nonbank 

subsidiaries), respectively, in order to assess risks to the depository 

institutions that could arise because of their affiliation with other entities 

in a consolidated structure.15 The Board and OTS have general authority to 

examine holding companies and their nonbank subsidiaries, subject to 

some limitations, to assess, among other things, the nature of the 

operations and financial condition of the holding company and its 

subsidiaries; the financial and operations risks within the holding 

company system that may pose a threat to the safety and soundness of any 

depository institution subsidiary of such holding company; and the 

systems for monitoring and controlling such risks.16 This authority is 

limited with respect to certain types of subsidiaries, such as those 

regulated by the Securities and Exchange Commission or state insurance 

regulators, but even those subsidiaries may be examined by the Board 

under appropriate circumstances where the Board “has reasonable cause 

to believe that such subsidiary is engaged in activities that pose a material

risk to an affiliated depository institution” or the Board has determined 

that examination of the subsidiary is necessary to inform the Board of the 

systems the company has to monitor and control the financial and 

operational risks within the holding company system that may threaten the 

safety and soundness of an affiliated depository institution.17 Also, under 

 15As noted above, the Securities and Exchange Commission has approved the applications 

of five investment banks, including the parent companies of several large ILCs, to be

subject to consolidated supervision. This prudential supervision regime entails SEC 

oversight of the risk management and control systems and SEC examination of unregulated 

entities within the holding companies.

16See 12 U.S.C. §§ 1844(c)(2)(A), 1467a., and 12 U.S.C. § 1831v(b). 

17See 12 U.S.C. § 1844(c)(2)(B). 

Page 12 GAO-06-961T 
the BHC Act, a Board examination of a holding company must, to the 

fullest extent possible, focus on subsidiaries that could have a materially

adverse effect on the safety and soundness of the affiliated depository 

institution due to the subsidiary’s size, condition or activities or the nature

and size of transactions between the subsidiary and the depository 

institution. OTS’ examination authority with respect to holding companies 

is subject to the same limitation.18 Even with these limitations, both the 

Board and OTS have direct authority to examine a subsidiary – based 

solely on characteristics of the subsidiary – in order to assess the 

condition of an affiliated bank. 

In contrast to the consolidated supervisory approaches of the Board and 

OTS, FDIC’s supervisory authority is more limited and does not 

specifically address the circumstances of an ILC holding company or its 

nonbank subsidiaries except in the context of a relationship between the 

ILC and an entity affiliated with it through the holding company structure. 

Specifically, FDIC’s authority to examine state nonmember banks, 

including ILCs, includes the authority to examine some, but not all, 

affiliates in a holding company structure. Under section 10(b) of the FDI 

Act, FDIC, in the course of examining an institution, may examine “the 

affairs of any affiliate of (the) institution as may be necessary to disclose 

fully—( i) the relationship between such depository institution and any 

such affiliate; and (ii) the effect of such relationship on the depository 

institution.”19 According to FDIC officials, FDIC can use its subpoena and 

other investigative authorities to obtain information from any affiliate, as 

well as any nonaffiliate, to determine compliance with applicable law and 

with respect to any matter concerning the affairs or ownership of an 

insured institution or any of its affiliates.20 According to FDIC officials, 

such an investigation would be triggered by concerns about the insured 

institution. 

Consolidated supervisors have also instituted standards designed to 

ensure that the holding company serves as a “source of strength” for its 

insured depository institution subsidiaries. For example, the Board’s 

regulations for bank holding companies include consolidated capital 

requirements that, among other things, can help protect against a bank’s 

 18See 12 U.S.C. §§ 1467a(b)(4), 1831(a). 

19See 12 U.S.C. 1820(b)(4)(A). 

20See 12 U.S.C. § 1820(c). 

Page 13 GAO-06-961T 
exposure to risks associated with its membership in the holding 

company.21

Because FDIC does not supervise institutions affiliated with depository 

institutions on a consolidated basis, it has no direct authority to impose 

consolidated supervision requirements, such as capital levels on ILC 

holding companies. However, FDIC does have authorities that it can use 

for certain purposes to address risk to depository institutions in a holding 

company structure. For example, FDIC indicated that it can initiate an 

enforcement action against an insured ILC and, under appropriate 

circumstances, an affiliate that qualifies as an institution-affiliated party 

(IAP) of the ILC if the ILC engages in or is about to engage in an unsafe or

unsound practice.22 An ILC affiliate is an IAP if, among other things, it is a 

controlling stockholder (other than a bank holding company), a 

shareholder who participates in the conduct of the affairs of the 

institution, or an independent contractor who knowingly or recklessly 

participates in any unsafe or unsound practices.23 However, FDIC’s ability 

to use this authority to, for example, hold an ILC holding company 

responsible for the financial safety and soundness of the ILC is less 

extensive than application of the source of strength doctrine by the Board 

or OTS under consolidated supervision. 

Figure 3 compares some of the differences in explicit supervisory 

authority between FDIC and consolidated supervisors, specifically the 

Board and OTS. This figure shows that in two of the eight areas FDIC has 

examination authority with respect to ILC affiliates that have a 

relationship with the ILC, as do the Board and OTS. However, we 

identified six areas where FDIC’s explicit authority with respect to ILC 

holding company affiliates is not as extensive as the explicit authorities of 

consolidated supervisors to examine, impose capital-related requirements 

on, or take enforcement actions against holding companies and affiliates 

of an insured institution. In general, FDIC’s supervisory authority over 

holding companies and affiliates of insured institutions depends on the 

 2112 C.F.R. Part 225, Appendices B & C. 

22FDIC has no authority to take action against an ILC affiliate whose activities weaken the

holding company, and potentially the ILC, unless the affiliate is an IAP and the IAP 

participated in conducting the ILC’s business in an unsafe or unsound manner, violated a 

legal requirement or written condition of insurance, or otherwise engaged in conduct

subject to enforcement. See 12 U.S.C. § 1818(b). 

23See 12 U.S.C. § 1813(u). 

Page 14 GAO-06-961T 
agency’s authority to examine relationships between the institution and its 

affiliates and FDIC’s ability to enforce conditions of insurance and written 

agreements, to coerce conduct based on the prospect of terminating 

insurance, and to take enforcement actions against a holding company or

affiliate that qualifies as an IAP.24

Figure 3: Comparison of Explicit Supervisory Authorities of the FDIC, Board, and OTS

a

FDIC may examine an insured institution for interaffiliate transactions at any time and can examine 

the affiliate when necessary to disclose the transaction and its effect on the insured institution. 

 24In addition to these authorities, we note that measures under the prompt corrective 

action provisions of the FDI Act based on an institution’s undercapitalized status include a 

parental capital maintenance guarantee and the possibility of divestiture of a significantly 

undercapitalized depository institution or any affiliate. See 12 U.S.C. § 1831o. These

measures apply equally to all FDIC insured institutions and their respective regulators. 

Page 15 GAO-06-961T 
b

The authority that each agency may have regarding functionally regulated affiliates of an insured

depository institution is limited in some respects. For example, each agency, to the extent it has the 

authority to examine or obtain reports from a functionally regulated affiliate, is generally required to 

accept examinations and reports by the affiliates’ primary supervisors unless the affiliate poses a

material risk to the depository institution or the examination or report is necessary to assess the 

affiliate’s compliance with a law the agency has specific jurisdiction for enforcing with respect to the 

affiliate (e.g., the Bank Holding Company Act in the case of the Board). These limits do not apply to

the Board with respect to a company that is itself a bank holding company. These restrictions also do

not limit the FDIC’s authority to examine the relationships between an institution and an affiliate if the 

FDIC determines that the examination is necessary to determine the condition of the insured 

institution for insurance purposes. 

c

FDIC may take enforcement actions against institution-affiliated parties of an ILC. A typical ILC 

holding company qualifies as an institution-affiliated party. FDIC’s ability to require an ILC holding 

company to provide a capital infusion to the ILC is limited. In addition, FDIC may take enforcement 

action against the holding company of an ILC to address unsafe or unsound practices only if the

holding company engages in an unsafe or unsound practice in conducting the affairs of the depository

institution. 

d

FDIC maintains that it can achieve this result by imposing an obligation on an ILC holding company

as a condition of insuring the ILC. FDIC also maintains it can achieve this result as an alternative to

terminating insurance. FDIC officials also stated that the prospect of terminating insurance may 

compel the holding company to take affirmative action to correct violations in order to protect the 

insured institution. According to FDIC officials, there are no examples where FDIC has imposed this

condition on a holding company as a condition of insurance. 

e

In addition to an enforcement action against the holding company of an ILC in certain circumstances

(see note b), as part of prompt corrective action the FDIC may require any company having control

over the ILC to (1) divest itself of the ILC if divestiture would improve the institution’s financial 

condition and future prospects, or (2) divest a nonbank affiliate if the affiliate is in danger of becoming

insolvent and poses a significant risk to the institution or is likely to cause a significant dissipation of 

the institution’s assets or earnings. However, the FDIC generally may take such actions only if the 

ILC is already significantly undercapitalized. 

Further, in our report we described various areas where FDIC officials 

asserted that their supervisory approach could achieve similar results to 

those of consolidated supervision. However, we found that FDIC’s 

authority in each of these areas was less extensive than consolidated 

supervision because these authorities can only be used under specific 

circumstances and they do not provide FDIC with a comprehensive 

supervisory approach designed to detect and address the ILC’s exposure 

to all risks arising from its affiliations in the holding company, such as 

reputation risk from an affiliate that has no relationship with the ILC. 

Table 2 provides a summary of what FDIC officials told us about their 

authority over holding companies and affiliates of insured depository 

institutions and our analysis of the limitations of these authorities. Today, 

I will highlight two of these areas: the ability to examine certain ILC 

affiliates and the ability to terminate deposit insurance to illustrate how 

FDIC’s authority is not equivalent to consolidated supervision of the 

holding company. 

Page 16 GAO-06-961T 
Table 2: The Extent of Selected FDIC Authorities

FDIC authority Extent of authorities

Examine certain ILC affiliates.

a

Only to determine whether the affiliate has a relationship with the ILC 

and, if so, to disclose the effect of the relationship on the ILC. The 

authority does not extend to determining how the affiliate’s involvement 

in the holding company alone might threaten the safety and soundness

of the ILC. 

Impose conditions on or enter agreement with an ILC 

holding company in connection with an application for 

deposit insurance. 

Only in connection with an application for deposit insurance and cannot 

be used to unilaterally impose conditions on an ILC holding company 

after the application has been approved. 

Terminate deposit insurance. Only if certain notice and procedural requirements (including a hearing 

on the record before the FDIC Board of Directors) are followed after 

FDIC determines that 

• the institution, its directors or trustees have engaged in unsafe or 

unsound practices; 

• the institution is in an unsafe or unsound condition; or 

• the institution, its directors or trustees have violated an applicable 

legal requirement, condition of insurance, or written agreement 

between the institution and FDIC. 

Obtain written agreements from the acquiring entity in 

connection with a proceeding to acquire an ILC.b

Could be used if grounds for disapproval exist with respect to the 

acquirer. 

Take enforcement actions against ILC affiliates.

c

Only if an affiliate is an IAP; and 

Only if the IAP engages in an unsafe or unsound practice in conducting 

the business of the ILC or has violated a legal requirement. If the IAP is

functionally regulated, FDIC’s enforcement grounds are further limited. 

Source: GAO analysis of the supervisory authorities stated by FDIC officials. 

a

FDIC’s ability to examine ILC affiliates is limited by the meaning of the term “relationship,” which is

unclear in situations where the ILC and the affiliate do not engage in transactions or share operations. 

In this respect, FDIC’s authority is less extensive than consolidated supervision because (1) the 

examination authority of consolidated supervisors does not depend on the existence of a relationship 

and (2) without a relationship, FDIC generally needs the consent of the affiliate to conduct an 

examination of its operations. 

b

FDIC’s ability to obtain written agreements from the acquiring entity in connection with a proceeding 

to acquire an ILC is limited because certain types of risks, such as reputation risk, could be unrelated 

to any of the grounds for disapproval of a Change In Bank Control Act notice. Moreover, this ability

would not be related to concerns arising after the acquisition is made. Further, some experts stated 

that it is unlikely that FDIC could require capital-related commitments from a financially strong, well 

managed commercial enterprise that seeks to acquire an ILC. 

c

In accordance with 12 U.S.C. §§1848a, 1831v(a), FDIC’s authority to take action against a

functionally regulated IAP is limited to where the action is necessary to prevent or redress an unsafe

or unsound practice or breach of fiduciary duty that poses a material risk to the insured institution and 

the protection is not reasonably possible through action against the institution. 

Page 17 GAO-06-961T 
FDIC officials stated that its examination authority is sufficient to address 

any significant risk to ILCs from holding companies and entities affiliated 

with the ILC through the holding company structure. For example, FDIC 

officials told us that it has established effective working relationships with 

ILC holding companies and has conducted periodic targeted examinations 

of some ILC holding companies and material affiliates that have 

relationships with the ILC, which includes those affiliates that are 

providing services to or engaging in transactions with the ILC. FDIC 

officials also told us that these targeted reviews of holding companies and 

affiliates help to assess potential risks to the ILC. 

FDIC’s Examination 

Authority Is Less 

Extensive Than a 

Consolidated Supervisor 

We agree that the scope of FDIC’s general examination authority may be 

sufficient to identify and address many of the risks that holding company 

and affiliate entities may pose to the insured ILC. However, FDIC’s general 

examination authority is less extensive than a consolidated supervisor’s. 

Because FDIC can examine an ILC affiliate only to determine whether it 

has a relationship with the ILC and, if so, to disclose the effect of the 

relationship on the financial institution, FDIC cannot examine ILC 

affiliates in a holding company specifically to determine how their 

involvement in the holding company alone might threaten the safety and 

soundness of the ILC. When there is no relationship between the ILC and 

the affiliate, FDIC generally would need the consent of the affiliate to 

conduct an examination of its operations. According to its officials, FDIC 

could use its subpoena powers and other authorities under section 10(c) 

of the FDI Act to obtain information, but the use of these powers appears 

to be limited to examinations or investigations relating to the insured 

depository institution.25 In contrast, the examination authorities of the 

Board and OTS focus on the operations and financial condition of the 

holding company and its nonbank subsidiaries and specifically on financial 

and operations risks within the holding company system that can threaten 

the safety and soundness of a bank subsidiary.26 To the extent that an 

affiliate’s size, condition, or activities could expose the depository 

institution to some type of risk, such as reputation risk, where no direct 

relationship with the bank exists, the consolidated supervisory approach

 25See 12 U.S.C. § 1820(c). 

26See, for example, the focus of bank holding company examinations as prescribed in the

BHC Act. 12 U.S.C. § 1844(c)(2). 

Page 18 GAO-06-961T 
is more able to detect the exposure.27 FDIC’s authority does not permit it 

to examine an affiliate based solely on its size, condition, or activities. 

While the most serious risk to an ILC would come from holding companies 

or affiliates that have a relationship with the ILC, the possibility that risks 

could come from affiliates with no relationship with the ILC should not be 

overlooked. While no recent bank failures may have resulted from 

reputation risk, it continues to attract the attention of the FDIC and the 

Board. Moreover, consolidated supervision requirements can address risks 

that might not be discernible at a particular point in time, whereas FDIC 

can exercise its authorities only under certain circumstances, such as 

when an application for insurance is granted. 

FDIC’s Authority to 

Terminate Insurance Can 

Be Exercised in Certain 

Circumstances 

FDIC officials stated that, even if conditions or agreements were not 

established in connection with the issuance of an ILC’s insurance, the

prospect of terminating an institution’s insurance can serve to compel the 

holding company to take measures to enhance the safety and soundness of 

the ILC. Under the FDI Act, FDIC can initiate an insurance termination 

proceeding only if certain notice and procedural requirements are 

followed after a determination by the FDIC that (1) an institution, its 

directors, or trustees have engaged in or are engaging in an unsafe or 

unsound practice; (2) an institution is in an unsafe or unsound condition; 

or (3) the institution, its directors, or trustees have violated an applicable 

legal requirement, a condition imposed in connection with an application

by the depository institution, or a written agreement between the 

institution and FDIC.28 In addition, termination proceedings must be 

conducted in a hearing on the record, documented by written findings in

support of FDIC’s determination, and are subject to judicial review.29 FDIC 

officials told us that if the grounds for termination exist, FDIC can provide 

the holding company of a troubled ILC with an opportunity to avoid 

termination by agreeing to measures that would eliminate the grounds for 

termination. These measures could include an agreement to infuse capital

 27See 12 U.S.C. 1844(c)(1)(C) Board examinations, to fullest extent possible, are to be

limited to examinations of holding company subsidiaries whose “size, condition, or

activities” could adversely affect the affiliated bank’s safety and soundness or where the 

nature and size of transactions between the affiliate and the bank could have that effect.

28The procedural requirements include notifying the appropriate federal or state banking 

supervisor of FDIC’s determination for the purpose of securing a correction by the 

institution. 12 U.S.C. § 1818(a)(2)(A). 

29See 12 U.S.C. § 1818(a)(3),(5). 

Page 19 GAO-06-961T 
into the ILC or provide reports about the holding company and its 

affiliates. According to FDIC officials, the prospect of terminating 

insurance is usually sufficient to secure voluntary corrective action by a 

holding company to preclude the occurrence of an unsafe or unsound 

practice or condition or restore the institution to a safe and sound 

financial condition. FDIC officials stated that FDIC has notified insured 

institutions that it intended to terminate deposit insurance 184 times. 

Between 1989 and 2004, FDIC initiated formal proceedings to terminate 

deposit insurance in 115 of these cases because necessary corrections 

were not immediately achieved and terminated deposit insurance in 21 of

these cases. In 94 of these 115 instances, corrective actions were taken,

and the deposit insurance was not terminated. 

As demonstrated by the number of institutions that took measures to 

enhance the safety and soundness of the insured depository institution, 

the threat of insurance termination has been an effective supervisory 

measure in many instances. However, FDIC’s ability to use the possibility 

of insurance termination to compel the holding company to enhance the 

safety and soundness of the insured institution is limited. For example, 

because the statutory grounds for termination relate to the condition of 

the institution and practices of its directors or trustees, the prospect of 

termination would not be based solely on the condition or operations of an 

institution’s affiliate. While conditions could exist in the holding company 

that might threaten the holding company and thereby indirectly threaten

an ILC, these conditions would not serve as grounds for termination of 

insurance unless they caused the institution to be in an unsafe or unsound 

condition. Further, unlike the consolidated supervision approach, FDIC 

insurance termination authority does not give it power to require a holding

company or any of its nonbank affiliates to change their operations or 

conditions in order to rehabilitate the ILC. The extent to which FDIC could 

enter into an agreement with a holding company would depend on 

whether the holding company has an incentive to retain the institution’s 

insured status and/or the resources to take the action FDIC seeks. 

FDIC Actions May Help 

Mitigate Potential Risks 

FDIC’s bank-centric, supervisory approach has undergone various 

modifications to its examination, monitoring, and application processes, 

designed to help mitigate the potential risks that FDIC-examined 

institutions, including ILCs in a holding company structure, can be 

exposed to by their holding companies and affiliates. For example, FDIC 

revised the guidance for its risk-focused examinations to, among other 

things, provide additional factors that might be considered in assessing a 

holding company’s potential impact on an insured depository institution 

Page 20 GAO-06-961T 
affiliate. These changes may further enhance FDIC’s ability to supervise 

the potential risks that holding companies and affiliates can pose to 

insured institutions in a holding company structure, including ILCs. In 

addition, FDIC’s application process may also help to mitigate risks to 

ILCs with foreign holding companies and affiliates. While FDIC has 

provided some examples where its supervisory approach effectively

protected the insured institution and mitigated losses to the bank 

insurance fund, questions remain about whether FDIC’s supervisory 

approach and authority over BHC Act-exempt holding companies and 

affiliates addresses all risks to the ILC from these entities. 

FDIC’s Supervisory Model 

and Authority Over BHC 

Act-Exempt Holding 

Companies and Nonbank 

Affiliates Has Been Tested 

on a Limited Basis in 

Relatively Good Economic 

Times

Although there have been material losses to the bank insurance fund 

resulting from two ILC failures in the past 7 years, the remaining 19 ILC 

failures occurred during the banking crisis in the late 1980s and early 

1990s. Most of these ILCs were small California Thrift and Savings and 

Loan companies that, according to FDIC, had above-average risk profiles. 

FDIC’s analysis of bank failures during this time period indicates that 

California experienced deteriorating economic conditions and a severe 

decline in the real estate industry, which contributed to the failure of 15 

ILCs in that state. As previously discussed, FDIC has since implemented 

changes to its supervisory approach and has told us about some recent 

examples where, according to FDIC, its supervisory approach—including 

its influence and authority as the provider of deposit insurance—has 

effectively protected the insured institution and prevented losses to the 

Fund. However, all of the ILCs that failed since the late 1980s, as well as 

those ILCs that became troubled and FDIC took corrective action, were 

relatively small in size compared with some of the large ILCs that currently

dominate the industry. FDIC has no experience using its supervisory 

approach to mitigate potential losses from troubled ILCs that would 

qualify for supervision under its Large Bank program.30

FDIC’s supervisory model and authority over BHC Act-exempt ILC holding 

companies and affiliates has emerged during a time when the banking 

industry has experienced relatively good times. Former FDIC Chairman 

Donald Powell described the past decade as a “golden age” of banking.

The past 10 years can be characterized by stable economic growth, which 

has contributed to strong industry profitability and capital positions. 

 30FDIC’s large bank program provides an on-site presence at depository institutions with 

total assets greater than $10 billion or because of their size, complexity, and risk profile. 

Page 21 GAO-06-961T 
During the past 8 years, only 35 financial institutions protected by the 

Fund have failed, and FDIC has reported that insured institutions’ earnings 

for 2004 set a new record for the fifth consecutive year and that the 

industry’s equity capital ratio is at its highest level since 1938.31 In contrast, 

1,373 financial institutions protected by the Fund failed between 1985 and 

1992 due to, among other things, poor management and poor lending 

practices. 

How FDIC’s supervisory approach would fare for large, troubled ILCs 

during an adverse external environment is not clear and the test of 

supervision is its effectiveness during periods of stress. We have long

advocated comprehensive regulation of financial services holding 

companies on both a functional and consolidated basis in order to assess 

how risks in other components of the holding company may affect the 

insured bank. We have stated that capital standards for both insured banks 

and their holding companies should adequately reflect all major risks. Our 

belief in the importance of consolidated supervision and consolidated 

capital standards is partly based on the fact that most bank holding 

companies are managed on a consolidated basis, with the risks and 

returns of various components being used to offset and enhance one 

another. In addition, past experience has shown that, regardless of 

whether regulatory safeguards—such as sections 23A and 23B

limitations—are set properly, even periodic examinations cannot ensure 

that regulatory safeguards can be maintained in times of stress. 

 31Equity capital or financing is money raised by a business in exchange for a share of

ownership in the company. Financing through equity capital allows a business to obtain 

funds without incurring debt or without having to repay a specific amount of money at a

particular time. The equity capital ratio is calculated by dividing total equity capital by total

assets. 

Page 22 GAO-06-961T 
ILC holding companies and their affiliates may be able to mix banking and

commerce more than other insured depository institutions because the 

holding companies and affiliates of ILCs are not subject to business 

activity limitations that generally apply to insured depository institution 

holding companies. Except for a limited category of firms, such as 

grandfathered unitary thrift holding companies and companies that own 

limited purpose credit card banks (CEBA credit card banks), entities that 

own or control insured depository institutions generally may engage, 

directly or through subsidiaries, only in activities that are financial in 

nature.32 Because of a provision in the ILC exception in the BHC Act, an 

entity can own or control a qualifying ILC without facing the activities 

restrictions imposed on bank holding companies and nonexempt thrift 

holding companies. As a result, the holding companies and affiliates of 

some ILCs and other subsidiaries are allowed to engage in nonfinancial,

commercial activities. 

Today, nonfinancial, commercial firms in the automobile, retail, and 

energy industries, among others, own ILCs. As of March 31, 2006, 10 ILCs 

with total assets of about $ 3.6 billion directly support their parent’s 

commercial activities. However, these figures may understate the total 

number of ILCs that mix banking and commerce because 5 other ILCs are 

owned by commercial firms that were not necessarily financial in nature.

Because these corporations, on a consolidated basis, include

manufacturing and other commercial lines of business with the financial 

operations of their ILC, we determined that these entities also mixed 

banking and commerce. Thus, we found that, as of March 31, 2006, 

approximately 15 of the 61 active ILCs were owned or affiliated with 

commercial entities, representing about $13.2 billion, (about 8.5 percent) 

and $8.2 billion (about 9.7 percent) of total ILC industry assets and 

estimated insured deposits, respectively.33 In addition, there are a number 

ILCs May Offer 

Commercial Holding 

Companies a Greater 

Ability to Mix Banking 

and Commerce than 

Other Insured 

Depository 

Institutions, but Views 

on Competitive 

Implications Are 

Mixed 

 32See 12 U.S.C. §§ 1843, 1467a(c). As previously discussed, grandfathered unitary thrift 

holding companies are not subject to these activities restrictions. Limited purpose credit

card banks also are exempt from the BHC Act. See 12 U.S.C. § 1841(c)(2)(F). 

33When determining the current levels of mixed banking and commerce within the ILC

industry, we considered only ILCs owned or affiliated with explicitly nonfinancial, 

commercial firms. Because some owners and operators of ILCs are engaged in business

activities that are generally financial in nature, but still may not meet the statutory

requirements of a qualified bank or financial holding company, officials from the Federal 

Reserve Board noted that they interpret the level of mixed banking and commerce among 

ILCs may be greater than 8.5 percent of industry assets and 9.7 percent of industry 

estimated insured deposits. 

Page 23 GAO-06-961T 
of pending applications for deposit insurance with FDIC involving 

commercial firms, including one of the largest retail firms. 

Regulators and practitioners with whom we spoke with also noted, 

however, that several other major industrial nations do allow a greater 

mixing of banking and commerce than does the United States. For 

example, in Europe there are generally no limits on a nonfinancial, 

commercial firm’s ownership of a bank. However, the European Union has 

mandated consolidated supervision. Japan has also allowed crossownership of financial services firms, including banks and commercial 

firms, permitting development of industrial groups or keiretsu that have 

dominated the Japanese economy. These groups generally included a 

major or “lead” bank that was owned by other members of the group, 

including commercial firms, and that provided banking services to the 

other members. The experience of these nations provides some empirical 

evidence of the effects of increased affiliation of banking and commercial 

businesses, particularly pointing to the importance of maintaining 

adequate credit underwriting standards for loans to affiliated commercial 

businesses. Problems in Japan’s financial sector, notably including 

nonperforming loans, often to commercial affiliates of the banks, have 

contributed in part to the persistent stagnation of the Japanese economy 

beginning in the 1990s. However, important differences between the 

financial and regulatory systems of these nations and the United States, 

and limitations in research into the effects of these affiliations, limit many 

direct comparisons. 

Mixing Banking and 

Commerce Presents Both 

Potential Risks and 

Benefits 

The policy generally separating banking and commerce is based primarily 

on limiting the potential risks that may result to the financial system, the 

deposit insurance fund, and taxpayers. We have previously reported that

the potential risks that may result from greater mixing of banking and 

commerce34 include the (1) expansion of the federal safety net provided 

for banks to their commercial entities, (2) increased conflicts of interest 

within a mixed banking and commercial conglomerate, and (3) increased 

economic power exercised by large conglomerate enterprises. However, 

generally the magnitudes of these risks are uncertain and may depend, in 

part, upon existing regulatory safeguards and how effectively banking 

regulators monitor and enforce these safeguards.

 34GAO, Separation of Banking and Commerce, GAO/OCE/GGD-97-16R (Washington, D.C.:

Mar. 17, 1997). 

Page 24 GAO-06-961T 
The federal government provides a safety net to the banking system that 

includes federal deposit insurance, access to the Federal Reserve’s 

discount window, and final riskless settlement of payment system 

transactions. According to Federal Reserve officials, the federal safety net 

in effect provides a subsidy to commercial banks and other depository 

institutions by allowing them to obtain low-cost funds because the system 

of federal deposit insurance shifts part of the risk of bank failure from 

bank owners and their affiliates to the federal bank insurance fund and, if

necessary, to taxpayers. The system of federal deposit insurance can also

create incentives for commercial firms affiliated with insured banks to 

shift risk from commercial entities that are not covered by federal deposit 

insurance to their FDIC-insured banking affiliates. As a result, mixing 

banking and commerce may increase the risk of extending the safety net, 

and any associated subsidy, may be transferred to commercial entities. 

This risk, however, may be mitigated by statutory and regulatory 

safeguards between the bank and their commercial affiliates such as 

requirements for arms-length transactions and restrictions on the size of 

affiliate transactions under section 23A and 23B of the Federal Reserve 

Act. However, during times of stress, these safeguards may not work 

effectively—especially if managers are determined to evade them. 

The mixing of banking and commerce could also add to the potential for 

increased conflicts of interest and raise the risk that insured institutions 

may engage in anticompetitive or unsound practices. For example, some 

have stated that, to foster the prospects of their commercial affiliates, 

banks may restrict credit to their affiliates’ competitors, or tie the 

provision of credit to the sale of products by their commercial affiliates. 

Commercially affiliated banks may also extend credit to their commercial 

affiliates or affiliate partners, when they would not have done so 

otherwise. Additionally, some have also stated that mixing banking and 

commerce could promote the formation of very large conglomerate 

enterprises with substantial amounts of economic power. If these 

institutions were able to dominate some markets, such as the banking

market in a particular local area, they could impact the access to bank 

services and credit for customers in those markets. 

Other industry observers envision potential benefits from mixed banking

and commerce, including allowing banks, their holding companies, and 

customers to benefit from potential increases in the scale of operations, 

which lowers the average costs of production, known as economies of 

scale, or from potential reductions in the cost of producing goods that 

share common inputs, known as economies of scope, and enhanced 

product and geographic diversification. Because banks incur large fixed

Page 25 GAO-06-961T 
costs when setting up branches, computer networks, and raising capital, 

these institutions may benefit from the selected economies of scale and

scope that could result from affiliations with commercial entities. Mixed 

banking and commercial entities may also benefit from product synergies 

that result from affiliation. For example, firms engaged in both the 

manufacturing and financing of automobiles may be able to increase sales 

and reduce customer acquisition costs by combining manufacturing and 

financing. Enhanced product and geographic diversification could also 

reduce risk to the combined entity. 

However, during our search of academic and other literature, we were 

unable to identify any conclusive empirical evidence that documented 

operational efficiencies from mixing banking and commerce. One primary 

factor in the lack of empirical evidence may be that, because of the policy

generally separating banking and commerce, few institutions are available 

for study. 

Because GLBA removed several restrictions on the extent to which 

conglomerates could engage in banking and nonbanking financial 

activities, such as insurance and securities brokerage, some analysts had

expected that conglomeration would intensify in the financial services 

industry after GLBA. However, as yet, this does not seem to have 

happened. The reasons vary. Many banks may not see any synergies with 

insurance underwriting. Additionally, it may be that many mergers are not 

economically efficient, the regulatory structure set up under GLBA may 

not be advantageous to these mergers, or, it is simply too soon to tell what 

the impact will be. Further, a general slowdown occurred in merger and 

acquisition activity across the economy in the early 2000s, which may also

be a contributing factor to the pace of industry conglomeration post 

GLBA. 

As we stated in our 2005 report, ILCs have significantly evolved from the 

small, limited purpose institutions that existed in the early 1900s. Because

of the significant recent growth and complexity of some ILCs, the industry 

has changed since being granted an exemption from consolidated 

supervision in 1987, and some have expressed concerns that ILCs may 

have expanded beyond the original scope and purpose intended by 

Congress. The vast majority of ILCs have corporate holding companies 

and affiliates and, as a result, are subject to similar risks from holding 

company and affiliate operations as banks and thrifts and their holding 

companies. However, unlike bank and thrift holding companies, most ILC 

holding companies are not subject to federal supervision on a 

Concluding Remarks 

Page 26 GAO-06-961T 
consolidated basis. While FDIC has supervisory authority over an insured 

ILC, it does not have the same authority to supervise ILC holding 

companies and affiliates as a consolidated supervisor. While the FDIC’s 

authority to assess the nature and effect of relationships between an ILC 

and its holding company and affiliates does not directly provide for the 

same range of examination authority, its cooperative working 

relationships with state supervisors and ILC holding company 

organizations, combined with its other bank regulatory powers, has 

allowed the FDIC, under limited circumstances, to assess and address the 

risks to the insured institution and to achieve other results to protect the 

insurance fund against ILC-related risks. However, FDIC’s supervisory 

approach over ILC holding companies and affiliates has not been tested by 

a large ILC parent during periods of economic stress. Moreover, we are 

concerned that insured institutions posing similar risks to the Deposit 

Insurance Fund are not being overseen by bank supervisors that possess 

similar powers. Because of these differences in supervision, we found that, 

from a regulatory standpoint, ILCs in a holding company structure may 

pose more risk of loss to the Fund than other types of insured depository 

institutions in a holding company structure. To better ensure that 

supervisors of institutions with similar risks have similar authorities, 

Congress should consider various options such as eliminating the current 

exclusion for ILCs and their holding companies from consolidated 

supervision, granting FDIC similar examination and enforcement authority 

as a consolidated supervisor, or leaving the oversight responsibility of 

small, less complex ILCs with the FDIC, and transferring oversight of 

large, more complex ILCs to a consolidated supervisor. 

In addition, although federal banking law may allow ILC holding 

companies to mix banking and commerce to a greater extent than holding

companies of other types of depository institutions, we were unable to 

identify any conclusive empirical evidence that documented operational 

efficiencies from mixing banking and commerce, and the views of bank 

regulators and practitioners were mixed. Nevertheless, the potential risks 

from combining banking and commercial operations remain. These 

include the potential expansion of the federal safety net provided for 

banks to their commercial entities, increased conflicts of interest within a 

mixed banking and commercial conglomerate, and increased economic 

power exercised by large conglomerate enterprises. In addition, we find it 

unusual that this limited exemption for ILCs would be the primary means 

for expanding the mixing of banking and commerce than afforded to the 

holding companies of other financial institutions. Because it has been a 

long time since Congress has focused on the potential advantages and 

disadvantages of mixing banking and commerce and given the rapid 

Page 27 GAO-06-961T 
growth of ILC assets and a potential for increased attractiveness of the ILC 

charter, we concluded in our 2005 report that Congress should more 

broadly consider the advantages and disadvantages of mixing banking and 

commerce to determine whether continuing to allow ILC holding 

companies to engage in this activity more than the holding companies of 

other types of financial institutions is warranted or whether other financial 

or bank holding companies should be permitted to engage in this level of 

activity. 

Mr. Chairman, this concludes my prepared statement. I would be pleased

to answer any questions you or other Members may have at the 

appropriate time. 

For further information on this testimony, please contact Richard Hillman 

at (202) 512-8678 or hillmanr@gao.gov. Contact points for our Office of 

Congressional Relations and Public Affairs may be found on the last page 

of this statement. Individuals making key contributions to this testimony 

included Dan Blair, Tiffani Humble, James McDermott, Dave Pittman, and 

Paul Thompson. 

GAO Contacts and 

Staff 

Acknowledgments 

Page 28 GAO-06-961T (250306) 
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