John R. Walter

English

Research Papers in Economics

M
any U.S. firms include both commercial and non-
bank financial units. For example, Ford Motor
Co. encompasses not only units that manufac-
ture automobiles but also those, such as Ford Motor Credit,
that gather funding and make loans to individuals. Firms
that handle both commercial and financial activities appear
to reap significant benefits which create the appeal of 
such combinations. One byproduct of a commercial firm’s 
activities may be information about its customers’ financial
situation. The financial affiliate might then use this 
information to inexpensively target products to particular
customers, benefiting both the financial firm and its 
customers, an activity commonly know as cross-selling.
While finance-commerce combinations are widespread,
combinations between banks and commercial firms typi-
cally are prohibited. But the law does provide a loophole
that allows nonfinancial firms to engage in a limited range of
banking activities. It is through this well-traveled loophole
that retail giants Wal-Mart and Home Depot recently have
submitted applications to form or buy banks.
These applications have focused a great deal of attention
on the controversial combination of banking and commerce.
The merits of the specific Wal-Mart and Home Depot appli-
cations aside, this may be a good time to ask why
banking-commerce combinations are typically prohibited in
the first place.
The Bank Holding Company Act of 1956 prohibits 
commercial firms from owning banks. This keeps manufac-
turers and operators of retail stores, for example, from
purchasing banks. The Gramm-Leach-Bliley Act, enacted in
1999, opened the opportunity for banks to be owned by
companies engaged in the financial activities of securities
dealing and insurance, but did not allow bank ownership to
nonfinancial commercial firms.
The Bank Holding Company Act, however, does allow
commercial companies to own industrial loan corporations
(ILCs), or industrial banks. These institutions are funded
with Federal Deposit Insurance Corp.-insured deposits but
typically do not offer checking accounts to businesses.
(Wal-Mart wants to create an industrial bank and Home
Depot wants to buy one.)
According to a Government Accountability Office study,
there were 57 industrial banks at the end of 2004. They held
$140 billion in assets, and about 3 percent of all insured 
bank deposits. While many are owned by financial firms, a 
number are owned by commercial firms such as the auto-
motive company BMWand retailer Target Corporation.
Why are banking-commerce combinations controver-
sial? Observers have at times raised concerns over conflicts
of interest that might arise if banks and commercial 
companies are owned by the same firm. They argue that 
such concerns justify keeping banking and commerce 
separate. While this argument takes several forms, the 
most frequent is that a bank affiliated with a commercial
firm would tend to deny loans to the affiliate’s competitors.
Under this scenario, a bank with a commercial affiliate —
say, a restaurant — would not wish to provide funding to
competing restaurants. Helping the competitor would 
tend to lower the profits of the affiliated restaurant.
On the other hand, if competition is reasonably strong —
and there is every reason to think that today’s banking 
markets are quite competitive — denying loans to competi-
tors only lowers overall profits of the consolidated
banking-restaurant firm. If there are alternative lenders 
over which the affiliated bank has no price advantage, the
competing restaurant would receive a loan regardless at the
same interest rate the affiliated bank would offer. So, by 
failing to make the loan, the bank loses any profit it might
have made on that loan, hurting the bank. And the affiliated
restaurant gains no advantage.
Consequently, concerns regarding conflicts of interest
are probably insufficient justification for maintaining the
current wall separating banking and commerce and denying
firms the opportunity to benefit from combinations.
Nevertheless, there remains a hazard that could justify the
continued presence of the wall, or at least require that 
significant precautions be taken if the wall is removed.
The hazard is that a combined company can be expected
under certain circumstances to withdraw resources from its
bank to hide problems in its commercial subsidiary, damag-
ing bank safety. A holding company owning a bank and a
commercial entity can be expected to choose this course
when it can hide its commercial subsidiary losses from
investors and analysts by shifting commercial subsidiary
losses to the affiliated bank. Since bank assets are often 
considered more opaque to outsiders than nonbank assets,
such losses might be better hidden if shifted to the bank. If
commercial firm losses can be expected to be shifted to
insured banks, and perhaps on to the FDIC, there may be
reason to prevent combinations.
Potential loss-shifting presents real risks to the public.
Stepped-up oversight could potentially mitigate those risks
and, as a result, allow us to remove the wall between banking
and commerce. For now, though, combinations through the
industrial bank loophole raise legitimate concerns for bank
regulators, and deserve careful consideration before being
approved.  RF
John R. Walter is a research economist at the Federal
Reserve Bank of Richmond. 
BY JOHN R. WALTER Mixing Banking and Commerce
60 Region Focus • Summer 2006
OPINION
RF Summer 2006v27  7/24/06  12:53 PM  Page 60

Opinion: Mixing banking and commerce

http://www.richmondfed.org/publications/research/region_focus/2006/summer/pdf/opinion.pdf

Opinion: Mixing banking and commerce

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