This is the second article in our series on utilizing what banks can do. Last month, we made some notes and comments on some of the basic things that banks do. We then took a deeper dive into deposits, lending, and the primary functions of banks. This month, we want to dive a little further into some other activities that banks can actually participate in.
Insurance Agencies
Were you aware that a bank can run an insurance agency? It doesn’t matter whether you’re a national bank or a state bank, and the format might look a little bit different depending on where your bank is located and how big your community is, but this is something that your bank can look at doing.
How does it work? You can do this one of two ways. First, you can act as an insurance agent, having employees who act as insurance agents, give quotes, collect premiums, and take care of customers throughout the insurance life cycle. Second, you can just refer the insurance to an insurance broker who will handle the business and collect a referral fee. The bank can either do this directly, or the bank holding company can have a subsidiary that acts as an insurance agency.
There are a lot of caveats built around this. For example, if you are in a location with a population of 5,000 or less, it’s going to be a little bit easier for you to act directly as an insurance agency. If you’re in a location with a population larger than 5,000, and depending on which federal circuit you’re in, you might have to have a financial subsidiary offer that to you. Bank of America pushed a case through the courts that let Bank of America act as an insurance agent. The branch in question was in a location with a population of 5,000, and the court seemed to think that was okay.
Understanding that the how, where, and what the format needs to look like would need to be looked at for each individual bank, yes, a bank can act as an insurance agency. This can be an entirely new line of business. It can be home, auto, and life insurance, or some other type of insurance line altogether.
Software Development
This next item is kind of exciting in today’s world, where there’s so much focus on technology and software development. Banks can develop software. This comes out of the powers of banks to engage in incidental activities to the business of banking. National banks and state banks are generally authorized to engage in incidental activities. In other words, if you need software to help you record transactions, or to help with your loan origination, or with business intelligence, you can develop that and then license it to other institutions.
With so much focus on cyber security and issues with fraud, there’s a lot of need to develop solutions to help avoid ransomware, to increase and better the way that cybersecurity is handled, and to improve the way the industry tackles that issue. Banks can do that if they’re developing that software for the purpose of furthering their business. The bank can then turn around a license for that same service to other banks and financial institutions. They can even provide access capacity to non-banking institutions. There’s really a lot more opportunity there than might be apparent. Also, since that sort of software development is an incidental activity to this banking, a bank can make an investment in another firm that is engaging in those activities.
There are a few things you must be aware of. If you do make an in another company, that company needs to limit its activities to activities that are acceptable for a bank or financial institution. A while back, as an example of this type of business activity, Truest went ahead and started to offer core processing services to other community banks and financial institutions. Software development has so many potential offerings, and there is lots of flexibility there. I wouldn’t be surprised to see at least some banks take a step in that direction.
Venture Capital
The next area is venture capital. This is a little different in that a bank can’t engage in venture capital activities directly, but a bank holding company can own a venture capital firm. This is true venture capital. This means you’re going to make an investment in an enterprise where the outcome is uncertain. Yes, you can take an equity position; it doesn’t have to be a loan position, and you can count on capitalizing on that when there is growth in the business, and you sell at the time you desire to exit the company.
Venture capital is possible through a bank-holding company, and you’ll see some of the larger entities and bank-holding company families have a venture capital arm. A lot came into play back when some of the large venture capital firms became troubled in need of support, such as TARP funds or other funding. At this time, the government allowed venture capital firms to jump into a bank holding company family to take advantage of some of the capital support that was available through the banking industry infrastructure. It’s still available. It can still be used. You don’t have to be a giant institution to engage in that. You do need to keep your activities safe and sound, though. It needs to be a support for the bank and not a super risky activity that will draw away from the strength of the bank.
Investment in Commerce
The last one we want to talk about is really interesting. There is a provision in section four (see the bank holding company act) that allows a bank holding company to make a less than 5% investment in an enterprise. This is kind of an oddball exception. In most cases, there’s a strong division between banking and commerce. That is, banks and bank holding companies generally cannot engage directly in commerce or make investments other than loans in commercial enterprises. So, this “less than 5%” is a big exception. It is available. Some banks have used it in the past and may still be using it. It needs to make sense for the bank, but that’s an interesting exception that may be used.
Conclusion
So why are we going over these things? We’re hoping to give some more inspiration to our community bank clients. We see that, aside from just the traditional loans and deposits, there may be income-generating activities that make sense for a bank if only they were aware of them.
Farley Law specializes in working with both community banks and small businesses. If you are interested in learning more about these or any other income-generating activities for banks, please feel free to contact us at Farley Law, where we help our client financial institutions develop new products and financial services. Have a question or a comment? Send us a note at business@farleylawpllc.com, or set up an introductory call using our bookings service.
