ega-retailer Wal-Mart Stores Inc. has turned cost cutting into an extreme sport, so it's no surprise that its latest move to slash expenses has created a firestorm. The goliath wants to charter a limited-purpose bank to handle payment processing and other financial services in-house.

Wal-Mart estimates that its customers make about 2 billion purchases with bankcards and checks each year. First Data Corp. handles most of the company's payment processing business; a Wal-Mart spokesman said that if Wal-Mart processed payments through its own bank, it would save millions of dollars each year.

Some see this development as far from benign.

One application, many ripples

Wal-Mart submitted its application for a license to own a special, limited-use bank, known as an Industrial Loan Company (ILC) or Industrial Bank, in July 2005. The application is now pending before the Federal Deposit Insurance Corp. (FDIC), which has scheduled two public hearings on the matter for April, one in Washington, D.C. and the other in Kansas City, Mo.

According to the FDIC, these are the first hearings ever held to discuss a banking application. New bank applications typically generate little interest; this application has spurred over 1,900 comment letters from various sectors including community banks, an array of politicians, and trade groups such as the American Bankers Association and the Independent Community Bankers Association.

The Fed weighs in

Everyone, it seems, has something to say about Wal-Mart, even Ben Bernanke, the new Federal Reserve Chairman. In an appearance before the U.S. Senate Banking Committee in February, Bernanke raised concerns over "recent proposals that ILCs will have additional powers including interest on business checking and out of state branching."

Bernanke said these powers "would in de facto make ILCs the functional equivalent of banks." If this happens, he said, "[T]hey should receive parallel treatment in terms of consolidated supervision and other responsibilities and requirements that banks face."

Bernanke also asked, "[I]f a commercial firm owns a bank, would it not be possible that the safety net [for the bank] be inadvertently extended to the commercial firm? Would we be able to segregate the financial condition of the commercial firm and its bank?"

Other heavies weigh in too

Given that Target Corp. already has a bank charter that is uses to issue store credit cards, Sen. Robert Bennet (R-Utah) said that he didn't understand "why it's OK for one large retailer to have such a charter and not its competitor."

Sen. Paul Sarbanes (D-Md.) even questioned the validity of ILCs because a recent government study found them to be inadequately regulated. The FDIC disagreed. "[I]t is not a slam dunk" to obtain a charter and federal deposit insurance, and "the regulatory and supervisory process for ILCs, by the FDIC is adequate," said an FDIC spokesman.

Federal guidelines do not classify ILCs as standard banks. Thus, they are exempt from regulations that prohibit commercial ownership of financial institutions. According to the FDIC, about 60 such institutions are in operation today; a number are chartered by commercial firms including Target, Volkswagen, Nordstrom and General Electric.

Give 'em an inch ...

Community bankers fear that Wal-Mart will expand its limited charter by offering consumer and commercial banking services. The retailer counters this by pointing to over 1,100 community banks around the country operating branches inside Wal-Mart stores. A Wal-Mart representative said that current plans call for expanding the partnerships, not putting potential partners out of business.

In its application, Wal-Mart stated that its ILC will be used solely to process electronic transactions. The company said that it has no plans for branches, loans, deposits and other financial services. However, the application also stated that "short term certificates of deposit" will be offered to 501(c)(3) nonprofits and "individual investors generated through deposit brokers."

A Wal-Mart spokesman said that deposit brokers function like stock brokers and that short term deposit certificates could be part of something similar to a mutual fund. He stressed that this would happen on a very small scale. Time will tell.