Following months of speculation, on December 2, 2016, the Office of the Comptroller of the Currency (OCC) announced that it will consider applications from fintech companies seeking national bank charters. A national bank charter would enable a fintech company to originate loans and access the payment system directly, without relying on third-party banks. And because an OCC charter is national in scope, a fintech company with a national bank charter could operate across the country without acquiring a separate license in each state that its customers are located in.
National banks, however, are subject to broad federal regulation and supervision. Fintech companies, like other emerging technology companies, typically exploit thin levels of capital, low operating and staff expenses and nimble business plans compared to traditional banks that must bear the regulatory costs that accompany a banking charter. Fintech companies will have to decide whether the advantages of a national bank charter, such as uniform regulation and the ability to "export" the legal limits on interest rates of the bank's home state, merit sacrificing the competitive advantages that federal regulation and supervision may require. Similarly, fintech companies will have to weigh the benefits of national regulation over the other two prevailing models: state licensing, which comes with state-by-state regulation, and sponsorship arrangements with third-party banks.
The Advantages of a National Bank Charter
In the United States a bank can be chartered by either a state or by the OCC.
The OCC is an independent bureau of the U.S. Department of the Treasury. The OCC charters all national banks. The OCC also regulates and supervises these financial institutions.
A national bank charter authorizes an institution to operate nationwide without the need to obtain and maintain multiple licenses on a state-by-state basis. Licensing processes vary from state to state, so nationwide licensing is a complex task that is often impractical for nonbanks.
- Without a bank charter, a nationwide lender must comply with the supervisory laws of each state in which it conducts business, such as licensing requirements and limits on interest rates. The largest platform lenders generally attempt to avoid these regulatory requirements by marketing and selling loans that are actually originated by third-party banks through sponsorship arrangements. With a national bank charter, these fintech companies could originate loans themselves without state licenses, exporting the interest rate of their home state, and avoiding the legal uncertainty and costs of bank sponsorship structures.
- Fintech companies engaging in payment businesses are similarly required to consider the laws of states where customers are located, many of which require these companies to be licensed as money transmitters or sellers of stored value. A fintech company with a national banking charter generally would not be subject to these state licensing requirements.
Special Purpose Charters
In addition to chartering traditional full-service national banks, the OCC also charters special purpose banks with charters that may limit their business to trust activities or serving as credit card banks, for example. The OCC anticipates that fintech companies may seek limited charters. To apply for a national bank charter, a fintech company must plan to engage in at least one of the following functions: receiving deposits, paying checks, lending money or fiduciary/trust activities. In this sense, the OCC isn't really creating a new fintech charter or class of banks. Rather, the OCC is announcing that it will accept applications for bank charters, including special purpose charters, from innovative financial companies.
A fintech company that will accept deposits would be required to apply to, and receive approval from, the FDIC in addition to the OCC and would be subject to the FDIC's rules and regulations, though the OCC would remain the company's primary federal banking regulator. By seeking a special purpose charter that does not allow it to accept deposits, a fintech company could avoid FDIC regulation.
The OCC's White Paper
The OCC's announcement was accompanied by a white paper, "Exploring Special Purpose National Bank Charters for Fintech Companies." The white paper outlines the OCC's existing licensing and supervisory processes and how they will apply to fintech companies seeking charters. The white paper also solicits comments on aspects of the OCC's proposal. The white paper emphasizes that all national banks, including fintech companies with limited-purpose charters, are required to "meet high supervisory standards." In addition, the OCC will consider an applicant's plans to ensure "financial inclusion," asserting that national banks must "provide fair access to financial services by helping to meet the credit needs of its entire community."
The white paper suggests that the OCC is prepared to begin accepting charter applications from fintech companies immediately. The white paper does not, however, offer specific guidance about many of the most significant questions that fintech companies considering a national charter are likely to consider:
- What standards will apply when the OCC evaluates charter applications?
- Will a national charter enable a fintech company to select a state and use the usury limits of that state for nationwide lending, just like a traditional national bank?
- Will a fintech company with a national charter have access to the Federal Reserve's discount window as a Federal Reserve member?
- How will the OCC's expectations about "financial inclusion" impact fintech companies engaged in specialty lending activities? How will the OCC enforce these expectations after a charter is issued?
- How will the OCC apply traditional capital and liquidity requirements to fintech companies that don't hold loans after origination? The white paper notes that both qualitative and quantitative factors will apply to fintech companies, but does not specifically address Basel capital adequacy standards, which are somewhat onerous on a startup and could make it more difficult to raise funds from investors.
- How will the OCC react to business plans with a narrow or specialized focus?
- How will the OCC, which has traditionally associated swift growth with increased risk, react to business plans anticipating the type of rapid growth associated with successful emerging growth companies?
- What expectations and requirements might the FDIC impose on applicants seeking deposit insurance? Given that national banks are Federal Reserve members by default, what expectations will the Federal Reserve have with respect to charter applications?
Implications of Operating Under the Bank Regulatory Framework
Fintech companies with OCC charters will be subject to the same regulatory and supervisory requirements as traditional national banks, although fintech companies that don't accept deposits won't be subject to FDIC regulations. These requirements, which are intended to protect bank customers and the banking system generally, are broad and may present challenges to the traditional startup model of the thinly staffed, venture-backed company banking on rapid growth:
- These banking laws include regulatory capital requirements, the Bank Secrecy Act, anti-money laundering laws and lending limits, as well as many consumer laws that already apply to fintech companies offering consumer financial products and services. Fintech companies seeking national charters will be required to demonstrate that they are prepared to comply with these laws and will face regular OCC compliance examinations.
- National banks are subject to Regulation W, a Federal Reserve rule limiting transactions between banks and their affiliates. The rule generally requires that all transactions between a bank and its affiliates be on arm's-length terms, sets quantitative limits and quality requirements for credit transactions between a bank and its affiliates and prohibits the sale of an affiliate's "low-quality" assets to a bank. Affiliates may include a bank's parent company or controlling shareholder, companies under common control and potentially other entities having a control relationship. Fintech firms that are accustomed to moving funds seamlessly between various licensed entities, operating entities and financing entities may find it more difficult to do so with a chartered bank subsidiary that is subject to Regulation W and specific capital restrictions.
- Unlike an ordinary corporation, a national bank's activities are limited to those that are closely related to banking, as determined by the OCC. While the OCC has permitted national banks to engage in a wide range of financial activities, national banks are generally barred from engaging in commerce or providing services unrelated to banking.
- As part of the application process, the OCC will evaluate an applicant's business plan for risk and the likelihood of success. For fintech companies planning to accept deposits, the FDIC requires new banks to seek advance regulatory approval for any material changes to its business plan during its first three years of operation.
- Fintech companies evaluating a bank charter will need to consider laws governing bank control as part of their capital-raising efforts. An investor must seek advance regulatory approval before acquiring control of a national bank. Generally, a shareholder having the power to vote 10% or more of any class of a bank's voting shares is presumed to control the bank. A controlling investor that is a company, such as a corporation, partnership, limited liability company or certain trusts, may be a bank holding company under the Bank Holding Company Act if the fintech company is a bank within the meaning of the act. Bank holding companies are subject to supervision and examination by the Federal Reserve and are required to be a source of financial and managerial strength for the banks they control. In addition, the Bank Holding Company Act generally limits the activities of bank holding companies and their subsidiaries to those relating to financial services. This restriction may preclude a technology company engaged in nonfinancial activities from owning or controlling a fintech subsidiary that is a bank within the meaning of the Bank Holding Company Act.
- The National Bank Act and OCC regulations control many aspects of a national bank's governance and management. These restrictions include limitations on a national bank's ability to pay dividends and make other distributions. A national bank's creation of new series of preferred stock requires advance OCC approval, and some customary antidilution provisions included in typical venture capital financings may preclude financing proceeds from being counted as capital for regulatory purposes.
- The OCC will expect a chartered fintech company to meet its "financial inclusiveness" expectations, even if the company does not accept FDIC-insured deposits. An applicant will need to ensure that its business plan demonstrates how it will meet this expectation and should expect that the OCC will monitor its compliance. This requirement has received particular attention, including whether Community Reinvestment Act rules and standards might inform the OCC's financial inclusiveness expectations.
Is It Worth It?
Many players in the emerging fintech industry, such as platform lenders and those facilitating payments, have enjoyed a competitive advantage over banks by offering functionally similar services without bearing the costs and living within the limits of bank regulation. Those companies will now need to decide whether the privileges of a national charter merit the regulatory costs that will follow—many of which are uncertain and will continue to evolve as the OCC issues its first fintech charters.
At a recent Marketplace Lending & Investing conference following the release of the white paper, many were excited about the prospects of becoming a chartered bank, but there was also some skepticism. One panelist noted, "It will depend on how much pain I have to go through to get and keep my charter versus the cost of available alternatives."