Fintech companies seeking a new bank charter in the United States have generally found the proposition to be a nonstarter. But could casting their eye toward Main Street become a viable solution to getting in the U.S. banking system?
Although fintech might revel in its outsider status, there are real benefits to being a bank and observers say as the sector matures, expect more fintech companies to seek charters. For lenders, deposits insured by the Federal Deposit Insurance Corp., are one of the cheapest funding sources around. The core banking business could provide them with a revenue stream. And having a charter could eliminate the middleman and the risk associated that, since many rely on bank partners to execute their business.
"If interest rates rise, I can see a scenario where these companies turn around and find that they need a bank charter to fund the growth of their operations," said J. Brennan Ryan, an Atlanta-based attorney with Nelson, Mullins, Riley & Scarborough. "That's the whole reason to have a bank: to have customer deposits and make loans and make money off the spread. I would not be surprised if in the next year or two if we saw more fintech-type companies applying for a bank charter."
Much of the conversation around fintechs becoming banks centers on getting de novo charters from regulators. That's a tough play — besides the complexities of fintech, de novo activity overall is rocky. There have been few since the economic downturn of 2008. Even regulators have been increasingly optimistic about de novos, observers often say that the business case for starting a new bank is not there. But with 183 banks still on the Federal Deposit Insurance Corp.'s problem list and scores of other small banks grappling with succession issues, could fintech's future be in buying relics?
Maybe, observers say. But don't expect it to be an easier path than going the de novo route. The problem ones still have troubled loans. The legacy technology is likely not suited for a slick digital platform. They'd need capital and would also likely need seasoned bankers to help them run it and win over the regulators.
Nonetheless, it is a strategy that banking attorneys say is occasionally discussed. And it is one that fintech companies determined to be a bank should consider.
"If you want to charter a new bank, expect 15 months of your life devoted to getting it," said Thomas Vartanian, a partner at Dechert. "My first choice when advising clients is to buy something. If it has some problems, the regulators likely want it acquired. That's a better situation than you begging them for a new charter."
Unlike Europe, where regulators in various countries have issued charters to digital-only startup "challenger banks," U.S. regulators have taken a more cautious approach. There are some signs that might be changing, albeit slowly. The Office of the Comptroller of the Currency said on May 9 that it was contemplating a "limited-purpose" charter designed for fintech companies. However, no decision has yet to be made and the agency has thus far offered no details about what a limited-purpose charter might look like. The OCC didn't return calls for comment. The FDIC declined to comment.
That reticence from regulators has generally led fintech companies to seek a bank partnership to do business in the U.S. That's the path taken by Fidor Bank, the highly popular German digital bank formed in 2007, which said in March it would not seek a U.S. bank charter — as it had initially mulled and successfully did in its expansion to the U.K. — and instead would seek a bank partnership.
Fidor took that route not only because it was an easier path to doing business in the U.S., but also so it could begin operating here more quickly, its chief executive Matthias Kroner said in an email.
However, one of the clear advantages of getting a charter, regardless if it is new or an acquired one, is the ability to eliminate partnerships. Currently, much of fintech relies on banks to operate. For instance, many marketplace lenders work with a small number of banks to initially make the loans. However, there is risk in that model. A fintech company's business is reliant on a bank and its operations could be challenged should something happen to the bank. (Indeed, PayPal considers this one of its risk factors in its corporate filings.)
"It can be a contagion," said Lawrence Kaplan, a partner at Paul Hastings. "If you're already working with a bank, you're effectively being regulated by a bank. In that case, are you ready to be a bank?"
Fintech companies would need a clear strategic plan in place and the proper investment in place for regulators to feel comfortable. Those expectations might be even higher if the fintech sought to buy a troubled bank, Ryan said.
Former regulators, data scientists and academics have come up with a way to turn financial contracts of almost all types into algorithms computers can easily read. The ACTUS standard, if implemented across the board, could ideally give regulators and banks a true systemic view of risk.