On 2 December 2016, the Office of the Comptroller of the Currency (“OCC”) in the U.S. announced its intention to take applications from fintech companies that wish to obtain a special purpose national bank charter (“The Announcement”). In line with Hong Kong’s focus on innovation, Hong Kong may consider a similar move to revamp its regulatory framework for fintech companies performing traditional banking functions, with a focus on deposit-taking.
Background: The Announcement by the OCC
The Comptroller of the Currency, Thomas Curry, announced that the OCC would move forward to consider taking applications from fintech companies to become a special purpose national bank. Whilst fintech companies have traditionally cooperated with, they are now provided with the opportunity to become national banks themselves.
What are special purpose banks?
Unlike traditional banks, special purpose banks limit their activities to fiduciary activities or to other activities within the business of banking, such as credit card operations and other special purposes. Special purpose banks adhere to established charter procedures with modifications appropriate to their circumstances as determined by the OCC.
A special purpose bank that carries on activities other than fiduciary activities, must conduct at least one of the three core banking functions, namely; (i) receiving deposits, (ii) paying checks or (iii) lending money. Fintech companies that submit an application to become a special purpose bank must perform at least one of these three core banking functions.
Referencing the U.K.’s regulatory development, Curry explained in his address at Georgetown University, 2 December 2016, that the OCC’s intention is to update the regulatory systems to allow for financial experiments that could improve consumers’ experience. The move also ensures the safety and soundness of new fintech banks, as well as supporting fair access and fair treatment of customers.
In coordination with the Announcement, the OCC also issued a white paper listing the agency’s authority to grant the status of special purpose banks to fintech companies and the conditions of the grant. In essence, special purpose banks would be subject to the same standard of regulations and obligations as traditional full-service national banks. However, for deposit-taking fintech companies, are still required to obtain approval from the Federal Deposit Insurance Corporation (“FDIC”), and it is highly uncertain whether these deposit taking companies could get its approval in view of the heightened regulatory scrutiny.
The differences in requirement reveals that the OCC is inclined to give more favorable support to fintech companies that do not accept deposits. There are two main reasons for the difference. Firstly, traditional banks are concerned with fairness if new players are subject to a lower compliance requirement. Secondly, the level of risks of deposits that retail customers are exposed to would be different between traditional and special purpose banks. As a result, fintech players are held to the same standard of regulatory requirements when taking deposits.
Hong Kong: Existing Legislation on Deposit-taking Institutions
In line with the vision of Hong Kong becoming a fintech hub, as announced by the Financial Secretary of Hong Kong in his 2016-17 budget speech, perhaps similar legislation would bring a more dynamic regulatory landscape to support and monitor fintech companies, with a specific focus on deposit-taking functions.
Hong Kong maintains a three-tier system of deposit-taking institutions, including licensed banks, restricted licence banks and deposit-taking companies. They are collectively referred to as “authorized institutions” under the Banking Ordinance (Cap. 155) (“the Ordinance”) and are regulated by the Hong Kong Monetary Authority (“HKMA”).
Licensed banks are full service banks that may accept current and saving deposits of any size and maturity from the public. Meanwhile, restricted licence banks and deposit-taking companies may take deposits with restrictions on the size and maturity. Restricted licence banks are primarily engaged in merchant banking and capital market activities and can take deposits of any maturity of HK$500,000 and above. Deposit-taking companies are mostly owned by or associated with banks which engage in a wide range of specialized activities, such as consumer finance and security business. They may accept deposits of HK$100,000 or above with an original term of maturity of at least three months. There are, however, no distinctions in the types of lending or investment business in which the different tiers of authorized institutions may engage in.
In addition, under the Ordinance, a large number of exemptions have been granted to institutions that are required to take deposits in their operations, but are not monitored by the HKMA. Examples include trust companies registered under the Trustee Ordinance (Cap. 29), banks incorporated outside Hong Kong that are not authorized institutions, solicitors who take deposits from a client or a stakeholder in the ordinary course of business, money lenders licensed under the Money Lender Ordinance (Cap. 163), and businesses that deal with securities, future contracts, leveraged foreign exchange trading or securities margin financing under the Securities and Futures Ordinance (Cap. 571).
Deposit protection scheme
Similar to FDIC in the U.S., the Hong Kong Deposit Protection Board (“HKDPB”) also sets a safety net guaranteeing deposits for retail depositors under the Deposit Protection Scheme (“DPS”). Among these deposit-taking institutions, only deposits to licensed banks would be protected. The DPS covers all deposits denominated in Hong Kong Dollars, Renminbi or any other currency deposits held with the Hong Kong offices of a scheme member. The maximum protection is up to HK$500,000 per depositor per scheme member, including both principal and interest. Conventional deposits such as savings, current and time deposits with a term not longer than 5 years are also protected. Licensed banks, unlike the FDIC, need not obtain separate approval from the HKDPB but would be subject to a duty to disclose information to the HKDPB to carry out its statutory duties.
Implication of OCC’s announcement on Hong Kong’s regulation on deposit-taking institutions
Fintech companies vary in business models, with some providing loans, others offering payment-related services through to those engaged in digital currency or financial planning. The option of taking deposits would drastically change how fintech companies operate. It has the potential to shake up the market and allow for further innovation. If fintech companies were allowed to accept deposits, it is likely the HKMA would regulate such activity. Saying that, the Securities and Futures Commission (“SFC”) may be well placed to provide additional supervision.
Allowing fintech companies to take deposits will mean adding a brand new layer to the existing three-tier system of deposit-taking institutions, which is unlikely to be favorable due to the complexity that it may bring to the existing regime. The regulations and protection levels set out by the DPS as well as the activities and powers granted to the HKDPB would need to be reviewed and revised in order to allow market entry by non-licenced banks.
The question would then be whether fintech companies would qualify to become a member of the DPS, which has little effect in terms of compliance costs, but may affect the level customer protection, and their confidence in these entities. If, on the other hand, the funds are classed as “investments” and are not required to be a member of the DPS, it is likely the SFC would take the lead in monitoring such activities.
Established entities, such as banks and investment funds, that deal with funds, whether money, stored value or trading of securities, are more than often required to obtain HKMA or SFC licences in order to comply with Hong Kong’s regulatory framework. Fintech companies who may be granted the same privileges as these entities would be able to structure and conduct business in a new way, generating healthy competition to the banking industry.
Drawing from the merits of overseeing fintech companies that offer services similar to traditional banks as mentioned by Curry, Hong Kong may also consider taking steps to encourage the healthy development of fintech companies with adequate support and supervision. Although the introduction of a special purpose bank concept may not be suitable in Hong Kong, a more coherent and encompassing regime should be called for to cover all players to ensure the safety and soundness of industry. Irrespective of the shape or form deposits may be taken by fintech companies, there needs to be considerable attention given to the concept / idea, failing which, Hong Kong will lose out on its jockeying position to be a leader in the space.
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