“There is much discussion regarding whether there is a role for a non-bank federal charter. The OCC is conducting a careful analysis of the issues associated with this. As they proceed with this process we urge policymakers to consider…Charter Purpose – Regulators should examine the specific nature of the charter being requested and how it compares to an existing bank charter. The OCC has been given authority to charter federal institutions that serve a public purpose. The federal bank charter serves such public purposes today. Regulators need to consider how a proposed charter would differ from existing bank charter options and why a different regulatory approach is necessary… Consistent Protection – Any new charter must ensure that customers are adequately protected. When customers receive financial services they expect consistent levels of protection, regardless of the provider. Any such charter must provide the same level of consumer protection and oversight as a federal bank charter.” - Selected excerpts from Rob Nichols, on behalf of the American Bankers Association before the Financial Services Committee Subcommittee on Financial Institutions and Consumer Credit of the United States House of Representatives, July 12, 2016
On July 12, 2016, the Subcommittee on Financial Institutions and Consumer Credit of the House Financial Services Committee held a hearing titled Examining the Opportunities and Challenges with Financial Technology (“FinTech”): The Development of Online Marketplace Lending. During the hearing, a representative from the American Bankers Association (ABA) emphasized that if the Office of the Comptroller of the Currency (OCC) decided to permit a new type of financial technology bank charter, then the OCC make sure the new charter serves a public purpose and that customers of the new bank be adequately protected.
In response to the ABA and others, on March 15, 2017, the OCC posted to its website two documents that have moved the OCC to the forefront in the movement to advance the growth of financial technology companies (FinTech) in financial services. These documents include Draft Supplement to OCC Licensing Manual on Evaluating Charter Applications From Financial Technology Companies (OCC Licensing Manual) and OCC Summary of Comments and Explanatory Statement: Special Purpose National Bank Charters for Financial Technology Companies (OCC Comment Summary). These documents, when combined with Comptroller Thomas J. Curry’s March 6, 2017 remarks at LendIt USA 2017 (Comptroller’s Remarks), Exploring Special Purpose National Bank Charters for Fintech Companies (December 2, 2016) (Exploring FinTech Charters) and Supporting Responsible Innovation in the Federal Banking System: An OCC Perspective (March 31, 2016) (Responsible Innovation), provide a very helpful and reasonably detailed roadmap for investors who wish to obtain a special purpose FinTech national bank (FinTech Bank) charter. A FinTech Bank distinguishes itself from a FinTech company by offering the prospect of operating across state lines with tremendous operational efficiencies and cost savings derived from uniform national standards and supervision by one prudential supervisor. A FinTech Bank also offers the possibility of removing barriers that prevent quality control and standardization. The removal of those barriers has long been requested by investors who favor uniform systems and primarily one set of federal laws interpreted primarily by one prudential supervisor. As a further advantage, on April 13, 2017, the OCC announced that, commencing on May 16 and May 17 in the OCC’s San Francisco office, it will host two days of office hours for national banks, federal savings associations, and Fintech companies who would like to discuss the OCC’s perspective on responsible innovation. These advantages move the FinTech Bank and the OCC to the forefront of advancing the growth of FinTech in the US. For those FinTech companies and others who urged Congress and the OCC to offer a national bank charter, the OCC’s proposal offers an immediate opportunity to forge ahead in financial services.
The OCC’s Position on Its Legal Authority to Approve FinTech Bank Charters
For OCC purposes, a FinTech Bank is “a national bank that engages in a limited range of banking activities, including one of the core banking functions, but does not take deposits and is not insured by the Federal Deposit Insurance Corporation (FDIC).” Core banking functions include receiving deposits, paying checks or lending money. One of the threshold questions the OCC publicly addressed in December 2016 was whether there was a legal basis upon which the OCC could grant a FinTech Bank charter. In Exploring FinTech Charters, the OCC takes the emphatic position that it has authority to grant FinTech Bank charters under the National Bank Act (NBA) for commercial banks and under the International Banking Act (IBA) for foreign banks that operate in the US through federal branches and agencies. In support of its position, the OCC points to its history of chartering other special purpose national banks such as special purpose trust banks, credit card banks, bankers’ banks, community development banks and cash management banks. Similarly, the OCC makes it clear that a FinTech Bank may generally engage only in activities that are permissible for national banks, and the authority for such powers derive from, among other places, statutes, regulations, court cases, OCC legal opinions, and OCC corporate decisions. Likewise, the OCC emphasizes that the business of banking (and presumably the authority of national banks and federal branches and agencies to engage in an activity) develops over time as the economy and business methods (and presumably delivery channels) evolve, further highlighting the OCC’s position that it would be incorrect to interpret the NBA or the IBA in isolation without taking into account the ever changing world in which national banks operate, the changing demands of customers, and technology advances. As might be expected, not everyone agrees with the OCC’s position on FinTech Bank charters.
Challenges to the OCC’s Position on FinTech Bank Charters
While the Conference of State Bank Supervisors (CSBS), and collectively, the Clearing House Association, L.L.C., the Independent Community Bankers of America, and the Securities Industry and Financial Markets Association provided comprehensive comments on the OCC’s proposal, perhaps the strongest challenge to the OCC’s position on FinTech Bank charters is set forth in a letter dated January 13, 2017 from CSBS (CSBS Objection). The CSBS Objection focuses on one legal argument and three policy arguments. First, the CSBS Objection takes the position that the OCC does not have the legal authority under the NBA to charter FinTech Banks. In the view of CSBS, the OCC’s authority to charter a national bank that does not accept deposits is permissible only if the special purpose bank is expressly authorized in statute, and there is no such authorization of a FinTech Bank. Second, the CSBS Objection urges that such a FinTech Bank would destabilize the legal and regulatory structure of banking by exempting FinTech Banks from the majority of federal banking laws applicable to insured depository institutions, un-leveling the playing field in favor of FinTech Banks, calling into question the OCC’s ability to enforce federal securities laws against FinTech Banks, and limiting the applicability of federal consumer financial laws to FinTech Banks. Third, the CSBS Objection claims that a FinTech Bank charter would eliminate the authority of states to apply state consumer protection authority to FinTech Banks. Fourth, the CSBS Objection argues that FinTech Banks would create tremendous uncertainty and risk to access to government resources such as the Discount Window of the Board of Governors of the Federal Reserve System, payment systems and the federal safety net. In OCC Comment Summary, the OCC addresses not only the CSBS Objection but also comments in support of and in opposition to the OCC’s consideration of a FinTech Bank. After reviewing more than 100 comment letters, the OCC concluded that it would move forward with FinTech Bank charters that meet OCC standards under 12 C.F.R. 5.
Laws Applicable to FinTech Banks
In Exploring FinTech Charters, the OCC identifies a reasonably detailed list of laws the OCC expects to apply to FinTech Banks. As a starting point, the OCC takes the position that a FinTech Bank will generally be subject to the same laws, regulations, examination, reporting requirements, and ongoing supervision as other national banks. Implicit in the OCC’s position is the practical advice that the applicable laws will be determined by the activities in which the FinTech Bank engages, the location of the operations and activities of the FinTech Bank and certain laws that apply to national banks in their capacity as national banks without regard to whether those national banks are members of the Federal Reserve System or offer FDIC insured deposits. Unlike state chartered banks, which have the option to become a member bank of the Federal Reserve System, the overwhelming majority of national banks are required to become member banks of the Federal Reserve System. Similarly, the overwhelming majority of national banks are FDIC insured, but, for OCC purposes, by definition, FinTech Banks, will not be FDIC insured, and thus, would not be subject to laws that only apply to insured depository institutions.
Activity based laws, such as national bank legal lending limits under 12 U.S.C. 84 and 12 C.F.R. 32 for banks that may loans or national bank investment limits under 12 U.S.C. 24 (Seventh) and 12 C.F.R. 1 for banks that make investments, would apply to FinTech Banks that make loans or make investments. An example of laws that apply to all national banks without regard to whether the bank is a member bank or FDIC insured and without regard to the activities to which the bank engages include the Bank Secrecy Act under 31 U.S.C. 5311 et al., 31 C.F.R. 1020, and 12 C.F.R. 21. The OCC also takes the position that the OCC’s authority to preempt state laws for national bank would be the same for FinTech Banks, and the traditional states laws that are applicable to national banks (i.e., state laws prohibiting discrimination, fair lending laws, debt collection laws, taxation laws, zoning laws, criminal laws, and laws covering torts) would also be applicable to FinTech Banks. Perhaps the most comprehensive series of applicable laws for FinTech Banks that plan to make consumer loans include prohibitions against unfair and deceptive acts and practices under Section 5 of the Federal Trade Commission Act and unfair, deceptive and abusive acts and practices under Title X of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 along with the Truth in Lending Act, the Real Estate Settlement Procedures Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Fair Housing Act, and the Fair Debt Collection Practices Act. Finally, the OCC, under its chartering authority, has the authority and typically exercises that authority to restrict certain activities of newly chartered banks and place certain conditions on their operations. The OCC noted that it expects to do the same with FinTech Banks.
Navigating the OCC’s Application Process for a FinTech Bank Charter
The OCC has indicated that it will follow the same process for FinTech Bank charters that it follows for national bank charters. This should mean that the Comptroller’s Licensing Manual will be the best source for guidance for investors who wish to charter a FinTech Bank. For example, in the OCC Licensing Manual, the OCC provides that it will follow the licensing process set forth in 12 C.F.R. 5 and the various booklets that form the basis of the existing Comptroller’s Licensing Manual along with the prefiling process that the OCC follows for other charter or licensing applications. The OCC also emphasizes that it would apply the same standards and principles to evaluate a FinTech Bank charter application that it uses for national bank charter applications, namely, whether the proposed FinTech Bank:
- has organizers and management with appropriate skills and experience;
- has adequate capital to support the projected volume and type of business and proposed risk profile;
- has a business plan that articulates a clear path and a timeline to profitability; and
- includes in its business plan, if applicable, a financial inclusion plan (FIP) that has an appropriate description of the proposed goals, approach, activities, and milestones for serving the relevant market and community.
Like with any other national bank charter applications, the OCC will also place great weight on the applicant’s business plan, its proposed executive officers and board of directors, its initial capital, and its proposed risk management and corporate governance structure. It is also substantially likely that the OCC will also place great weight on a proposed FinTech Bank’s FIP, when an FIP is required.
Three Critical Challenges for FinTech Bank Applicants
While all of the OCC application requirements are important, not all of the requirements carry equal weight. Many banking law experts believe the three most important requirements include (1) the business plan; (2) the proposed chief executive officer and board of directors; and (3) capital.
When considering the application documents for bank charters that carry the most weight, the business plan may be first among equals. This is not just the case for the OCC. During Congressional testimony, for instance, the FDIC has consistently taken the position that inadequate business plans is one of the main reasons for the limited number of approved de novo charters between 2008 and 2016. Similarly, anecdotal evidence suggests that the OCC, the FDIC and the Federal Reserve raise more questions and place more emphasis on proposed business plans than on other issues related to new charters. This is certainly not surprising because in more cases than not, if a licensing or chartering authority is uncomfortable with the business plan, then the agency is concerned about whether the proposed bank can succeed. Since a FinTech Bank charter is a new type of charter, it is likely that the OCC will be even more rigorous in its review, and will require even more than it normally would for national bank charters, especially during the first round of applications for a FinTech Bank charter. Like with national bank charters, the OCC will use the Interagency Business Plan Guidelines to help applicants with their business plans.
The OCC emphasizes that the business plan should be a comprehensive written document that:
- Is an integral part of the management and oversight of the FinTech Bank;
- establishes the FinTech Bank’s goals and objectives;
- Summarizes how the business will organize its resources to meet its goals and how the FinTech Bank will measure progress;
- Evidences in-depth planning by the FinTech Bank’s organizers and management;
- Realistically forecasts market demand, customer base, competition, and economic conditions;
- Reflects sound banking principles and demonstrates a realistic assessment of risk in light of economic and competitive conditions in the market to be served;
- Covers three years and provides detailed explanations of actions that are
proposed to accomplish the primary functions of the FinTech Bank;
- Provides enough detail to demonstrate that the FinTech Bank has a reasonable chance for success, will operate in a safe and sound manner, and will have adequate capital to support the risk profile; and
- Includes a marketing plan that explains how the FinTech Bank would achieve brand recognition.
In a sense, the business also covers the chief executive officer and board of directors and capital requirements even though those areas are also reviewed separately and are heavily weighted during the OCC’s review of a national bank application. For FinTech Banks, the OCC also stresses that FinTech Banks need to include a clear and detailed definition of the market the FinTech Bank plans to serve and the products and services it will provide through electronic channels. Given the critical importance of business plans, it is imperative that applicants seek assistance from experienced outside advisers.
Chief Executive Officer and Board of Directors
If the business plan is first among equals, then the selection of the proposed chief executive officer and the board of directors is a close second. On the one hand, many licensing or chartering authorities are willing to defer to the judgment of an experienced proposed chief executive officer and board of directors with a track record of success in operating other banks or successful businesses. On the other hand, it is not uncommon for licensing or chartering authorities to approve a business plan with the condition that the applicants find different proposed chief executive officers and boards of directors. The OCC, in particular, prefers to see the proposed chief executive officer and board of directors actively engage in the prefiling process and have a major influence on the business plan.
Federal law limits the number of national bank directors to no fewer than 5 and no more than 25, unless the OCC authorizes a greater number. In addition, the OCC prefers the directors to strike an appropriate balance between insider and outside directors. On the one hand, the OCC has taken the position that too many inside directors might mean the board will not exercise independent judgment and may be too reliant on management. On the other hand, the OCC has taken the position that too many outside directors might mean the board does not have enough “skill in the game,” or the board’s goals and objectives might not be properly aligned with the best interests of the bank. Many banking law experts believe the most important decision of the board of directors of the bank is to hire a qualified and competent chief executive officer of a bank.
Responsibilities of Board of Directors
For national banks, the OCC provides clear guidance regarding the responsibility of the board of directors, including:
- Provide credible challenge to management;
- Make sure the bank operates in a safe and sound manner;
- Make sure the bank supports the local community;
- Establish an appropriate corporate culture, including through the adoption of a code of conduct or code of ethics, and setting the tone at the top in satisfaction of internal or external audit, the federal banking agencies, and the Financial Crimes Enforcement Network (FinCEN) and the Office of Foreign Assets Control;
- Understand its role in monitoring the operations of the bank;
- Stay informed about the bank’s operating and business environment;
- Understand the legal and regulatory framework applicable to the bank’s activities;
- Maintain appropriate affiliate and holding company relationships, if any;
- Perform board self-assessments;
- Understand the bank’s material risks and confirm that the bank has a risk management system suitable for the bank’s size and activities;
- Set realistic strategic goals and objectives and oversee management’s implementation of those goals and objectives; and
- Ensure that the bank maintains an effective Bank Secrecy Act/Anti-Money Laundering control structure to the satisfaction of the bank regulatory agencies and FinCEN.
Responsibilities of Individual Directors
For national banks, the OCC also provides clear guidance regarding the responsibility of individual board members, including:
- Attend and participate in board and, where applicable, board committee meetings;
- Request and review meeting material;
- Make decisions and seek explanations;
- Review and approve policies;
- Exercise independent judgment;
- Disclose any potential, apparent or actual conflict of interest;
- Refrain from voting on or recuse yourself from any matter that might be perceived to be a usurpation of a corporate opportunity for the bank;
- Err on the side of caution and disclose all business relationships with the bank;
- Proactively engage management on any matters requiring board attention pursuant to a report of examination;
- Obtain and review tracking reports from audit, risk management or compliance; and
- Review closely and actively engage management on reports of examination; corrective action letters; administrative or supervisory actions; component and composite ratings; and exit meetings with examiners.
The capital requirement is specific to the proposed FinTech Bank, and will be determined as a part of the review of the business plan. In general, a FinTech Bank that proposes to engage in higher risk activities will be required to have more capital than a FinTech Bank that proposes to engage in low risk activities. Likewise, a FinTech Bank whose market area is nationwide should expect to have more capital than a FinTech Bank whose market area is within a single state. Even within a state, a FinTech Bank that proposes to operate in a large city like New York with an extensive list of competitors will require more capital than a FinTech Bank that proposes to operate in a small city with minimal competition. Anecdotal evidence suggests that it is not uncommon for the OCC to require a minimum of $20 million in capital in New York and as little as $5 million in small cities. The amount of capital is more art than science, and the OCC will work closely with applicants to determine the minimum level of capital needed for the bank for the first three years. While the quantity and quality of capital is critical, a strong capital position will not overcome an inadequate business plan or a weak choice for chief executive officer and board of directors. Applicants should seek the assistance of experienced outside advisers to help determine the minimum level of capital to propose to the OCC.
Ten Important Observations about What the OCC’s Actions Mean for FinTech
There will always be different ways to interpret or understand the actions of the OCC and what those actions mean for FinTech companies. There are ten observations that underscores what the OCC has in mind and how prospective applicants should interpret the OCC’s actions:
- The OCC’s actions mean that unless a court or Congress prevents the OCC from doing so, the OCC will begin to charter FinTech Banks. It is not a matter of whether; it is a matter of when.
- The initial round of applications will be reviewed centrally out of Washington, D.C. and will undergo the most intense scrutiny. This likely means the initial round of approvals will take more than nine months and will be extremely expensive.
- The OCC is not likely to approve any FinTech Bank charter the OCC believes raises a “rent a charter” issue or the OCC believes is solely for the purpose of avoiding state consumer protection laws.
- Proposed FinTech Banks that will focus on lending will find it challenging to get the OCC to accept a lean infrastructure. While technology is important, the OCC is still very likely to require key staff positions in risk management, compliance, anti-money laundering and counterterrorism, and cyber security.
- For competitive equality purposes, the OCC is very likely to attempt to balance the concern that brick and mortar national banks, especially community banks, have expressed about the cost of compliance with the need to resist overburdening FinTech Banks with unnecessary compliance costs. This concern is likely to be managed or addressed by the conditions the OCC places on an approval of a FinTech Bank charter and in the operating agreement the OCC will require.
- While many banks have expressed concern about FinTech Banks as competitors, the most likely scenario is that FinTech Banks will cause non-FinTech Banks to invest more in technology or to outsource or co-source their technology needs to FinTech companies or FinTech Banks. In many cases, FinTech Banks and FinTech companies will not compete directly with banks. Rather these FinTech Banks and FinTech companies will provide banks greater access to technology and offer ways to help those banks improve their efficiencies.
- Many policymakers will continue to encourage growth in FinTech, but many other policymakers will regularly attempt to impose numerous requirements on FinTech Banks, including laws that are not applicable to non-depository institutions.
- The Consumer Financial Protection Bureau (CFPB) will likely attempt to assert jurisdiction over FinTech Banks even FinTech Banks with less than $10 billion in consolidated assets, who do not offer retail products, and who are not insured depository institutions.
- Given the likely size of the average FinTech Bank, FinTech Banks will not need nearly as much capital as the average bank because the risk profile of a FinTech Bank should be materially different and less risky than the average bank.
- While the OCC has moved to the forefront in the US, the US itself may be behind Europe in encouraging the expansion of FinTech in financial services.