The Comptroller of the Currency, Thomas Curry, announced on December 2, 2016, that the Office of the Comptroller of the Currency (OCC) intends to move forward with issuing limited purpose national bank charters to financial technology (Fintech) companies under certain conditions. The modern-day history of limited charters has included a variety of bank chartering policies that have led to the creation of (among others) trust banks, non-bank banks, credit card banks and industrial loan companies. Fintech companies should evaluate the benefits and costs associated with pursuing and maintaining a national bank charter once the terms of engagement are articulated by the OCC.
Growth of Fintech Sector and U.S. Regulatory Responses
U.S. regulators are keenly aware of the role that technology plays in financial services, as well as the opportunities and issues that it raises. There are more than 4,000 Fintech companies in the United States and the UK, and the worldwide investment in that sector has grown from $1.8 billion to $24 billion over the last five years. Clearly, the market is reflecting that these companies will have a significant role in the delivery of financial services in the future.
A significant line of business in the U.S. Fintech sector is online marketplace lending. In July 2015, the U.S. Department of the Treasury (Treasury) requested public comment on issues regarding online marketplace lending,1 and subsequently issued a white paper on the topic in May 2016.2 The white paper provided a series of recommendations intended to facilitate the safe growth of online marketplace lending, while fostering affordable access to credit for consumers and businesses.
In March 2016, the OCC issued a paper titled Supporting Responsible Innovation in the Federal Banking System: An OCC Perspective. The paper discussed the principles that the OCC will apply to the offering of innovative products and services by OCC-regulated national banks and federal savings institutions. On October 1, 2016, the OCC established an Office of Innovation to act as a clearinghouse for requests and information regarding these market developments.
On November 14, 2016, the Securities and Exchange Commission (SEC) held its first Fintech Forum. The Forum focused on three areas: (i) automated investment advice; (ii) distributed ledger technology (e.g., “blockchain”) for trading, settlement and clearing processes; and (iii) online marketplace lending and crowdfunding portals.3
OCC Limited Purpose National Bank Charters
The OCC, which has a long history of issuing limited purpose national bank charters for trust company banks and credit card banks, is now planning to move forward to create a bank chartering option for Fintech companies that offer bank products and meet OCC standards and chartering requirements. The specific standards and chartering requirements that will be established are yet to be determined – it is therefore not clear whether the standards and requirements implemented will be reasonably attainable by those companies who seek to take advantage of such a charter. In that regard, the OCC issued a paper titled Exploring Special Purpose Bank Charters for Fintech Companies, and is soliciting comments from the public by January 15, 2017 on the issues raised by the issuance of a new Fintech charter.
The OCC will consider a limited purpose national bank charter for Fintech companies if they conduct at least one of three core banking functions: (i) receiving deposits; (ii) paying checks; or (iii) lending money. Currently, many Fintech companies must rely on the services of a bank to conduct their operations and gain access to the payments system and the benefits of federal preemption with respect to certain of their operations.
The OCC’s decision to proceed with Fintech charters is based on the conclusions that:
- Such charters will be in the public interest, to the extent that Fintech companies have the potential to expand financial inclusion, empower consumers and help families and business take more control of their financial interests.
- Providing a national bank charter option to Fintech innovators that meet the OCC’s high standards may represent the future of banking and the economy, and could help promote economic growth and services.
- A chartering process that vets risks, and imposes federal supervision that seeks to ensure safe and sound operations, will be an effective way of achieving consumer protection and strong capital and liquidity for entities operating in this sector.
Matters for Fintech Companies to Consider
Fintech companies will face significant issues and options to carefully evaluate and balance as they consider the best path forward, including:
- The decision to transfer a Fintech business into a federally regulated bank charter will add a new and very significant level of regulation that could limit the ability of such business to pay dividends, expand into other business lines and create exit plans through merger and acquisition. In effect, the government would have cradle-to-grave control over the business – a level of regulation with which most types of business are not familiar.
- Fintech companies will need to consider the benefits of federal preemption and the efficiency of direct access to the payments system (and, in some cases, low-cost consumer deposits) in light of the increased costs of pervasive prudential regulation.
- Fintech companies that operate through a special bank charter will become subject to federal affiliated transaction rules, which will limit the company’s ability to engage in certain transactions with affiliates and may impact the efficiency of their business model.
- If low-cost consumer deposits are the basis of the business model proposed, the Federal Deposit Insurance Corporation (FDIC) will need to approve the new charter’s ability to accept insured deposits, which will impose another level of restrictions and costs. Alternatively, if the charter will not accept insured deposits, it will not be subject to certain requirements, including the Community Reinvestment Act (CRA). However, the OCC has signaled that Fintech companies that engage in lending may become subject to CRA-type requirements as part of the charter approval process. Such companies must demonstrate a commitment to financial inclusion which supports fair access to financial services and fair treatment of customers.
- A Fintech organization will need to determine whether to limit the activities of its national bank charter so that it is NOT treated as a bank for purposes of the Bank Holding Company Act (BHCA), thereby avoiding the restrictions that the BHCA imposes on bank holding companies and their affiliates.4
Fintech companies will have to decide whether they can, and are prepared to, operate under the close supervision of federal regulators. Such supervision would determine, among other matters: what such companies can do; how they do it; whether they can pay dividends; what exit strategies are acceptable; and when the company will be subject to being seized and put in receivership. The impact of moving from an entity regulated largely from the perspective of consumer protection to one that is regulated from cradle-to-grave is sometimes a startling cultural and operational change for those unfamiliar with it.
Federal Reserve Board (FRB) Governor Lael Brainard recently discussed this cultural challenge at an FRB conference on financial innovation:
Financial services firms must pair technological know-how and innovative services with a strong compliance culture and a thorough knowledge of the important legal and compliance guardrails. While “run fast and break things” may be a popular mantra in the technology space, it is ill-suited to an arena that depends on trust and confidence. New entrants need to understand that the financial arena is a carefully regulated space with a compelling rationale underlying the various rules at play, even if these are likely to evolve over time.5
Regardless of the path a Fintech company chooses to pursue, the OCC plans to design a set of risk-based requirements to address the risks created by such institution’s particular operations. A Fintech charter applicant will no doubt be subject to inquiry regarding, among other matters: the strength of its business plan; the adequacy of its capital levels; its liquidity capacities; its compliance risk management program; and how the institution will enhance inclusion of a broad, diverse segment of U.S. consumers.
Factors that will interact and affect how these requirements are harmonized and regulatory decisions are formulated will include: a change of Administration; the competitive impact of new Fintech charters; the views of the banking industry and state regulators; and a variety of other important policies.