Who will be first in line for a national Financial Technology (FinTech) bank charter, now that the Office of the Comptroller of the Currency (OCC) has begun accepting applications? A nationally recognized leading FinTech company? A deep-pocketed tech company? A wild card? It would be unwise to predict. Instead, this question calls to mind a wise saying about situations of great uncertainty: “Everyone wants to be the first to be second."
On the surface, a national FinTech charter appears to be an attractive proposition. It could solve a number of issues that new entrants to the financial services industry now face, with many FinTechs relying on a patchwork of state-by-state authorizations and other arrangements to stitch together regional or nationwide services. Yet any first mover pursuing a charter would face significant regulatory and legal hurdles—exactly how many and how high is unknown at this point.
As the charter is currently designed, only a few companies would be likely to clear these hurdles. It will take a lot of capital, but also a significant investment in infrastructure, operations, and governance to routinely satisfy the nation’s prudential regulators and their standards for examination and resilience to business cycles.
Ultimately, the deciding question will not be “who?” but “when?” That is, when will FinTechs’ need or desire to replace their current options for conducting interstate banking outweigh their inclinations to avoid the “unknown unknowns” of a groundbreaking new national policy. And then there’s the “how many?” question. When a first mover does set the stage, how many will be able to follow?
In July, the OCC said it would begin accepting applications for special purpose national bank charters from FinTech companies, as promised late last year.1 “Companies that provide banking services in innovative ways deserve the opportunity to pursue that business on a national scale as a federally chartered, regulated bank,” the agency said.2
The entire financial services industry has been awaiting this moment with great anticipation. Could this be a watershed event—one where the industry looks back in 10 years and says, “so this is where it all started”?
While that’s possible, we believe there’s still too much that’s unknown. Yes, it’s true that we now have some insight into the OCC’s procedure and the high-level expectations surrounding certain criteria. But the unknowns loom large, as one would expect with any new announcement from a financial services regulator.
Any FinTech leadership team considering an application is likely to be weighing the costs of the current alternatives and their regulatory burdens against the prospect of a more consolidated regulatory structure—but one with potentially more stringent and direct federal regulatory oversight.
How stringent? One indication, in the OCC’s licensing manual supplement for FinTech charters,3 is the long list of risks to be managed. Among them are liquidity, operational, Bank Secrecy Act/Anti-Money Laundering (BSA/AML), cybersecurity, third-party oversight, technology, consumer protection, and fair lending risks.
And it gets more complicated when drilling down further. For example, there’s been a lot of regulatory focus recently on financial inclusion (and it’s included in Appendix B of the licensing supplement). This is a sensitive topic for FinTechs, which often use alternative or non-traditional data sources such as social media, utility payment records, and mobile phone use.
The data landscape continues to change with exponential increases in both the amount of personal information available and the processing power for its analysis. Regulators will want to know how data, and its use, may positively or negatively impact the availability of financial services to protected populations. Will the approval of a national charter application potentially open up products and services for the currently underserved? Are there fair lending implications in the algorithms or so-called “deep learning” models that may use personal data to make decisions on approval and/or pricing of credit or transactions?
With so many unknowns, any company applying at this point would need scale. And by scale, we don’t just mean the size of assets or number of employees. Rather, any applicant will require a sufficient supply of capital (including the ability to raise additional funds as necessary in volatile markets), as well as having an existing level of sophistication in infrastructure and proper governance with regards to operations, compliance, information security, and technology. The cost of doing business could increase exponentially.
Weighing the Alternatives
The current FinTech slate of options for interstate business includes state-by-state banking charters or business licenses and strategic partnerships with other federal or state chartered banking institutions.
In the absence of concrete examples of how any first movers have navigated the national charter application process, the existing bank “sponsor” model would appear to be the preferred model to achieve scale—at least for FinTechs focused on consumer lending products. In this long-tested model, a FinTech partners with a chartered bank and utilizes the bank’s platform to make loans on a national basis and export interest rates. There are increased compliance costs to operating in this model, since regulators require chartered institutions to oversee their FinTech partners’ compliance.
Another regulatory model that seems to be coming back in vogue is the Industrial Loan Corporation (ILC) charter, which is available in some states (most notably, Utah), and enables companies, including FinTechs, to make loans nationally and export interest rates across state lines. Will ILCs continue to attract the interest of FinTech companies? This might prove to be a path of less resistance since, on the surface, it would appear to carry less litigation risk. However, there’s still uncertainty about the speed of the application adjudication process. Several companies have started down this route, which could potentially provide significant cost-of-fund advantages if it were to also extend Federal Deposit Insurance Corporation (FDIC) coverage—presuming the company were to take deposits. Two FinTechs and one student finance company, (Square, SoFi, and Nelnet, respectively) filed and subsequently revoked or paused their applications.
Ultimately, though, a single national regulatory construct could offer significant advantages such as independence and operational flexibility. An exception might be cases, such as high-cost credit products and services (in excess of limits set under state usury statutes), in which a state-by-state approach could still prove preferable, if not necessary.
Beyond consumer banking, other FinTech “banking activities,” such as payments and wealth management, could still prefer a national solution first.
The Path Forward
The OCC says it is “providing a path” to national bank status for FinTechs. If so, perhaps we should begin to consider its application for a full national charter as a “graduation,” once a company uses other regulatory alternatives to achieve sufficient scale.
The application process could itself be quite long. Naturally, the entire time through the process would vary by applicant. We know there are four stages (pre-filing, filing, review, and decision). Unfortunately we do not have sufficient empirical data to go on. Not only is the FinTech charter new, but industry-wide, de novo bank applications have been few since the global financial crisis. A report in American Banker earlier this year cited only five from 2013 to 2017, with a few more in progress in 2018.4
Any appeals could further lengthen the process. The OCC argues in its policy statement5 that it has full authority to issue a charter under the National Bank Act. However, as already evidenced, a special purpose national charter has not been popular among the state regulatory community. Indeed, there has been litigation on behalf of the Conference of State Bank Supervisors, and the first mover in this space faces a risk of litigation that could increase the length of its timeline.
Which companies have the funds and tenacity to play the long game? Will someone take up the mantle and be the standard bearer for the industry?
In continuing this discussion, it is also important to highlight the major milestone that Varo Money recently accomplished, receiving preliminary approval for a conventional national bank charter by the OCC. This application does not fall under the new FinTech charter application process, per se. But if successful, Varo could provide another path and blueprint for FinTechs interested in a national footprint.
In addition to recognized FinTech market leaders, it will be very interesting to see how the “big tech” companies approach this—say, Facebook, Amazon, or Google. And we could someday see a wild card—even a foreign entity, such as Alibaba or Tencent, with its combination of scale, capital, and payments infrastructure and experience in China’s massive consumer market.
Eventually, we will likely see at least one well-capitalized company apply for the new charter and set precedent for others to follow; it’s just a matter of when. We are standing at the crossroads. But the light is still flashing yellow.
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1 New Coordinates: https://www.treliant.com/News-and-Events/New-Coordinates-Newsletter/NC-Articles-Details/ArticleID/27258/Crossroads-Ahead-for-FinTech-The-Future-of-the-OCC-Special-Purpose-Charter-Mark-Westmoreland-Eric-Reusch-and-Jason-P-Boova
2 OCC news release: https://www.occ.treas.gov/news-issuances/news-releases/2018/nr-occ-2018-74.html;
3 OCC licensing manual for FinTechs: https://www.occ.treas.gov/publications/publications-by-type/licensing-manuals/file-pub-lm-considering-charter-applications-fintech.pdf
4 American Banker: https://www.americanbanker.com/slideshow/rebirth-the-de-novo-bank-class-of-2018
5 OCC policy statement: https://www.occ.gov/publications/publications-by-type/other-publications-reports/pub-other-occ-policy-statement-fintech.pdf
Treliant, LLC, Compliance, Risk Management, and Strategic Advisors to the Financial Services Industry and Consumer-Oriented Businesses, brings to you New Coordinates, a quarterly newsletter offering insights and information regarding pertinent issues affecting the financial services industry. This article appeared in its entirety in the Fall 2018 issue. To subscribe to our quarterly newsletter, please Contact Us.