Last December, the US Office of the Comptroller of the Currency (OCC) announced that it will issue special purpose national bank charters to FinTech companies that satisfy certain chartering criteria. This post explores the benefits and drawbacks of obtaining a FinTech Charter from the OCC.
FinTech Charter. There’s nothing new about special purpose national bank charters. The OCC has chartered special purpose institutions for years (though fewer in recent years). These institutions range from credit card banks to trust banks. A list of those institutions can be found here.
To qualify as a special purpose national bank, a FinTech company must generally limit its activities to one or more of the three core functions within the “business of banking,” such as (i) receiving deposits, (ii) paying checks (through electronic payments), or (iii) lending money (making loans, discount notes, purchasing permissible debt securities, or engaging in lease-financing transactions).
What Is the Big Deal?
The competitive premise is that the OCC’s proposal would extend the regulations and privileges of a special purpose national bank charter to FinTech firms, which will enable FinTechs to maintain certain regulatory advantages over their non-bank competitors.
But, will a FinTech Charter really provide a competitive advantage to those firms? Do those advantages outweigh the cost and effort required to obtain a FinTech Charter?
The benefits associated with a FinTech Charter are (i) federal preemption, (ii) interest rate exportation, (iii) consistent federal regulation, and (iv) direct access to the Federal Reserve payments system. Each of these benefits may afford FinTechs significant cost savings and obviate the need to partner with traditional banks and financial institutions.
- Federal Preemption. FinTechs are currently required to comply with local licensing laws and other state law requirements in each jurisdiction where they operate. As a special purpose national bank, a FinTech would be entitled to federal preemption of state law, and be exempt from state licensing laws to the same extent as a national bank (note that federal preemption does not exempt FinTechs from complying with certain state consumer protection laws).
- Interest Rate Exportation. The interest rate exportation doctrine allows national banks to charge, or “export,” the maximum interest rate of its “home state” in loan transactions in other states without regard to the usury laws of those states. A FinTech Charter would provide FinTechs significant flexibility as firms would otherwise be required to comply with state-specific interest rate caps and usury laws.
- Consistent Federal Regulation. Chartered FinTechs could avoid costly state compliance requirements and would deal primarily with federal bank regulatory agencies. For FinTechs operating nationwide, dealing with fewer federal regulators with a more consistent application of federal law, compared to multiple state regulators (each with conflicting laws and regulations), would provide greater clarity and certainty to FinTechs with expansive geographic operations. The OCC will exclusively supervise chartered FinTechs engaging in consumer financial activities with less than $10bn in assets. Chartered FinTechs larger than $10bn will be subject to supervision and examination by the OCC, as well as the Consumer Financial Protection Bureau (CFPB), regarding the firm’s consumer financial activities.
- Access to the Federal Reserve Payment System. As national banks, FinTechs will be required to become members of the Federal Reserve System. This will allow FinTechs direct access to Federal Reserve payments networks and provide cost savings as FinTechs will no longer access payments functions through partnerships with traditional banks. However, as national banks, FinTechs will also become subject to additional supervisory and regulatory requirements (capital, affiliate transaction restrictions) by the Fed.
Significant drawbacks limit the practical utility of the FinTech Charter. Drawbacks relate to (i) investor restrictions, (ii) cost structure concerns, (iii) activities restrictions and capital requirements, (iv) time and expense, and (v) additional regulatory burden.
- Investor Restrictions. Controlling investors in FinTech firms, such as venture capital and private equity groups, may become subject to supervision by the Federal Reserve if the firm is a “bank” as defined by The Bank Holding Company Act of 1956. Investors will also be required to complete IBFRs, which are tedious, invasive and time-consuming.
- Cost Structure Concerns. FinTechs pursuing a Charter should be prepared to assume higher fixed costs (capital, examinations, compliance, etc.), as compared to the variable costs (less regulation, a percentage of origination volume paid to partner banks, customer service fees, etc.) sustained through existing bank partnership models. This varying cost structure may impact the FinTech’s business model and, consequently, its overall valuation.
- Activities Restrictions and Capital Requirements. FinTechs must limit the scope of activities to those permissible for national banks. As a condition of preliminary approval, a FinTech and the OCC may enter an operating agreement addressing charter restrictions. This agreement will likely include liquidity and capital conditions. FinTechs would further be required to consult with the OCC prior to changing its business model or conducting certain activities. FinTechs will also be required to satisfy regulatory capital requirements applicable to national banks.
- Time and Expense.The chartering application process is extensive. An application for a national bank charter is typically a minimum of one year and costs at least $1.5m, not including capital requirements. Supplemental regulatory restrictions also impose additional operational expenses which, for some FinTechs, may entail an overhaul of their current business model.
- Additional Regulatory Burden. The OCC may require chartered FinTech firms to comply with “financial inclusion” requirements comparable to the Community Reinvestment Act of 1977 (CRA); however, it is unclear what these CRA-like requirements will be. FinTechs accepting deposits will also be subject regulation by the FDIC as deposit insurer (however, deposits will provide lower funds’ cost for FinTechs). Firms will also become directly subject to Bank Secrecy Act requirements.
Comptroller Curry’s term is scheduled to expire April 1, 2017. The successor Comptroller appointed by the Trump administration might reject the OCC’s proposal for FinTech companies and/or adopt a different plan altogether. While the repeal of existing federal banking regulations may be deferred as independent federal banking agencies (Federal Reserve, OCC, FDIC) are not subject to Presidential Executive Orders, it is clear that federal financial deregulation is a priority. Deregulation may somewhat level the playing field between traditional banks and FinTechs, or create separate incentives to obtain a FinTech Charter.
The OCC’s proposal makes clear that FinTech Charters aren’t ideal for all companies, particularly cash-strapped, early-stage firms. The FinTech Charter could, however, provide significant benefits for some firms, such as large online and marketplace lenders with nationwide operations that are better able to sustain the high regulatory costs required to operate a national bank. Such benefits, though, are likely negated by the regulatory constraints imposed on a firm’s business model, the considerable effort required to obtain a Charter, and the ongoing regulatory expenses borne by national banks. FinTechs considering a Charter should carefully evaluate their business plan, venture financing strategy and capital structure before proceeding.