Feds Greenlight Fintech Bank Charter

The federal agency responsible for chartering national banks has approved issuing new bank charters for financial technology companies.

The Office of the Comptroller of the Currency (“OCC”) announced that this new category of “fintech charters” will enable new fintech banks to focus on providing automated and digital financial products and services, without the need to provide the
full suite of bank services required from banks operating under traditional charters.

The Fintech Charter

The new fintech charter will allow banks to receive many of the powers of the national charter, but without the burden of taking deposits. Thus, fintech chartered banks can offer loans and participate in the credit card payment ecosystem without the burden of complying with the myriad of rules aimed at traditional deposit-taking banks. Furthermore, without deposits these new banks will avoid the need for federal deposit insurance and escape the numerous rules and watchful eye of the Federal Deposit Insurance Corporation.

New Chance to Shop for the Most Lenient Regulator

Another bonanza for these banks is the chance to avoid many state consumer and other restrictions otherwise imposed on organizations that do not have federal bank charters. Under general principles of federal banking law, the federal rules governing national banks “preempt” state rules. This is music to the ears of potential fintech charter applicants, such as non-bank financial service companies. Without the special fintech charter, these non-bank firms would be subject to the rules of each of the 50 states. This means different interest rates, penalties, collection practices and other significant restrictions on consumer lending practices. 

With a fintech charter, these streamlined technology-enabled banks can set up shop in one state, and then operate in every other state subject primarily to the laws of the original “home state.” Unlike other non-bank, multi-state lenders, the new fintech bank need only comply with the home state rules and those of the OCC and the National Bank Act.

Another potential regulatory break for these new fintech banks is looser community reinvestment and lending requirements.  Traditional banks are subject to strict requirements to lend money in their market areas. With a new type of technology-enabled bank, regulators have suggested that they may loosen these community lending requirements.

The Other Bank Business – Payments

Financial technology companies, if licensed under the fintech charter, would be able to participate in credit and debit card payment networks. These payment networks drive most of the online and offline non-cash consumer and small business payments. With a bank charter, a technology-enabled lender or payments company needed to contract with a traditional bank so that the non-bank lender could offer a full-service credit or debit card payment system. This meant sharing substantial revenue and profit with each of the banking providers. Without the fintech charter, the more traditional full-service national and state banks had a monopoly on connecting with some of the largest payment providers or card processing companies.

OCC Meets TBD: Unresolved Regulatory Details

The OCC’s new fintech charter rules have many blanks that require filling. For example, under traditional bank charters, banks primarily lend money and take deposits. The regulations therefore reflect the risks and compliance requirements associated with these traditional services. For example, the OCC now monitors the bank loan portfolios, looking for over-concentrations in real estate, commercial, general consumer, or consumer mortgage loans. Today, if a bank generates significant service revenue by providing lending or processing services associated with credit cards, the regulators may penalize the institution for over-concentration in a particular niche industry.

The OCC’s new policy on fintech charters only states that the agency will address issues concerning concentration of business risks, capital requirements, and special rules addressing the specific technology used by the fintech bank. For example, the federal regulators must still determine rules to assign bank capital requirements based on the perceived risk of the fintech activities. With so many gaps in regulatory clarity, no entity has yet applied for this special charter.

Family Feud – Regulatory Style

For many banks, the fintech charter is benign, if not banal.

However, in the world of turf-conscious federal and state bank regulators, the new charter is tantamount to a declaration of war.

State banking regulators share a concurrent power to issue bank charters with the federal government. Banks may operate under a state charter or national charter. Though most larger banks chose the more powerful national charter, thousands of smaller banks still operate under their state-issued charters. Some of these charters date to well before 1900. This “dual-banking system” arose from the earliest days of the United States and the definition of the rights and relationships of state and federal government. The state charters are also products of many of the industries that could benefit from a locally-controlled bank regulatory system. In the 1800s, this meant farmers. In the early 1900s, this resulted from lobbying by Massachusetts and New York trust companies.

Today, the turf war has shifted to technology-enabled financial service companies.

State regulators, through their trade association, have argued that the new fintech charter is unconstitutional, unnecessary, inefficient, incomplete, inconsistent and just an overall bad idea. The New York State Banking Commission, as a kind of first among equals of state bank commissioners, has taken a leading role in the filing of a federal law suit to stop the implementation of the new fintech charter.

The Long Fight

These are merely the first shots in what could be a long turf war. The outcome will determine the scope and legal contours of the charter. Some commentators see this as kind of a cold war among industry groups. The largest traditional banks, along with the largest technology-enabled non-bank lenders, support the national fintech charter. Smaller independent banks see the possible loss of business to financial competitors playing under a much looser set of rules. Consumer groups are furious over the possibility that these fintech banks could use the charter as a loophole to evade decades of hard-fought state restrictions.

The outcome will be determined by a long regulatory chess game. The first move will likely be the issuance of the first fintech charter. The next moves will be lawsuits brought by state regulators. After that, likely more regulatory clarification by the OCC.  Then, more innovation and clever exploitation of unanticipated loopholes. After that, a few more years of litigation. Finally, a truce and consensus about the regulations and the ultimate nature of a fintech bank. Business and technological innovation might accelerate the process.

However, in the realm of the judges and legislative chambers, and absent a spectacular crisis, financial regulatory innovation for fintechs will likely be a slow march into the future.

This article was prepared by the Firm’s Craig McCrohon. Craig’s work has included bank organization and acquisitions; venture capital; securities offerings; and domestic, European, and Asian joint ventures. He serves as Trustee, Investment Committee member, and formerly served as Investment Chairman, of the $20 billion Illinois University Retirement System. Craig can be reached at 312/840-7006 or cmccrohon@burkelaw.com.