Computer Services : The Pros and Cons of the OCC’s Fintech Charter

What the Push for Innovation Could Mean for Your Institution

Technology advances at warp speed, while regulatory change moves at a glacial pace. This dichotomy has repeatedly challenged our industry. The latest example is the Office of the Comptroller of the Currency's (OCC) special purpose national bank charter for financial technology (fintech) firms. As regulators attempt to catch up to technology and encourage further innovation, the rest of us are left to wonder what it will mean for traditional banks.

To provide some context, let's first explore the events that led to the creation of the fintech charter.

Getting to This Point

The concept of digital wallets emerged twenty years ago with the genesis of PayPal and the promise to disrupt the banking industry. However, only in the last five years has widespread consumer adoption occurred, a fact that has regulators now backpedaling to catch up.

Two years after Apple Pay debuted in late 2014, the OCC sought public comments on its decision to consider accepting special purpose national bank charter applications from fintechs, non-bank firms involved in the digital movement of money. Such a charter would alleviate the need for a fintech to acquire a state charter in each state where it operates, which is a timely and costly process.

The OCC's December 2016 announcement was met with significant industry resistance, including lawsuits filed in 2017 by the Conference of State Bank Supervisors and the New York Department of Financial Services. Both suits were dismissed by the courts on the grounds that, at the time, the OCC had not yet issued any regulation on the matter.

That changed this summer.

BCFP, Treasury Make Moves

On July 31, when the OCC announced that it would begin accepting charter applications from fintechs, it was on the heels of the Bureau of Consumer Financial Protection (BCFP) and the U.S. Department of the Treasury making their own moves to encourage innovation in our industry.

On July 18, the BCFP announced a new Office of Innovation with the purpose of 'encouraging consumer-friendly innovation' through a regulatory sandbox. According to JD Supra, a regulatory sandbox 'is a structure allowing FinTech companies to experiment with new tools, data, or business models, while remaining under the supervision of regulators.'

Then on August 7, the BCFP announced its participation in the newly created Global Financial Innovation Network. The goal of this international group is to 'provide a more efficient way for innovative firms to interact with regulators, helping them navigate between countries as they look to scale new ideas.'

As for the Treasury, it issued a detailed report just hours before the OCC announcement. 'A Financial System That Creates Economic Opportunities,' and its fact sheet, urged the OCC to move forward with its 'special purpose national bank charter to provide a federal approach to reducing regulatory fragmentation and supporting beneficial business models.' It also indicated that the Treasury would 'work with federal and state regulators to establish a system similar to a 'regulatory sandbox' to invite innovations from new and existing market participants.'

Introducing the OCC's Fintech Charter

The OCC's Policy Statement on Financial Technology Companies' Eligibility to Apply for National Bank Charters states that the agency will consider 'applications for special purpose national bank charters from financial technology (fintech) companies that are engaged in the business of banking but do not take deposits.'

Fintechs that seek such a charter must demonstrate the following to the OCC through the charter application process:

• A reasonable chance of success
• Safe and sound operations
• Fair access to financial services
• Fair customer treatment
• A reasonable expectation of achieving and maintaining profitability
• A commitment to financial inclusion
• A contingency plan to deal with significant financial stress

The Comptroller's Licensing Manual Supplement further notes that fintechs that are approved for a special purpose national bank charter 'will be subject to the laws, rules, regulations, and federal supervision that apply to all national banks.'

Now that we know why the charter was created, let's weigh the pros and cons.

Understanding the Potential Upside

Encouraging the development of innovative financial products and services and modernizing the way they are regulated has the potential to benefit traditional banks in addition to fintechs:

• Safe expansion into new product offerings: Consumers, especially millennials, love the convenience and access of the latest fintech innovations. Banks that had previously been unwilling or unable to cash in on this popularity can now partner with a chartered fintech. Knowing that such a firm is subject to a uniform set of standards and will be supervised by the OCC provides an additional layer of risk mitigation to the prospect
  of jumping into this arena.
• Fewer 'rogue' non-banks: As legitimate fintechs gain special purpose national bank charters through the OCC, it could likely reduce the credibility and viability of riskier fintechs that are currently attempting to undercut traditional banks through unsafe banking and lending practices. Such firms may also face more public and regulatory scrutiny as a result of their above-board competitors earning charter status.
• Modernization of other regulations: The OCC fintech charter could be the beginning of real change in financial regulation, a prospect that has the potential to significantly benefit traditional banks that are subject to many outdated and cumbersome regulations. The Treasury's report specifically calls for such change: 'The U.S. regulatory framework for key financial services requires meaningful modifications to improve the delivery of both digital and non-digital financial services to consumers and businesses.'
• Economic growth and job creation: Many believe that creating a market environment where innovation and experimentation are encouraged fosters stronger economic growth. Such growth typically leads to more jobs, which puts more money in consumers' pockets to spend, invest and collateralize for greater financial wealth. Traditional banks will still play a major role in helping the beneficiaries of economic growth put their money to work.

Preparing for the Potential Downside

As many critics of the OCC's fintech charter point out, this push for modernization and innovation could also pose some disadvantages to traditional banks:

• Increased competition:Bloomberg notes that, 'Traditional banks already are facing a growing number of fintech startups looking to provide financial services faster and cheaper.' The OCC's move could encourage more fintechs to open their doors or existing ones to expand their offerings. In addition, traditional banks may face increased competition from other traditional banks that partner with a chartered fintech in order to provide the latest banking innovation.
• Unlevel regulatory playing field: The OCC has said its supervision of chartered fintechs will be similar to that of national banks with regard to capital, liquidity and risk management. But critics, including the Independent Community Bankers Association (ICBA), argue that this equivalency will be difficult to ensure. The consulting firm Federal Financial Analytics says that typical fintech business models are not capital intensive, calling into question how capital requirements can be applied in the same way. The publication also points out that if a parent company of a fintech is not a bank holding company, as most may not be, it would not be subject to the same cross-selling prohibitions that apply to the traditional bank subsidiary and parent relationship. In addition, it questions whether parent companies would stand behind their fintechs during times of financial stress.
• Fintech competitive advantage: If the OCC's planned uniformity for supervision of chartered fintechs is ultimately impossible to execute, such firms will likely enjoy the status of a charter without the regulatory constraints that traditional banks face. And in fact, Federal Financial Analytics notes that, 'Absent egregious violations, a charter granted cannot be revoked.' These factors could lend fintechs an even greater competitive advantage over legacy institutions.
• Risk to the financial system: Granting fintechs legitimacy through charters, but without the appropriate regulatory guidance, could inject greater risk into the financial system. Federal Financial Analytics worries that the OCC fintech charter will create 'significant consumer protection, safety-and-soundness, and structural impact.' It recommends that the OCC 'be sure it isn't a shadow-bank enabler before it hands out these high-powered charters.' Otherwise, both consumers and the overall financial system could be put at greater risk.

Keeping an Eye on the Future

Ironically, while traditional banks argue that the planned OCC fintech charter applies a light regulatory touch, fintechs themselves don't quite view it that way. They express concern about the cost of complying with onerous national bank regulatory scrutiny, and they also worry about the impact that potential renewed legal challenges could have on how-and to whom-the OCC grants charters.

Ultimately, the impact to the traditional industry may largely depend on the number of applications the OCC receives and the percentage of those that are granted a charter. According to The Financial Brand, 'Some experts think both the number and speed with which applications will come in won't pose much of a threat to legacy banking providers.'

We won't know the accuracy of that statement for a while, but one thing is certain-our industry is moving in new directions with new players entering the field all the time. Traditional banks must keep a watchful eye on the future in order to ensure their place in it.

Amber Goodrich, compliance strategist for CSI Regulatory Compliance, has more than 10 years of financial industry experience. She is a Certified Regulatory Compliance Manager (CRCM) and Certified Bank Secrecy Act (BSA) Professional (CBAP).