Treasury and OCC push for new FinTech tone, direction, and opportunities

August 3, 2018 | Financial services

However, there was immediate pushback³ from the New York Department of Financial Services (“NYDFS”) consistent with its past criticisms of a federal FinTech charter. The NYDFS voiced concerns that the federal regulatory scheme was “unjustified” and encroached on the state regulatory system. They also object to the Treasury’s proposal to allow regulatory “sandboxes” that would in their view allow companies to “evade laws that protect consumers.” How these different points of view may be resolved remains to be seen.

Recent interest for the FinTech industry has been on ways in which firms can gain better regulatory certainty and powers through partnerships, charters, or bank mergers. The Treasury Report and the OCC’s “Policy Statement on Financial Technologies’ Companies Eligibility to Apply for National Bank Charters”⁴ statement provide some clarity on current and future opportunities for FinTechs to operate more efficiently and with fewer regulatory barriers. However, some questions remain unanswered, with the OCC retaining flexibility in how to approach FinTech applications.

Key aspects of the Treasury Report

The Treasury Report covers four main topics:

• Embracing digitalization, data, and technology
• Aligning the regulatory framework to promote innovation
• Updating activity specific-regulations
• Enabling the policy environment

Here are some key takeaways from the report focusing on implications.

Inefficiencies in the current framework call for action

The Treasury Report points out the contradiction between the efforts of FinTechs to advance financial innovation at scale and the patchwork of state licensing and regulatory bodies that encumber their ability to provide services to their customers efficiently anytime and anywhere. While the Treasury Report encourages state harmonization efforts and recognizes past progress, it specifically recommended that the OCC pursue a special purpose FinTech charter consistent with the OCC’s earlier proposal. The OCC’s policy statement issued later that day followed the Treasury’s recommendation, but without specifying tailoring around financial inclusion, the Community Reinvestment Act (CRA), capital and other expectations of a traditional banking charter application (see more details below).

As envisioned, the national bank special purpose charter would not permit acceptance of insured deposits to reduce risk to taxpayers but would still require sound capital, liquidity, earning prospects and risk management consistent with the size and complexity of the FinTech. Treasury points out a key advantage relative to a state charter is the ability through the National Banking Act,⁵ to preempt state usury laws that cap interest rates. However, they also note that certain other consumer protections, state contract law and foreclosure laws would still apply.

Treasury also recommends that Congress codify the “valid when made” doctrine⁶ to preserve the functioning of US credit markets and the longstanding ability of banks and other financial institutions, including marketplace lenders, to buy and sell validly made loans without the risk of coming into conflict with state interest-rate limits.

Third-party risk management implications

The Treasury report outlines efforts needed to support FinTechs ability to prosper outside the banking industry as partners. These include rationalization of bank third-party risk management standards that might disadvantage smaller developing FinTechs for which high bank due diligence efforts might be too costly. In addition, Treasury notes the need to review or clarify due diligence expectations of third parties for their own third-party risk (bank fourth-party risk) as these might not be feasible for smaller FinTechs.

Federal Reserve membership unknown

One current unknown for any special purpose FinTech applicant is whether the Federal Reserve (“Fed”) would grant such firm’s direct access to the payment system through Fed Wire or access to the discount window. As Governor Lael Brainard⁷ noted in a speech last year, should a special purpose charter move forward the Fed would need to carefully evaluate FinTech applications for Fed membership and services they would be permitted to use.

Definition of control

In addition, to support the ability of firms to flexibly adapt to new technology and market developments and promote investment in innovative technologies, Treasury recommends that the Fed consider how to reassess the definition of Bank Holding Company (BHC) control to provide firms a simpler and more transparent standard to facilitate innovation-related investments.

Key aspects of the OCC policy statement

As noted, the OCC believes granting of a special purpose charter to FinTechs is within their current authority under the National Bank Act. Here are some key messages within the policy statement.

• OCC will use its existing chartering standards from its Licensing Manual
• Key criteria for judging the acceptability of a FinTech application will be consistent with standard bank applications and include:
  • Does the applicant have a reasonable chance for achieve and maintain profitability?
  • Will the firm be operated in a safe and sound manner?
  • Will it provide fair access to financial services?
  • Will it treat customers fairly?
  • Will it comply with applicable laws and regulations?
  • Will the firm be profitable?
  • Will granting the charter enhance competition?
  • Does it have organizers who are familiar with applicable laws and regulations?
  • Will it have competent management including a board of directors with relevant experience?
• Applications must include business plan that articulates a clear path and a timeline to profitability
• FinTech’s will be held to the same high standards as traditional national banks with regard to capital, liquidity, and risk management
• OCC will tailor its expectations based on size, complexity, and risk profile just as it does with traditional national banks
• Firms will be required to make a commitment to financial inclusion and be required to meet similar expectations to the CRA even though they do not accept insured deposits and are therefore technically exempt from the Act
• The nature of the commitment will depend on the FinTech’s business model, products, services, and activities
• An additional requirement for FinTechs would be a recovery and resolution plan that outlines actions they would take under severe financial stress or insolvency including selling, merging, or liquidating the firm if recovery actions are not successful
• They also emphasize they would not approve FinTech charters that would alter existing barriers between banking and commerce
• The timing of the application process and whether there would be any timing benefits relative to the existing charter timeline remain unclear

The OCC Fintech charter is just one option for FinTech’s entering the banking system. Federal, State Industrial Loan Corporation (ILC) banking charters offer various opportunities and challenges. A range of qualitative and quantitative considerations as well as formation options (acquisition, build, hybrid, partnership) should be evaluated considering the range of powers and alignment to the overall strategy for the FinTech. Potential options and strategic views should be developed to ensure flexibility as developments emerge.

Conclusion

The policy discussion has now moved more decidedly from debate to action with the Treasury Report and OCC Policy Statement toward a financial system that creates economic opportunities. In the coming months and years, it will be incumbent on regulators and the banking and FinTech industries to move forward and learn by doing. There will continue to be challenges and headwinds with pushback from various parties, and Fintech companies will each need to decide a path forward within the various formation options. As applications are submitted and implementation work actually begins, precedents will be established and lessons will be learned.

As further developments occur, Deloitte will issue additional updates as appropriate.

Organizations may contact Deloitte with questions about the changes and activities to assist with planning, preparation, and compliance.

¹ US Department of the Treasury, “Treasury Releases Report on Nonbank Financials, Fintech, and Innovation” (July 31, 2018) https://home.treasury.gov/news/press-releases/sm447

² Office of the Comptroller of the Currency (OCC), “OCC Begins Accepting National Bank Charter Applications From Financial Technology Companies” (July 31, 2018) https://www.occ.gov/news-issuances/news-releases/2018/nr-occ-2018-74.html

³ New York State Department of Financial Services (NYDFS), “Statement by DFS Superintendent Maria T. Vullo on Treasury’s endorsement of regulatory sandboxes for FinTech companies and the OCC’s decision to accept FinTech charter applications” https://www.dfs.ny.gov/about/statements/st1807311.htm

⁴ Office of the Comptroller of the Currency (OCC), “Policy Statement on Financial Technologies’ Companies Eligibility to Apply for National Bank Charters” https://www.occ.gov/publications/publications-by-type/other-publications-reports/pub-other-occ-policy-statement-fintech.pdf

⁵ 12 U.S.C. 38 – The National Bank Act https://www.gpo.gov/fdsys/granule/USCODE-2011-title12/USCODE-2011-title12-chap2-subchapI-sec38

⁶ H.R.3299 – Protecting Consumers’ Access to Credit Act of 2017 https://www.congress.gov/bill/115th-congress/house-bill/3299

⁷ Governor Brainard’s speech on “The Opportunities and Challenges of Fintech” at the Conference on Financial Innovation at the Board of Governors of the Federal Reserve System, Washington, D.C.” https://www.federalreserve.gov/newsevents/speech/brainard20161202a.htm