Seven Questions About FinTech Charters

August 1, 2018 at 11:00 am Leave a comment

Image result for fintechYesterday’s announcement by the OCC that it will begin accepting FinTech Bank charter applications is as big a development for banking as passage of the Riegle-Neal Act in 1994 which lead to the rapid consolidation of community banks and credit unions that we are still seeing today and the enactment of the Gramm Leach Bliley Act which broke down depression barriers between commercial and investment banking leading to the behemoths that we live with today. FinTechs will over time have a profound effect on the way credit unions and all financial institutions go about their business. Here are some questions I’ve been asking myself and some preliminary answers:

What is a FinTech Charter anyway? In 2003, the OCC amended §12 CFR 5.26 (e)(1). The new regulation authorized the creation of special purpose banks that do not engage in fiduciary activities but conduct at least one of the following core banking functions: receiving deposits, paying checks, or lending money. At the time the provision received little attention but it is this regulation that the OCC argues allows it to authorize special charters for companies that use computer platforms to process payments or lend money for example.

Why would companies be interested in a FinTech Bank Charter? As the New York Times explained this morning, tech companies have been advocating for just such a charter because they believe it will allow “online lenders and payment companies to more easily and directly compete with traditional banks, a change that one regulator said would allow innovative businesses to expand nationwide.” With a national charter, these companies will have one set of national rules. This has always been the appeal of a national charter.

Why should credit unions care? Now for the potentially more troubling reason, at least from a competition standpoint. Maybe not today, maybe not tomorrow, but someday and someday fairly soon, bigger FinTech companies will not be as dependent as they are now on establishing banking relationships. For example, many credit unions now have contracts with Apple’s iPay. The new charter will make it much easier for Apple to not only facilitate payments but ultimately to facilitate payments using its own bank. Think of how many vendors you have and then think of each one as a potential competitor.

Are there safety and soundness risks? That’s a great question Henry. The major concern that I have with this new charter is that it will further degrade the firewall between commercial business and banking. This approach worked great for the American economy in the 1920’s but not so much in the 1930’s. In its FinTech Chartering Manual released yesterday, the OCC acknowledged that FinTech’s will be unique. They will not accept deposits and therefore not be subject to FDIC oversight. But they will have to meet capital requirements. But even these capital requirements will be unconventional as much of the money for these businesses is raised by venture capitalists.

What are the appropriate capital requirements for FinTech charters? No one will really know precisely what an appropriate capital buffer will be for these financial entities. Here is my worst case scenario: Facebook creates a FinTech subsidiary that specializes in processing payments and making consumer and mortgage loans. How would the general public react the next time they find out that the parent company loses 20% of its value in one day? Even assuming that there is an adequate firewall between Facebook and its affiliated bank, I think your average consumer will react very nervously to this news.

How will this affect credit unions? To me the charter underscores why credit unions face an existential threat. Limiting the growth of any financial institution, let alone one that is dependent on deposits, is an antiquated regulatory straightjacket in an age of internet banking. If the industry does not get greater flexibility to grow, all but the largest credit unions are going to suffocate.

What Happens Next? The OCC is now accepting FinTech applications and the way it is talking, you can bet there are a few already in the hopper. Part of the application process is a public comment period which will allow interested stake holders to weigh in with any concerns that they have. There will also be lawsuits. In May 2017, in response to a white paper, New York State’s Department of Financial Services filed a lawsuit claiming, among other things, that the OCC did not have the authority to create FinTech charters. That case was dismissed late last year because the court concluded it was premature to bring such a lawsuit but with the OCC now open for business, the lawsuit making the same basic arguments is sure to come.

But I said it before and I will say it again. These companies are an inevitable outgrowth of changes in the economy. While it’s fun to grouse about competitive inequities, it’s much more beneficial to recognize the new reality and to start positioning your credit union to compete in this evolving ecosystem.

In an ideal world Congress would get involved in such an important issue. There are too many important legal and policy issues to be left exclusively to unelected regulators and federal judges but Congress hasn’t exactly demonstrated that it has the ability any longer to deal with complicated important issues.

 

Entry filed under: Legal Watch, Regulatory, Technology. Tags: , , .

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Authored By:

Henry Meier, Esq., Senior Vice President, General Counsel, New York Credit Union Association.

The views Henry expresses are Henry’s alone and do not necessarily reflect the views of the Association. In addition, although Henry strives to give his readers useful and accurate information on a broad range of subjects, many of which involve legal disputes, his views are not a substitute for legal advise from retained counsel.

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