The US Treasury Department (Treasury) has issued its fourth report1 in a series on the Administration’s core principles to regulate the US financial system. It signals a new regulatory approach toward nonbank financial institutions, financial technology (“FinTechs”), and financial innovation. Coupled with the Office of the Comptroller of the Currency’s (“OCC”) same day announcement2 that it is accepting FinTech special purpose charter applications, FinTechs considering entering the banking environment, through a bank charter themselves or indirectly through partnerships, can take a note of encouragement. That said, there were no big surprises relative to past statements about underlying regulations and bank charter applications at this time.
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:
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.
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.
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.
James D. Simpson
1US Department of the Treasury, “Treasury Releases Report on Nonbank Financials, Fintech, and Innovation” (July 31, 2018)
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