In December 2016, the OCC issued a statement that they would begin considering bank charter applications from fintech companies. These would be limited purpose charters, something I wrote about in an earlier post and an Executive Insight I wrote for Mercator Advisory Group.
The comment period for the OCC white paper is expired and the agency is reviewing the comments they’ve received prior to issuing a policy statement or defining a date to begin accepting charter applications. As one might imagine, the institutional market’s reaction has ranged from yawns to gasps while segments within the fintech market, like P2P lenders, appear enthusiastic.
This is an important moment for regulated financial services in the United States. It’s been quite a few years since the heyday of special purpose banks and the last time an outsider tried to get in, meaning WalMart, the institutional industry fought hard to prevent them (and as a result, any other applicant) from obtaining a limited banking license. Converging with this dynamic is the high state of innovation in the financial services industry. Alternative financial service providers are gaining ground, which is eating into regulated institutional services, but also exposes consumers to higher risk.
And putting this into context, let’s remember that the OCC published a white paper back in March 2016 that preceded their paper on Special Purpose Banking licenses, entitled “Supporting Responsible Innovation in the Federal Banking System: An OCC Perspective” which addressed the need for changes in the regulatory framework in order to address advancements in the demand and supply of financial services. This paper garnered 62 comments from across the industry.
First, let’s consider what the OCC has written in their white paper. The national banking system was signed into law by Abraham Lincoln, and the many decades of data and information we’ve gained since then establishes the efficacy of these charters. As the OCC states, these licenses have been especially valuable in defining what have essentially become the standards for banking services in the United States. In addition, the very large, national institutions have not only set the bar for what constitutes competitive bank-offered financial services, but they also lead the industry in investments in innovative technologies and services.
Now that financial services developed on fintech business models mature, does it make sense to bring them into the regulatory fold? The OCC thinks so and makes the argument for new licenses based on these three premises:
- Their business and operating models will be safer and sounder, providing more security to their customers.
- There will be improved consistency across financial services providers and improvements in consumer protection as a result.
- Regulators can have a positive impact on licensed entities by encouraging them to “innovate responsibly”.
It’s important to note that the OCC states that they are willing to take ” into account any relevant differences between a full-service bank and special purpose bank when considering a license application”. I take this to mean that there’s a grey area they’re open to exploring with these kinds of entities, which acknowledges the place fintech has established in the market and the fact that many of these companies don’t fit neatly into the category of “financial institution”.
Learnings From the Comments
In this section, I’m going to summarize the comments made for both papers mentioned in this post, since they converge with one another and both will have an impact on the OCC as it further develops its position. In total, there were 70 comments posted on the OCC’s public site, categorized in the table below:
|Banking Trade Groups||9||13%|
|Fintech Trade Groups||7||10%|
|Special Interest Groups||5||7%|
By far, the majority of comments submitted were by fintech companies and their trade groups coming in at 39% which if nothing else illustrates how engaged this segment has become with the regulatory process. This activity also signals that fintech has reached a maturity level where it recognizes there is value in regulation as a means of furthering M&A growth channels, encouraging investments and establishing market differentiation.
The Legacy Industry
As one might imagine, regulated institutions want rules that favor regulated institutions. It’s just that simple, but in their defense, many comments underscored the need for the OCC to address their existing rules and protocols for working with institutions to make innovation easier for them. This includes improved engagement in order to remove risk uncertainties and providing some protective rationalization for banks to be able to partner with venture-backed fintech companies.
The underlying currents however, serve to illustrate the real divide between the large and small scale institutions in the U.S. market. Bigger institutions want to partner (i.e., control) fintech companies and get a stake in future ventures. Smaller institutions need to protect themselves from being made irrelevant and unprofitable by fintech start-ups and are deeply concerned about fintechs cherry picking their best customers unless things like CRA requirements are made part of these special charters. Community banks specifically called out the potential for increasing predatory lending and the long-held fear of opening the door for entities like Wal-Mart, Apple and Google to own banks.
Fintech company comments tended to coalesce around a few primary needs:
- Flexibility in the regulations designed to protect them from the unknowns in their business plans. For example, creating a regulatory sandbox to test new products (i.e., Project Catalyst/CFPB). It was even suggested to create flexible regulations that would change according to things like developmental phase or risk profile.
- Harmonization of regulatory oversight across agencies (something most entities wouldn’t argue with) along with a national framework for innovation in financial services and most important, ensure these regulations preempt state and local regulations, which are a major headache for many fintech start-ups.
- Create an inter-operational innovation task force to work on these issues much like Faster Payments has done and work with other international organizations to address common issues and define common operational standards around the world.
The comments from fintech companies also put their innovative thinking on display with suggestions like allowing them to append a company to an existing regulated bank and then cut them free with their own license as they reach some pre-defined stabilization point or eliminate the demand for capital requirements. It was also suggested that business plans should include, at a minimum, what the benefits of its product are, thus encouraging an examination of social benefits and ensuring there is a viable growth opportunity for the company. Finally, there was the suggestion to foster open API’s in banking as well as open data (which market forces are well into making happen already).
Fintech Isn’t Waiting for an Invitation to Come In
The fintech community has had a significant impact on the financial institutional market around the world. Innovation across the value chain has taken place at a rapid rate and regulators are just as far behind the curve as many other market participants. In the very early stages of a market development cycle, regulations tend to act as barriers, keeping the outsiders out and protecting the insiders position. However, as the cycle turns, markets need regulators to provide stability, surety and protections in order to allow business models to mature into sustainable growth patterns.
What’s unique about this point in time is that the fintech community is likely to drive it’s innovative thinking into the regulators hallways as much as they have the open market. Consider some of the suggestions that were made by them in the comments, such as a more flexible regulatory framework, tethering rules and open operating environments. Outside the United States and in some emerging markets, these ideas are already taking shape through regulatory actions and that will happen here as well.
Legacy institutions and entities understand the need for regulatory changes that address the new realities of a fintech-driven market but viewpoints and needs vary depending on capabilities. This leaves the OCC and other regulators in a difficult position in the United States, where they serve the needs of a large, diverse and highly competitive financial services industry. Or, as one might say, no good regulation goes unpunished.
It’s going to be necessary to open many doors in the process of evolving our regulatory framework and market participants should be thinking about how they’re going to react when they have to welcome their new neighbors for dinner.