A fintech charter with a different name
The OCC may be able to overcome the legal obstacles to its new payment charter.
Imagine your life without a bank account. Where would you keep your money? How would you pay your bills? Who would give you a loan?
The COVID-19 pandemic has highlighted the struggle that one in four American households faces every day when they do not have access to basic banking services such as checking accounts, payment services, and affordable credit.
Financial technology companies, or “fintechs”, are helping some of these consumers access essential services at lower cost and in remote areas where traditional banks do not operate. However, banking regulation has not kept pace with these technological innovations in the industry.
Bundesbankenrecht currently does not offer a coherent regulatory framework for fintechs. This has forced fintechs to apply for licenses from a complex network of government banking regulators, adding to their costs and limiting their ability to offer better banking services to consumers.
In 2018, the Office of the Comptroller of the Currency (OCC) – the federal authority responsible for issuing charters to national banks and regulating their activities – made the first attempt to address this problem when it introduced a “Fintech Charter “Created.
In contrast to traditional banks, which offer all banking services from a single source, fintechs usually only offer payment or credit services, not both. The Fintech Charter gives fintechs that provide such tight banking services the opportunity to receive a national banking charter tailored to their needs, rather than forcing fintechs to navigate the complex and annoying web of government regulations. Although the fintech charter technically covers both payment and lending companies, the OCC designed the charter primarily for fintech lenders.
Since its inception, the OCC’s Fintech Charter has encountered significant legal obstacles preventing fintechs from applying for one. In October 2019, a federal judge in New York overturned the charter for exceeding the powers of the OCC as it applies to companies that do not take deposits. The judge found that the National Bank Act “clearly requires that … only depositaries are entitled to receive national banking charter from the OCC”. The OCC’s appeal against the judgment is still pending.
Despite this legal battle that has questioned the legality of the Fintech Charter, Auditor Brian Brooks – the OCC’s head – announced in June 2020 that the OCC intends to create a new one Payments Charter designed exclusively for fintech payment companies like Venmo or MoneyGram that hold users’ funds and transfer funds between accounts.
An important question is whether charting payment companies is legally different from chartering credit companies.
State banking regulators who have brought charges against the fintech charter have criticized the payments charter as “no different from the fintech charter” as both apply to non-custodians. The OCC does not deny this point. Instead, Comptroller Brooks claims that both charters are valid under the National Bank Act. He argues that the existing regulation gives the OCC the power to issue charters to non-custodian institutions involved in payments and lending.
If the OCC ultimately loses its appeal to the Fintech charter, the payment charter will likely – as proposed – also fail, as it also applies to non-custodian companies. In that case, the OCC will need another avenue to charter fintech payment companies.
One option for the OCC is to offer payment companies traditional national banking charter, known as “full-service” charters, that allow companies to take deposits, make loans, and facilitate payments. The OCC recently issued such a full-service charter to Varo Money – the first national charter ever awarded to a fintech.
However, full-service charters take a long time to procure and include extensive regulation that is often not suitable for payment companies with narrow business models. In these cases, the OCC may still be able to offer its tight payment charter by accepting requests from fintechs to take deposits.
The OCC designed the fintech charter for non-custodians because fintech lenders – the companies the OCC had in mind when drafting the fintech charter – have no reason to accept deposits. Fintech lenders use technology to facilitate credit, but place the risk of default on the consumers and financial institutions who provide the money. When a fintech lender takes deposits and offers loans, it would become a traditional bank and require a full service charter.
Payment service providers are different. Some experts argue that cutting-edge payment companies like cryptocurrency companies are already taking deposits. And those who don’t take deposits could save costs by doing so instead of paying third party banks to hold their users’ funds.
When fintech payment companies take deposits, they may not require the same level of supervision as fintech lenders or traditional banks. For decades, some scholars have argued that banks that focus closely on payments should face less regulation as they simply transfer funds or put deposits in low-risk assets. Auditor Brooks reiterated this argument when he proposed the OCC’s payments charter, advocating that the OCC should adapt the regulations to the tight services of fintech payment companies.
Most payment service providers do not hold deposits because they cannot obtain deposit insurance from the Federal Deposit Insurance Corporation and want to avoid being called a bank holding company. The OCC can solve both problems.
The OCC has declared – in an unrelated context – that it is authorized to issue special articles of association to custodians without deposit insurance if they can “work safely and soundly”. Fintech lenders are unlikely to meet these requirements as fintech lending carries significant risk to depositors, systemic risks to the economy, and potential consumer predatory practices.
Payment companies are less likely to take financial risk as they simply move users’ funds between accounts or invest those funds in low-risk assets such as US Treasuries. They don’t lend the money to borrowers who may default on a loan. Given this low risk, the OCC could grant deposit-taking payment companies a special charter claiming that they can operate safely and soundly without deposit insurance.
In addition, many fintechs fear that, as a bank holding company, they will deal with stricter regulation. Any institution that either has a deposit guarantee or accepts deposits and grants commercial loans could be considered a bank holding company within the meaning of the law. When fintech lenders accept deposits, they automatically qualify for making commercial loans. However, payment service providers can accept deposits without being a bank holding company as they do not offer loans or require deposit insurance. This difference means that, under the Bundesbankengesetz, the OCC could offer its payments charter to companies that only accept deposits and enable payments.
The OCC has not yet explored the idea of offering a special charter to fintechs that accept deposits. It can ultimately decide that payment companies are exposing consumers to too great a risk to accept deposits without insurance. Even if payment companies take less financial risk than traditional banks or fintech lenders, some commentators fear that payment companies are exposed to significant cyber risk, fraud, and other operational risks that pose a systemic risk to the financial system. This is an important issue for the agency to consider.
If the OCC loses its legal battle against the charter of non-custodian institutions, it will have to rethink the way it charter fintechs. In doing so, the OCC may have more options to charter fintech payment companies than fintech lenders.