After years of speculation, the Office of the Comptroller of the Currency (OCC) announced Tuesday that it would begin considering applications for special purpose national bank charters from financial technology (fintech) companies. The proposed “fintech charter” is an even more enhanced regulatory scheme than what was proposed under the Obama administration back in 2016, yet is an encouraging step, opening the door for online lenders to operate nationwide under a single regulatory regime.
Essentially, the charter allows fintech firms to operate nationally, pre-empting state usury laws, if they assume a similar kind of regulatory treatment as other nationally chartered banks. This would mean that fintech firms that are granted a charter will be:
- Subject to the same high standards of safety and soundness and fairness that all federally chartered banks must meet;
- Supervised like similarly situated national banks, including with respect to capital, liquidity, and risk management;
- Committed to financial inclusion, similar to the Community Reinvestment Act’s (CRA) expectations for national banks;
- Required to develop a contingency plan to address significant financial stress that could threaten the viability of the bank;
- Reasonably expected to achieve and maintain profitability;
- Not engaged in products and services that have predatory, unfair, or deceptive features or that pose undue risk to consumer protection.
As I have summarized previously, the fintech regulatory environment is often incoherent. Prior to the OCC’s announcement, nonbank fintech lenders had no option of federal chartering. Instead, each fintech lender would be required to charter in each state in which it originates loans. And because each state sets its own regulations with regards to interest rates, lenders would have to comply with a patchwork of different regulations in order to lend to customers across markets. That process of 50-state registration can take several years and cost between $1 million to $30 million, including legal fees and direct regulatory costs. This puts fintech lenders at a competitive disadvantage, as solely state-chartered firms cannot offer consistent products nationwide that can provide benefits from economies of scale.
To work around this regulatory problem, many fintech lenders rely on a bank-partnership model. Because banks can “export” their home state’s interest rate laws to customers in other states, fintech lenders often partnered with banks. Banks originate the loans and sell them to fintech lenders, who then service the loan and collect the payments. This is not a particularly efficient way of doing business, but it is more efficient than fintech lenders chartering in every state in which they extend credit.
The sensible option is, therefore, to create a national charter for fintech lenders that provides regulatory consistency. However, while the fintech charter proposed by the OCC is no doubt encouraging, it is far from perfect. In particular, it remains to be seen whether or not fintech firms will even want to take on the enormous burden of federal government regulation and supervision. Developing a contingency plan, abiding by enhanced prudential standards, and committing to CRA-like investments is an enormous burden with which only the largest of fintech lenders will be able to comply. It is far from the ideal of permissionless innovation for financial technology.
Essentially, it is a tradeoff between compliance costs: bite the bullet of enhanced federal regulation and obtain access to a national market, or patch together enough state-by-state licenses to operate across different regions.
An interesting implication of the charter, however, is the future of the “third way” fintech firms—those with a bank partnership. Because the national charter offered by the OCC is so burdensome, it is likely that many small-to-mid-sized fintech lenders will not have the resources available to take on that level of compliance. Many may want to remain in partnership with chartered banks. But there’s a problem: back in May, the OCC issued guidance on banks installment lending, stating “The OCC views unfavorably an entity that partners with a bank with the sole goal of evading a lower interest rate established under the law of the entity’s licensing state(s).” This is at odds with what the OCC has said previously, and seems to call into question the business model for fintech firms that partner with banks to operate on a national scale.
To date, the OCC has not brought enforcement actions in line with the guidance. But now that the OCC has offered up a pathway for national licensure, it may be more willing to bring action against fintech-bank partnerships that it deems inappropriate. That would be an unfortunate development to an otherwise encouraging policy.
To counteract that issue, Congress needs to act. H.R.4439, the Modernizing Credit Opportunities Act, introduced by Rep. Trey Hollingsworth (R-IN), would codify the fintech-bank partnership model into law, clarifying that state usury law pre-emption of an insured depository institution is not affected by any contract between the institution and a third-party service provider. The OCC’s fintech charter is a bold step in the right direction, but it must not be only to the benefit of the largest lenders that can afford its enhanced compliance.