March 16, 2017
Authored by: Dan Wheeler and Jonathan Hightower
Amid criticism from virtually every possible constituency, on March 15, 2017, the Office of the Comptroller of the Currency (OCC) released a draft supplement to its chartering licensing manual related to special purpose national banks leveraging financial technology, or fintech banks. As we indicated in our fintech webinar discussing the proposal last December, the OCC is proposing to apply many conventional requirements for new banks to the fintech charter. While the OCC’s approach is familiar to those of us well versed on the formation of new banks, there are a few interesting items of note to take away from the draft supplement.
- More bank than technology firm. Potential applicants for a fintech charter should approach the project with the mindset that they are applying to become a bank using technology as a delivery channel, as opposed to becoming a technology company with banking powers. While the difference might seem like semantics, the outcome should lead potential applicants to have a risk management focus and to include directors, executives, and advisors who have experience in banking and other highly regulated industries. In order to best position a proposal for approval, both the application and the leadership team will need to speak the OCC’s language.
- Threading the needle will not be easy. Either explicitly or implicitly in the draft supplement, the OCC requires that applicants for fintech bank charters have a satisfactory financial inclusion plan, avoid products that have “predatory, unfair, or deceptive features,” have adequate profitability, and, of course, be safe and sound. Each bank in the country strives to meet those goals, yet many of them find themselves under pressure from various constituencies to improve their performance in one or more of those areas. For potential fintech banks, can you fulfill a mission of financial inclusion while offering risk-based pricing that is consistent with safety and soundness principles without having consumer groups deem your practices as unfair? On the other hand, can you offer financial inclusion in a manner that consumer groups appreciate while achieving appropriate profitability and risk management? We think the answer to both questions can be yes, but a careful approach will be required to convince the OCC that it should be comfortable accepting the proposed bank’s approach.
- The cost of preemption. Bankers have heard us describe their regulatory environment as the “real cost of deposit insurance” many times. By that, we mean that one way to look at regulatory burdens is that they are a price to be paid for the benefit of gathering low-cost deposits from the public. Deposit insurance allows banks to leverage the implicit confidence in the FDIC rather than the strength of the bank’s balance sheet and liquidity as the sole source for repayment of that deposit. (Many might say that cost is far too high at the moment). For fintech charters, the regulatory burdens of a fintech bank charter should be viewed as a cost for obtaining federal preemption of many state law requirements and for having a single prudential regulator, in addition to the benefits described below. For some, the burden will be worthwhile, but for other fintech firms, it will not be. However, we believe this cost benefit analysis is both appropriate and important when considering a fintech bank charter.
- Don’t ignore the opportunity. As we study the draft supplement, the most important note is what it does not describe – the opportunity available in obtaining a bank charter. We believe obtaining a bank charter will set a fintech firm apart in an increasingly crowded field. As many fintech firms are painfully aware, bank procurement processes are necessarily painstaking, creating a challenge for fintech firms in seeking partnerships (given the lack of deposit gathering ability for fintech banks, we believe bank partnerships will continue to be valuable). We believe that obtaining a charter will put fintech firms in the “express lane” for bank partnerships, as well as other business relationships, given the apparent blessing of a federal regulator in the firm’s compliance practices.
Perhaps more importantly, obtaining a fintech charter will open up potential exit strategies for fintech firms. The hesitancy we most often hear from our bank clients in discussions of acquiring fintech firms is their doubts of cultural consistency as it relates to being in a supervised environment. Fintech banks, of course, will have lived in that environment, which we believe will ameliorate cultural concerns of potential acquirers in the banking space. We believe this benefit will not only enhance the ability of the firm to raise capital from outside investors but may also attract existing banks to make investments in fintech firms (potentially limited to 4.9% of voting securities) as the banks look to position themselves as the acquirer of choice for new fintech banks.
While the draft licensing manual supplement did not contain many surprises for advisors familiar with new bank formations, it highlights some of the unique challenges and opportunities in obtaining a fintech bank charter. As the supplement itself acknowledges, the chartering option will not be for all fintech firms, but we believe it presents a unique opportunity for a subset of this space.