Technological innovation in financial services is picking up speed, but U.S. state and federal authorities are still battling over how to regulate the new fintech companies.
In July, the Office of the Comptroller of the Currency, an independent bureau within the U.S. Treasury Department, announced that it would accept the first applications for regulation under its special purpose national charter for nondepository institutions. The department reported at the time that from 2010 through the third quarter of 2017, more than 3,300 new tech-based firms had been established, and the financing of such companies had grown to more than $22 billion annually. Lending by fintech companies had grown to 36 percent of U.S personal loans in 2017 from less than 1 percent in 2010.
But state regulators have been fighting against the OCC special purpose charter since it was first introduced in 2016, citing concerns about lax consumer protection and arguing that the OCC lacks the statutory authority to regulate nonbank institutions.
In October, the Conference of State Bank Supervisors, representing 26 states, filed a second lawsuit against the OCC in federal district court in the District of Columbia seeking to stop the OCC from granting the charters. A month earlier, the New York State Department of Financial Services, had filed suit in U.S. District Court for the Southern District of New York, also for the second time, arguing that the OCC’s power is limited to regulating institutions doing the “business of banking,” which requires taking deposits. The earlier suits were tossed for being premature. The OCC asked the court to dismiss the Manhattan suit last month. There have been no applications regarding the special purpose national bank charter as yet, an OCC spokesman confirmed on Monday.
We caught up with Manatt, Phelps & Phillips global payments partner Anita Boomstein and asked her to bring us up to date on the battle to regulate fintech. Her answers have been edited for brevity and clarity.
Corporate Counsel: This might seem too basic, but what kinds of businesses are we talking about when we say “fintech” companies?
Anita Boomstein: At its most basic, it is a financial product or service typically one offered directly to consumers—though it could be offered to a commercial entity—and the core of the definition of it is offered by an entity that is not otherwise a bank. It could be a lending product, a prepaid card manager, a marketplace lender—an online website that offers mortgage—or a nonbank that makes loans, or a payment processor, offered through the use of technology rather than a physical office or branch. [Editor's note: Some also use the catch-all term to apply to financial applications of blockchain and digital currency.]
CC: How is the OCC attempting to regulate fintechs?
Boomstein: The OCC is attempting to create a new category of bank called a special purpose national bank designed specifically for fintech companies that want to engage in lending or paying checks. (The equivalent today of paying checks is the electronic movement of funds.) There are three basic banking functions: lending money, paying checks and taking deposits. The OCC intends to allow this national bank to do those two functions, but it could not take deposits. But the advantage of this charter is that the OCC is the exclusive regulator of a national bank. Individual states could not license, audit or supervise the bank because under federal law that is the exclusive power of the OCC. That removes the problem that fintechs have today, which is that they may need to be licensed in 50 states. That is a cumbersome process and makes them subject to a wide variety of different requirements, which is an impediment to an efficient operating environment and customer experience. The OCC takes the position that if we want fintechs to develop, we need to encourage that development through a national charter.
CC: Why is there a conflict with states over this?
Boomstein: The states would like to retain their ability to regulate these entities. Through state licensing, they can decide if they [the institutions] have sufficient management and financial resources, among other things, and they don’t want to give up that right. The states are arguing that the OCC is exceeding its power. Their position is that by limiting the powers of this special-purpose bank, it is not really a “bank” and if it is not a bank, the OCC doesn’t have the authority to issue the charter. However, historically there have been many types of limited bank charters, such as for credit-card banks and for trust companies, and they have existed for many years. It remains to be seen whether the legal position of the states will resonate with the courts. They are resting it solely on the fact the entities will not take deposits, which is one of the critical elements of the so-called ”business of banking,” but not a mandatory activity, according to the OCC.
CC: Why don’t the states want to cede authority to the federal government?
Boomstein: No regulator wants to give up its authority to control activities within its state. They may also fear that a national regulator will not pay attention to some of the things they may look at on a state level. However, while a national charter provides exclusive supervisory authority, it does not mean these banks are immune from all state laws. National banks must comply with consumer protection laws, such as fair lending laws, so although state regulators are being protective of their own citizens there are still protections at a state level. [Editor's note: Some also use the catch-all term to include use of blockchain and digital currency.]
CC: Where are we now in this battle between states and the OCC?
Boomstein: We are far from a resolution. At the time of the last court challenge in 2017, the OCC had not yet accepted any applications for the special purpose charter, or given approval of any charter. It is entirely possible that the current suit will be dismissed for the same reason—it is not ripe. It will be several months before any charter application is given preliminary approval, which is likely to delay a court ruling, and appeals could follow.
CC: So what’s next for companies, their counsel and others waiting to see who will regulate fintechs?
Boomstein: The No. 1 takeaway is that there is going to be a long lead time before any special purpose charter receives final approval and the bank can open for business. In the interim, fintech companies will have to decide what they want to do. Do they want to wait for the national bank charter or operate as a nonbank and be subject to state licensing and other requirements? Other than time to market, another potential disadvantage is that this charter is new and untested, and changes in leadership or philosophy at the OCC could impact the regulations they ultimately pass or their willingness to go ahead with the charter. So it is possible that this institution would be disadvantaged relative to other banks and lenders. It is going to require a weighing of advantages vs disadvantages, at least in the near term.