Vedder Thinking | Articles So It Begins: FinTech Companies Obtain Legitimacy
Recently, in public remarks, the Comptroller of the Currency, Thomas J. Curry, announced that the Office of the Comptroller of the Currency (the “OCC”) would move forward with special purpose national bank charters for financial technology (“Fintech”) companies.
In coordination with this announcement, the OCC issued a white paper titled Exploring Special Purpose National Bank Charters for Fintech Companies, which summarized the OCC’s authority to grant special purpose national bank charters to Fintech companies and the conditions under which it may do so. The OCC makes clear that if granted a national charter, a Fintech company will be held to the same standards of safety and soundness, fair access and fair treatment of customers that all federally chartered institutions must meet. Below we provide a summary of the OCC’s announcement and its likely consequences.
What is a special purpose national bank charter?
The OCC has authority to grant charters for national banks and federal savings associations. That authority extends to the granting of charters for special purpose national banks. Special purpose national banks may limit their activities to fiduciary activities or to any other activities within the business of banking. A special purpose national bank that conducts activities other than fiduciary activities must conduct at least one of the following three core banking functions: (i) receiving deposits; (ii) paying checks; or (iii) lending money.
The OCC’s grant of special purpose charters is not a new concept. For example, the most common types of these charters are trust banks (national banks limited to the activities of a trust company) and credit card banks (national banks limited to a credit card business). The OCC does not attempt to provide a legal limitation on the type of “special purpose” for which a national bank charter may be granted, other than to state that an applicant must engage in fiduciary activities or in activities that include receiving deposits, paying checks, or lending money.
Why does the OCC believe this will be beneficial for the industry?
The OCC expresses three reasons why the agency believes it is in the public interest to provide special purpose Fintech charters:
- To ensure that Fintech companies operate “in a safe and sound manner” in serving customers, businesses and communities;
- To promote “consistency in the application of law and regulation across the country and ensure that customers are treated fairly;” and
- To “make the federal banking system stronger” by using OCC oversight to promote fair access, financial inclusion and responsible innovation.
What laws would apply to a nationally chartered Fintech company?
Generally, a special purpose national bank is subject to the same laws and regulations, examinations, reporting requirements, and ongoing supervision as other national banks, including, but not limited to the following:
General Application Statutes. Statutes that by their terms apply to all national banks will apply to all special purpose national banks, which include, but are not limited to, the following laws: (a) the Bank Secrecy Act/anti-money laundering laws; (b) the prohibitions on unfair or deceptive acts or practices under Section 5 of the Federal Trade Commission Act; and (c) certain prohibitions under the Dodd-Frank Wall Street Reform Act. Of critical importance to at least some potential applicants, the most favored lender status enjoyed by national banks would also apply to Fintech charters.
General Restrictions. Special purpose national banks will also have the same status and attributes under federal law as a full-service national bank. At the basic level, a special purpose national bank has the same charter as a full-service national bank, which limits activities through the bank’s articles of association and OCC-imposed conditions for approving the charter.
Specific Application Statutes. Statutes that apply to an entity based on the activities in which the entity engages. For instance, for Fintech companies engaged in lending activities, the following would apply: (a) the Truth in Lending Act; (b) the Real Estate Settlement Procedures Act; (c) the Fair Credit Reporting Act; (d) Home Mortgage Disclosure Act; (e) Equal Credit Opportunity Act; (f) Servicemembers Civil Relief Act; and (g) Military Lending Act.
Federal Reserve Requirements. With few exceptions, all national banks are required to be members of the Federal Reserve system and therefore must comply with statutes and regulations administered by the Federal Reserve. These requirements include restrictions on transactions with affiliated entities and insiders, among others. A limited purpose national bank would also have direct access to the Federal Reserve payment system.
Federal Deposit Insurance Corporation. If a chartered Fintech company accepts deposits, it would be required to apply to the FDIC for deposit insurance. Insured banks are subject to additional requirements administered by the FDIC, including obligations under the Community Reinvestment Act (“CRA”). The OCC notes that CRA and other financial inclusion statutes may be imposed upon non-deposit taking Fintech companies as part of the conditions for approval of the special charter. Exactly how the OCC would use its conditional approval authority remains to be seen.
What are the supervisory expectations for Fintech special charters?
The OCC emphasizes that the supervisory standards that will be required of Fintech companies will be tailored to the specific institution’s size, complexity and the inherent risk profile of the institution and its activities. However, the OCC identifies the baseline supervisory standards that will be required of all Fintech companies.
Business Plan. A well-developed business plan is a key component of any charter proposal. The OCC notes that there is no blueprint to an effective business plan, but notes that any business plan should include the following: (a) articulate why the entity is seeking a national bank charter; (b) define the market the proposed bank plans to serve; (c) realistically forecast market demand, economic conditions, competition and the proposed customer base; (d) realistically assess inherent risk in products and services, consumer protection, fair lending, and BSA/AML requirements; (e) propose mitigating risk management controls; (f) describe experience and expertise of proposed management and board of directors; (g) outline the plans for initial and future capital contributions; (h) how the bank expects to maintain appropriate capital levels; (i) provide best-case and worst-case scenarios for financial performance, revenue growth and market share; and (j) describe the organizing group’s knowledge and plans for serving the community.
Governance Structure. The OCC expects the governance structure for any proposed special purpose national bank to be commensurate with the risk and complexity of its proposed products, services, and activities, as it is for other national banks. Thus, the OCC expects a certain level of expertise and business acumen in finance and risk management. This is true for both members of management and the board of directors.
Capital. The required minimum and ongoing capital levels will be determined based on the risk and complexity of the proposed activities (including on- and off-balance sheet activities). The OCC’s evaluation of capital adequacy (initial and ongoing) will consider the risks and complexities of the proposed products, services, and operating characteristics, taking into account both quantitative and qualitative factors. The key qualitative elements that influence the determination of capital adequacy include, but are not limited to, the following: (a) the scope and nature of the bank’s proposed activities; (b) quality of management; (c) funds management; (d) ownership structure; (e) operating procedures and controls; (f) asset quality and earnings; (g) risk diversification; and (h) strategic planning. In addition to assessing the quality and source of capital, the OCC will also consider on- and off-balance sheet composition, credit risk, concentration, and market risks.
Liquidity. As with capital, minimum and ongoing liquidity (both operating and contingent obligations) for a special purpose national bank need to be commensurate with the risk and complexity of the proposed activities. In assessing the liquidity position of a proposed bank, the OCC considers a proposed bank’s access to funds as well as its cost of funding. Some key areas of consideration include, but are not limited to the following: (a) projected funding sources; (b) needs and costs; (c) net cash flow and liquid asset positions; (d) projected borrowing capacity; (e) highly liquid asset and collateral positions (including the eligibility and marketability of such assets under a variety of market environments); (f) requirements for unfunded commitments; and (g) the adequacy of contingency funding plans. All aspects of liquidity should address the impact to earnings and capital, and incorporate planned and unplanned balance sheet changes, as well as varying interest rate scenarios, time horizons, and market conditions.
Compliance Risk Management. All Fintech applicants, like any applicant for a national bank charter, are expected to demonstrate a culture of compliance that includes a top-down, enterprise-wide commitment to understanding and adhering to applicable laws and regulations and to operating consistently with OCC supervisory guidance. This would require each Fintech applicant to adopt and implement systems and programs to identify, assess, manage and monitor compliance (e.g., policies and procedures, practices, training, internal controls, and audit). Specifically, the OCC notes that a well-developed compliance management system includes: (i) a Bank Secrecy Act/anti-money laundering compliance program; and (ii) a consumer compliance program designed to ensure fair treatment of customers, fair access to financial services, Section 5 of the Federal Trade Commission Act (unfair, deceptive or abusive acts or practices) and all other applicable consumer financial protection laws and regulations.
Financial Inclusion. The OCC’s chartering regulation generally requires an applicant for a national bank charter to submit a business plan that demonstrates how the proposed bank plans to respond to the needs of the community, consistent with the safe and sound operation of the bank. Although this element of the business plan is not mandatory for all special purpose banks, the OCC expects a special purpose bank engaged in lending to explain its commitment to financial inclusion in its business plan. In developing the financial inclusion component of its business plan, a proposed special purpose bank engaged in lending should consider the following elements:
an identification of, and method for defining, the relevant market, customer base, or community;
a description of the nature of the products or services the company intends to offer (consistent with its business plan), the marketing and outreach plans, and the intended delivery mechanisms for these products or services;
an explanation of how such products and services, marketing plans, and delivery mechanisms would promote financial inclusion (e.g., provide access to underserved communities or small businesses); and
full information regarding how the proposed bank’s policies, procedures, and practices are designed to ensure products and services are offered on a fair and non-discriminatory basis.
As with other elements of the applicant’s business plan, the OCC may require a company to obtain approval, or no-objection, from the OCC if it departs materially from its financial inclusion plans.
Recovery and Exit Strategies; Resolution Plan and Authority. As noted above, the OCC expects a proposed bank’s business plan to include alternative business and recovery strategies to address various best-case and worst-case scenarios. Simply put, the OCC expects business plans to articulate specific financial or other risk triggers that would prompt the Board and management’s determination to unwind the operation in an organized manner.
How will the chartering process work for specially chartered Fintech companies?
The OCC’s standard process for reviewing and making decisions about charter applications would apply to applications from Fintech companies for a special purpose national bank charter. Charter applications are reviewed and processed through the OCC’s Licensing Department. The “Charters” booklet of the Comptroller’s Licensing Manual contains detailed information about that process, which consists of four stages:
Prefiling. Potential applicants engage with the OCC in formal and informal meetings to discuss their proposal, the chartering process, and application requirements.
Filing. Applicants submit their application to the OCC and publish notice of the application.
Review and Evaluation. The OCC reviews the application and conducts background and field investigations to determine whether to approve the application.
Decision. The OCC grants preliminary approval that may be subject to certain conditions. The applicant may then raise capital, prepares for opening and the OCC conducts a preopening examination. Thereafter, the OCC determines whether the bank has met the requirements and conditions for opening.
For Fintech companies that do not contemplate deposits, there will be no need to apply for FDIC insurance. Further, these special purpose banks may also avoid designation as a bank holding company.
What does this mean for the Fintech companies and the banking industry as whole?
The consequences of special purpose national bank Fintech charters remains to be seen. However, they are likely to be far ranging. Those likely consequences are noted below.
- What types of Fintech companies are likely to seek a special purpose charter? At the outset, it can be expected that better positioned, well-capitalized and more well-established Fintech companies are likely to seek Fintech charters. Specifically, those companies that have multistate, regional or national operations and that have the most to gain from utilization of the most favored lender status enjoyed by national banks.
- Why is this big news for Fintech companies? As a specially chartered national bank, Fintech companies may utilize the regulatory umbrella of federal preemption to prevent application of individual state usury laws, state licensing requirements (e.g., money transmitter licensure to be obtained in each state doing business) and haphazard regulatory scrutiny from state regulators. In addition, OCC supervision extends a level of legitimacy to a Fintech company and it operation. Fintech companies that remain untested during the credit cycle may see this as an opportunity to secure their image as legitimate business models. Consequently, Fintech companies that have obtained a special purpose charter will inevitably be stronger and be better perceived in the marketplace.
- Will this really save Fintech companies money through lower/lesser compliance costs? Special charter Fintech companies may remove the compliance costs for each state individually. However, the compliance costs associated with OCC supervision and capital level maintenance also need to be taken into account. Fintech companies are undoubtedly going to face enhanced scrutiny under OCC supervision due to the many unknowns of the individual company’s business model and product/service offerings. One can expect OCC supervision to be different than traditional commercial banks.
- What does this mean for the banking industry in the short-term? In the short-term the OCC’s policy will likely strengthen competition in the banking industry. By permitting Fintech firms to seek special purpose charters, the OCC is providing Fintech companies a platform to declare themselves as safe and sound as commercial banks. Combined with innovative technology, Fintech firms that have obtained charters will be strategically positioned to compete against community and larger regional banks. Ultimately, this could lead to increased pressure on community banks to compete against larger and more technologically versatile Fintech companies.
- What does this mean for the banking industry as a whole long-term? Generally, the industry has seen a dearth of de novo bank creation since the recession. Is this special purpose charter connected with the reality that there is close to zero de novo bank growth? Who can say. However, no one will argue with the idea that Fintech companies that have obtained charters will be better situated to transform themselves into deposit-taking banks. Consequently, there is a real possibility that Fintech companies may become the largest source for future de novo banks.
The OCC has announced that it will begin accepting special purpose national bank charter applications for Fintech companies. In furtherance of that announcement, the OCC is seeking feedback from the public on a number of questions listed in the white paper, specifically on the types of activities and expectations the OCC should require for entities seeking a special purpose national bank charter. Comments on its proposal are expected by January 15, 2017.
To view the full text of the OCC’s Announcement, click here.
To view the full text of the OCC’s White Paper, click here.
For more information about the recent OCC announcement, please contact James M. Kane at +1 (312) 609 7533, Daniel C. McKay, II at +1 (312) 609 7762, James W. Morrissey at +1 (312) 609 7717, Jennifer Durham King at +1 (312) 609 7835, Juan M. Arciniegas at +1 (312) 609 7655, Lisa M. Simonetti at +1 (424) 204 7738, Mark C. Svalina at +1 (312) 609 7741 or your Vedder Price attorney.