Fintech Financial Services: Which Path to Follow?

Some criticize the dual banking system (the federal chartering of national banks and states chartering banks under state laws) as being inefficient, duplicative and confusing. Praise for the system exists because it is said to create a competitive element that fosters innovation among banks and their regulators to ensure that consumers and businesses are offered products and services that meet their needs. It was the creativity and innovation of states that produced checking accounts that paid interest, variable-rate mortgages and home equity lines of credit, all to meet the needs of local consumers. National banks provide a venue for testing and evaluating the benefits that flow from having one regulator with a uniform system of standards for products and services. Whether a national bank operates in adjoining states or hundreds of miles apart it knows what to expect from its single federal regulator and the products and services that it can offer. As fintech online lenders want to become more bank-like, it is good that they will have a choice of how to be regulated: Which path will they follow?

Innovative Approaches by Federal Regulators

OCC

Among the federal regulators, the Office of the Comptroller of the Currency (“OCC”) was early in the effort to understand the impact that was occurring with the growth of non-bank lending, especially the evolution of online lending supported by innovation in technology. 

• In 2015 the OCC began developing a comprehensive innovation framework that would help it understand and respond to changes in the banking industry due to the evolution of fintech entities providing products and services to consumers and businesses. This effort led to the OCC creating its Office of Innovation to implement this framework and to serve as a clearinghouse for innovation-related issues, as well as a central point of contact for stakeholders. As a result, hundreds of meeting have been held with fintechs and banks that are interested in expanding its products and services through the use of innovative technology.
• With the information gathered by the OCC through its many meeting with banks and fintechs, its next step was to explore how banks, especially community banks that did not have the financial or technical resources available to it, could become partners in providing improved products and services to consumers and businesses. Banks could benefit from the fintechs expertise and fintechs could benefit from an expanded lending base as well as a less expensive source of funding. However, banks had to ensure that it understood the risks associated with third-party service providers, and fintechs had to understand that they were subject to more regulated scrutiny than previously existed.
• For a complete immersion into the OCC regime of powers and regulations, in July 2018, the OCC invited charter applications from fintech companies seeking to become a special purpose national bank (“SPNB”).  An SPNB would have a national bank charter and be able to engage in one or more of the core banking activities of paying checks or lending money but that would not take deposits or be insured by the FDIC. The SPNB proposal evolved over a period of many months during which the OCC issued a white paper on the subject and reviewed public comments on the proposal. To date, no application has been received by the OCC for an SPNB, although there have been published reports that “both Google and PayPal, as well as several others, have since backed off over fears that they could harm existing relationships with state regulators and concerns about whether the OCC will prevail in a legal challenge to its authority.” The OCC is being challenged in separate suits by the New York Department of Financial Services and the Conference of State Bank Supervisors (“CSBS”) that it does not have the authority to issue an SPNB charter. Additionally, any applicant for an SPNB is subject to high standards for capital, liquidity, consumer protection, and financial inclusion, possible creating further obstacles to obtaining a charter.
• Most recently, the OCC proposed to establish a voluntary Innovation Pilot Program (“Program”) to support the testing of innovative products, services, and processes that could significantly benefit consumers, businesses, and communities, including those that promote financial inclusion. Comments on the Program were solicited, which now are being reviewed by the OCC. This is an experimental approach to existing banks and their fintech partners to develop new products and services. However, the Program offers no “safe harbor” or waiver from statutory or regulatory requirements and, therefore, could create a barrier to the development and implementation of a new product, service, or process.

CFPB

About the same time that the OCC opened its window in July 2018, to accept SPNB applications, the Consumer Financial Protection Bureau (“CFPB”) created its Office of Innovation (“OI”) to implement a provision of the Dodd-Frank Act designed to increase fairness, transparency, competition, and consumer access within financial services. The OI proposes to fulfill this mission by revising the CFPB's innovation policies and creating regulatory sandboxes, which are designed to address regulatory uncertainty that may impede innovation. The CFPB proposals include the following efforts. 

• It has proposed the creation of a Disclosure Sandbox through revisions to its existing Policy to Encourage Trial Disclosure Programs. Both the existing and proposed policies are based on the provisions of Dodd-Frank, that allows the CFPB to deem a covered person conducting a trial disclosure program to be in compliance with or exempt from a requirement of a CFPB rule or certain federal laws.
• A second proposal to improve its innovation policies was issued in December 2018, to revise its existing policy on No-Action Letters. While the CFPB has issued only one No-Action letter under its existing policy, the CFPB proposed revisions to the policy that would, among other things:
  • Streamline the No-Action Letter application process;
  • Streamline the CFPB's review of No-Action Letter applications, and focus the review on the potential benefits to consumers and the extent to which the applicant identifies and controls for potential risks to consumers;
  • Revise data-sharing requirements and time-period limitations to more closely align the CFPB's no-action letter program with no-action letter programs offered by other Federal agencies; and
  • Replace staff-recommendations of no-action with CFPB commitments of no-action.
• Finally, like the proposed No-Action Letter program, the CFPB's proposed Product Sandbox would have a streamlined application and review process. It would also include a similar provision concerning CFPB coordination with other regulators that offer similar programs designed to facilitate innovation.

FDIC

The FDIC has created its own group to explore the use of technology in providing financial products and services. FDiTech will promote the adoption of innovative and transformative technologies in the financial services sector, help the FDIC better understand how innovation can contribute to the expansion of banking services to the unbanked, underbanked, and individuals in underserved communities as well as promote the adoption of technology that can help community banks compete in the modern financial market place.

While national banks and state banks derive their powers from the OCC and state banking regulators, respectively, the FDIC approach to innovative technology could focus on “regtech”-how technology can enable the FDIC to improve its supervisory functions while at the same time enable its insured institutions to more efficiently comply with applicable laws and regulations.

Additional efforts by FDiTech will focus on economic inclusion, consumer benefits, and increased competition. The FDIC’s most recent “Survey of Unbanked and Underbanked Households” shows that more than 32 million households do not have any relationship with the banking system or are underbanked, meaning they have a bank account but go outside of the banking system to satisfy some of their financial service needs.

One approach to promote greater access to financial products and services for unbanked and underbanked consumers through technological innovation is through the use of providing deposit insurance to fintechs that obtain an industrial loan company (“ILC”) charter and apply for FDIC deposit insurance. Because the parents of ILCs are not considered bank holding companies, fintechs that have the capital and managerial resources and commit to adhering to the rigorous standards that are necessary to obtain deposit insurance, an ILC charter could meet many of the needs of unbanked and underbanked consumers as well as small businesses that would serve them.

For a variety of reasons, ILC charter applications have been controversial in the past, but FDIC has safely insured billions of dollars of ILC deposits.  Many online lenders are successfully meeting the needs of those not currently being served by insured financial institutions, and ILCs could be a vehicle to increase the availability of products and services through the use of innovative technology.   

Innovative Approaches by State Regulators

Most fintech companies, whether they are online lenders, money transmitters or payment processors, if they are regulated at all, are regulated by state governments. Hence the problem: wouldn’t it be more efficient and cost-effective to have one regulator versus having to comply with 50± state regulatory schemes, many of which have different requirements for the same business type?

State regulators are listening and understand the competitive nature of the dual banking system-if it is more profitable to have one federal regulator than have to deal with several state examinations, the state must become more creative in how they regulate fintechs. 

In response to this challenge, about the same time that the OCC was developing its SPNB, the Conference of State Bank Supervisors (“CSBS”) announced its Vision 2020 program. Its purpose was to preserve the states’ role in protecting the financial system and consumers while addressing inefficiencies in current licensing and regulatory processes. Its goal was to work toward a more consistent, coherent and networked system of state regulation, leveraging technology and data.

Like the FDIC, state regulators strive to use regtech in its supervisory and application oversight, using technology to improve the efficiency and effectiveness of regulation. As an example, initially, seven states agreed to provide a common application for money services businesses, including money transmitters. The program allowed a single application in one state that contained most of the information that would be submitted for a similar license in any state. If any state had unique information that required a license approval, then an applicant only would have to provide that information to that state. The program has proven successful so that now 23 states participate in this program.

Common license applications are only one element of Vision 2020 in CSBS’s effort to have its state regulators to become more efficient, allow for the regulated entities to reduce time and effort in complying with state laws and regulations, all resulting in providing more financial products and services to consumers and businesses. Future efforts will focus on common reports to be made to regulators as well as common examinations-an examination by one state would be accepted by the regulator in another state.

Which Path to Follow?

It’s good to have choices and once again, the dual banking system has challenged both federal and state regulators to understand the innovations in technology that are resulting in more products and services being offered to consumers and businesses. Competition will result in the regulators understanding their role in how to better oversee the revolution that is occurring in online lending and the payments industries. Not every online lender can become an SPNB or an ILC, and not every bank has the capacity alone to take advantage of innovative technology. 

The positive result of continuous communication among regulators, banks and fintechs is that the change that is occurring will result in more providers of financial services as well as a significant increase of use of those financial services by those to whom there was limited or no access.