Fintech Banks - Comptroller Of Tthe Currency Proposes New Special Purpose Charter

The Comptroller of the Currency announced on December 2, 2016, that his Office ("OCC") was moving forward with a proposal to create a special purpose national bank ("Fintech Charter") for fintech firms ("Announcement"). The OCC simultaneously released Exploring Special Purpose National Bank Charters for Fintech Companies ("Release") (Dec. 2016). The Release discusses national bank powers, identifies baseline supervisory expectations, and provides an overview of the OCC's process for acting on Fintech Charter applications. Comments on the Release are due by January 15, 2017.

The Announcement and Release follow more than a year's work at the OCC to develop a:

... comprehensive framework to improve the OCC's ability to identify and understand trends and innovations in the financial services industry, as well as the evolving needs of consumers of financial services.1 The Comptroller stated that he was most excited about fintech's "... great potential to expand financial inclusion, reach unbanked and underserved populations, make products and services safer and more efficient, and accelerate their delivery." The OCC efforts to facilitate "responsible innovation" will be discussed more fully in a separate paper.

The OCC's work and the Announcement place the OCC in position to facilitate, as well as supervise, financial innovation through banks. The OCC historically has promoted innovation through legal and other interpretations of the National Bank Act to allow banks to adapt to technological and market changes. The OCC has the exclusive authority among the federal bank regulators to charter special or limited purpose banks, including non-depository banks. Fintechs considering a Fintech Charter, especially those that will take deposits, also need to consider the applicability of, and regulation under, the Federal Deposit Insurance Act ("FDI Act") and the Bank Holding Company Act of 1956 ("BHC Act").

The Announcement is a major change from the periodic regulatory and legislative hostility to special purpose charters of the last two decades. During this time, many credit card banks owned by retailers and nonbanks were criticized for asset concentrations and volatile funding through securitizations, the capital markets, and brokered deposits. Non-depository trust companies have been inhibited by confusion over the appropriate capital levels and by how a failure would be handled. All have been affected adversely by the greater regulatory compliance demands imposed on such charters, which were often disproportionate to such banks' relatively small size compared to their parents' nonbanking businesses. Since more than 400 banks failed during the last recession, including a disproportionate number of de novo institutions, the Federal Deposit Insurance Corporation ("FDIC") has granted FDIC insurance to only a handful of new charter applicants since 2008.2 Special purpose industrial loan companies ("ILCs") have been placed in various moratoria and were the subject of a study mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 ("Dodd-Frank Act").

SPECIAL PURPOSE CHARTERS

The Release confirms the OCC's authority to grant special purpose national bank charters to fintech and other firms seeking to conduct fiduciary activities, or at least one of three core banking activities—receiving deposits, paying checks, or lending money ("Core Activities"). 12 U.S.C. 1 et seq. and OCC Regulations ("OCC Regs.") § 5.20 The OCC has similar broad chartering authority with respect to federal thrifts under 12 U.S.C. 1461 et seq. and OCC Regs. § 5.20. Although grandfathered unitary thrift holding companies have been useful to commercial enterprises that have conducted banking business through a thrift, the thrift charter is not as useful as a Fintech Charter, and its use was not discussed in the Announcement or Release.

Special purpose banks primarily have been non-depository trust companies and FDIC-insured credit card banks. The national trust companies are typically used to serve customers in multiple states consistent with state laws limiting the exercise of fiduciary authority by out-of-state institutions and facilitated interstate expansion prior to the Dodd-Frank Act. Credit card banks were exempted from the BHC Act by the Competitive Equality in Banking Act ("CEBA") in 1987. These CEBA credit card banks were widely established by retailers and banks to locate their credit card operations in states with favorable interest rate laws and taxation, and to use 12 U.S.C. 85 to export interest rates across state lines.3 The OCC has chartered banker's banks engaged exclusively in providing services to or for other depository institutions and holding companies, and their officers, directors, and employees,4 in addition to cash management banks and community development banks. Many special purpose charters have been sought to avoid the BHC Act and its limitations on interstate expansion and on commercial, non-banking activities5 by relying on exceptions from the term "bank" in Section 2 of the BHC Act.

FINTECH MODELS AND THE USE OF A NATIONAL BANK

Fintechs should consider the desirability of bank powers in light of their business models. For example, fintechs providing payment services may primarily seek access to the payments system while avoiding state money transmission licensing and regulation. Such businesses, as well as wealth management and fiduciary services, may not need to take deposits or have FDIC insurance. Marketplace and other lenders may seek bank powers under 12 U.S.C. 85 to charge the same interest rates nationwide and avoid various state usury, lender and money transmitter licensing, and other laws.

Fintech lenders are likely to seek stable funding available through FDIC-insured deposits, where they would be required to obtain FDIC insurance and become subject to FDIC rules, including safety and soundness limitations and FDIC efforts to curb "brokered deposits." Fintech Charters are likely to be scrutinized on loan and funding concentrations, as well as capital. Nondiversified business models may have a more difficult time chartering a bank and, if chartered, may have to maintain substantially more capital. Often credit card banks have 25 percent or greater capital ratios. The Basel III capital rules eliminated securitization gains on sale from regulatory capital, and the risk retention rules effective this month, make it more difficult and costly for limited purpose lenders to rely on securitization lending.

Applicants for a Fintech Charter should consider the OCC securities rules and their ability to make securities offerings, for bank capital and/or funding purposes. The proposed OCC rules for Receiverships for Uninsured National Banks, 81 Fed. Reg. 62835 (Sept. 13, 2016), address longstanding OCC issues that have impeded chartering special purpose national banks, but these raise new issues regarding true sales and the structures and legal opinions needed for accounting, securitization, and loan sale purposes.

Activities that are novel or are perceived as risky by the OCC will slow the chartering and/or activity approval processes and may lead to OCC requests for substantially more capital than conventional national banks. Similarly, the Release emphasizes that fintech applicants will need to provide exit plans in case the business stumbles. While these are not the Dodd-Frank Act Section 165(d) resolution plans (living wills), this is a new type of requirement. The OCC's inexperience with this requirement may further slow Fintech Charter applications.

PROPOSED FINTECH NATIONAL BANK CHARTERS

The Release confirms that Fintech Charters will be treated identically to full-service national banks, generally. As a result, fintech companies need to carefully consider what activities are best included in the bank and which are better left outside the bank and OCC regulation, and if possible, outside of coverage by the BHC Act and Federal Reserve regulation of BHCs and their nonbank subsidiaries.

Regulatory considerations applicable to establishing and operating Fintech Charters include:

OCC Chartering Process

The OCC's standard chartering process will apply to applications from fintech companies for a Fintech Charter. Applicants should, however, depending on the complexity of their business model...