What You Need to Know About the OCC’s Fintech Charter

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OCC-10-17-18.pngOn July 31, 2018, the Office of the Comptroller of the Currency said it will begin accepting applications for a special purpose national bank charter designed specifically for fintech companies. The news came hours after the Treasury Department issued a parallel report preemptively supporting the move.

In connection with its announcement, the OCC issued a supplement to its Comptroller’s Licensing Manual as well as a Policy Statement addressing charter applications from fintech companies. Both are worth reviewing by anyone thinking about submitting an application.

The Application Process
To apply for a fintech charter, a company must engage in either or both of the core banking activities of paying checks or lending money. Generally, this would include businesses involved in payment processing or marketplace lending.

The fintech charter is not available for companies that want to take deposits, nor is it an option for companies seeking federal deposit insurance. Such companies would have to apply instead for a full-service national bank charter and federal deposit insurance.

The application process for a fintech charter is similar to that for a de novo bank charter, with each application reviewed on its own unique facts and circumstances.

The four stages of the application process are:

  1. The pre-filing phase, involving preliminary meetings with the OCC to discuss the business plan, proposed board and management, underlying marketing analysis to support the plan, capital and liquidity needs and the applicant’s commitment to providing fair access to its financial services
  2. The filing phase, involving the submission of a completed application
  3. The review phase, during which the OCC conducts a detailed review and analysis of the application
  4. The decision phase, during which the OCC determines whether to approve the application

The process from beginning to end can take up to a year or longer.

Living with a fintech charter
Fintech banks will be supervised in a similar manner to national banks. They will be subject to minimum capital and liquidity requirements that could vary depending on the applicant’s business model, financial inclusion commitments, and safety and soundness examinations, among other things.

Additionally, to receive final approval to open a fintech bank, an applicant must adopt and receive OCC approval of a contingency plan addressing steps the bank will take in the event of severe financial stress. Such options would include a sale, merger or liquidation. The applicant must also develop policies and procedures to implement its financial inclusion commitment to treat customers fairly and provide fair access to its financial services.
Similar to a traditional de novo bank, a fintech bank will be subject to enhanced supervision during at least its first three years of operation.

Pre-application considerations
A company thinking about applying should consider:

  1. The advantages of operating under a single, national set of standards, particularly for companies operating in multiple states
  2. The ability to meet minimum capital and liquidity requirements
  3. The time and expense of obtaining a charter
  4. Whether a partnership with an existing bank is a superior alternative
  5. The potential for delays in the regulatory process for obtaining a charter, including delays resulting from the OCC application process or legal challenges to that process

There is one complicating factor in all of this. Following the OCC’s initial proposal to issue fintech charters in 2017, two lawsuits were filed challenging the OCC’s authority to do so—one by the Conference of State Bank Supervisors and one by the New York State Department of Financial Services. Both were dismissed, because the OCC had yet to reach a final decision. But now that the OCC has issued formal guidance and stated its intent to accept applications, one or both lawsuits may be refiled.

Whether this happens remains to be seen. But either way, the OCC’s decision to accept applications for fintech charters speaks to its commitment to clear the way for further innovation in the financial services industry.

Three Strategic Considerations for Bank Boards About Fintech Charters

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strategy-10-4-18.pngStrategic planning is one of the most important roles of a financial institution’s board of directors. Since the 2008 financial crisis, financial institution boards have dealt with the emergence of fintechs as a primary consideration in developing their strategic plans. A few large financial institutions have opted to build fintech capabilities, but the majority of financial institutions have determined that the best strategy is either to invest in or partner with a fintech firm through an outsourcing process.

On July 31, 2018, the Office of the Comptroller of the Currency announced it would begin accepting applications filed by fintech firms for “special purpose” federal bank charters. While not unexpected given the conversations around this topic in recent years, the announcement garnered immediate and passionate responses from the interested constituents. Whichever strategy has been adopted and implemented in their firm, financial institution boards should consider the impact a “special purpose national bank charter” may have on their relationship with a fintech firm, or how newly chartered fintechs may change their strategic plan.

First: Re-evaluate Your Strategy
Financial institution boards should first consider if their strategy should change based on an assumption that fintech firms would become chartered special purpose banks. Applying the standard SWOT (strengths, weaknesses, opportunities, threats) approach to their strategic planning, the board might determine that what once was a strength for a financial institution (direct access to customers, ability to accept deposits) could become a threat as chartered fintechs obtain bank powers, while weaknesses (stricter regulatory oversight and related infrastructure expense) become strengths or opportunities. This shift in the playing field for fintech and financial firms should become a basis for deciding if the build, invest or partner strategy is still the best fit for the financial institution.

Second: Evaluate Your Options
Whether the board determines that their current strategy is appropriate or needs to be reconsidered, their decision will be influenced by the ability to and cost of change. The board should review the existing relationships that are in place and determine the feasibility of changing strategy. While building may be the best answer, the cost of building fintech expertise may not be a valid strategic option, given the expertise required and the size of investment. Likewise, finding a new vendor or outsourcing partner may be relatively easy, but exiting a current contract may be difficult or costly if there isn’t a valid contractual reason for termination.

Third: Focus on Execution
In their review of options the board should have been exposed to any shortcomings or important factors in executing the adopted strategy. Once the strategic approach has been decided, the basis of that decision must be taken into account in the execution. The possibility of a fintech firm obtaining a bank charter should be the cornerstone of execution. Directors should ask themselves whether getting a bank charter should be a basis for terminating a financial institution’s relationship with a fintech firm. If so, the terms should be clearly stated including financial outcomes and operational details. For example, any fintech investments or contracts should make it clear the financial institution will maintain the customer relationships and the related data. In addition, the arrangement should have appropriate non-solicitation and non-competition clauses to protect the financial institution in the event the fintech becomes a competitor. If the fintech firm can terminate the relationship, the financial institution should ensure there is an adequate conversion process that will allow it to pursue a different strategy or to migrate to a new strategic partner with minimal interruption to its customers.

It is not expected that fintech firms will rush to obtain charters or that charters will be granted to fintech firms in the near future. Significant barriers still remain for fintech firms to obtain charters. The application, review and examination process for obtaining a new (or de novo) charter is arduous and time consuming. In addition, newly chartered special purpose banks would need to build extensive regulatory infrastructure and would be subject to additional oversight and supervision during their early existence. Nevertheless, the OCC’s announcement will provide fintech firms with additional strategic options and a foothold for bringing further disruption to the financial services industry. Financial institution boards should be prepared to strategically respond to that challenge.

OCC Fintech Charter: Considerations for Banks

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fintech-4-12-17.pngThe Office of the Comptroller of the Currency (OCC) recently announced it would move forward with a plan to grant special purpose national bank charters to qualifying financial technology companies. The OCC has solicited comments on the proposal, which it will evaluate to determine whether to formally adopt the process for granting fintech charters. If adopted, companies granted such a charter would become national banks regulated by the OCC, with the attendant regulatory obligations and oversight, and would no longer need to partner with traditional banks to take advantage of preemption of certain state laws. As noted by the OCC Chief Counsel Amy Friend, the first charter may be granted in the first half of 2017.

General Requirements
Under the proposed rule, for a company to qualify for a fintech charter, it must have the appropriate corporate structure, engage solely in bank-permissible activities and adhere to certain regulatory requirements.

Generally, national bank charters subject their holders to specific standards and federal oversight such that the firm can conduct business nationally. Because the proposed fintech charter would be granted under the National Bank Act (NBA), fintech companies would need to adhere to the statute’s governance requirements. For example, a fintech firm chartered by the OCC would need to have a minimum of five board members.

In addition, fintech charter holders only would be permitted to engage in activities authorized by OCC regulations and associated interpretations. These activities can include, among others, lending money, issuing debit cards and facilitating payments, but also investment advisory services and certain brokerage activities. If a given activity is not clearly permitted by the OCC, the firm could seek permission from the OCC, which grants approval of new activities on a case-by-case basis. Beyond OCC regulations, the new charter would impose other laws on a chartered fintech firm, such as the Bank Secrecy Act and related anti-money laundering laws, as well as certain enhanced prudential standards under the Dodd-Frank Act if applicable.

Moreover, a fintech charter holder will be required to meet various supervisory requirements, including that it maintain a business plan documenting its activities, such as with respect to financial inclusion; have a governance structure that reflects the expertise, financial acumen and risk management necessary in light of the proposed business lines; effectively manage compliance risks, such as consumer protection and anti-money laundering; and address potential recovery and resolution. In addition, a fintech firm would need to maintain capital and liquidity commensurate with the risk and complexity of the proposed businesses, including any off-balance sheet activities.

Despite the many requirements the OCC is likely to impose when granting a fintech charter, fintech-chartered companies would have the advantage of no longer being required to register with or become licensed in each state where they conduct business. As enjoyed by national banks, the fintech charter generally would give a company the benefit of preemption under the NBA. Among other features, this would allow the exportation of interest rates from a bank’s home state to other states regardless of the home state’s usury restrictions.

Various stakeholders have reacted to the proposal with differing views. For example, the New York Department of Financial Services submitted a comment letter opposing the proposal and arguing that state regulators are the best equipped to regulate the fintech industry. Others in the industry have voiced their support.

Considerations for Existing Banks
Banks may see fewer partnerships with fintech companies as a result of the fintech charter because NBA preemption means that fintech firms no longer need a bank to obtain the advantage of state law preemption.

The fintech charter holders would not have a material competitive advantage with respect to banks because they are subject to the full panoply of OCC regulation and supervision.

Banks may consider seeking their own fintech charter, perhaps through an affiliate, if particular business lines might benefit or if they are currently chartered in one or only a few states in order to expand their national presence.