An OCC Insider’s Perspective on Fintechs and Bank Charters

While the novel fintech charter may never actually be granted, the concept ironically may usher in a rash of neobanks under full national charters, like Varo Bank. In a way that may end up creating a more level playing field.

A senior federal banking regulator once joked that when representatives from fintechs visited him in Washington, after he finished explaining to them what the regulatory implications of becoming banks were, they ran screaming from the building. As more fintechs and other companies find one path or another into banking, the screaming seems to be over — and the adapting seems to be beginning.

Michele Alt has helped with that transition. After a 22-year career in the legal section of the Office of the Comptroller of the Currency, Alt joined Promontory Financial Group, LLC, where many OCC alumni go to pursue private-sector advisory careers. Both there, and now at Klaros Group, where she is Partner and Co-Founder, Alt has helped fintechs explore, and in some cases apply for, banking charters. She is involved in multiple pending applications that if approved will break new ground.

In fact, having worked in both the regulatory and industry sectors, Alt says she has an answer for bankers — notably Chase Chairman Jamie Dimon — who want a level playing field with fintech and bigtech competitors.

“My response is that banks should insist on, rather than resist, the granting of new charters to fintechs,” says Alt. “Doing so would level that playing field, provide important safeguards and promote healthy competition, all to the benefit of consumers.”

“The answer isn’t to keep fintechs out of banking, but to let them in — provided they can satisfy the regulatory standards. To the extent there are competitive advantages of not being regulated, the answer is to regulate them.”

— Michele Alt, Klaros Group

For an industry that has historically set up (or attempted to rebuild) barricades to keep others off banking’s turf, this would be a major shift. As it is, banking lobbyists have questioned the continuing presence of the unused national fintech charter, citing an alleged confusing effect on the field. Others continue to call for the end of the industrial bank “loophole,” as they call it, in order to shut that door to newcomers and especially to commercial firms.

On the other hand, major banks as well as smaller players invest in fintechs and sometimes acquire them. And banks of all sizes pursue partnerships with fintechs.

( Read More: Introducing the World’s First Interactive Directory of Digital-Only Neobanks )

Bringing Two Cultures Close Enough for Change to Occur

The anecdote about running from the building stemmed not from misconceptions about the banking business, but instead because of very different mindsets, explains Alt.

“In the fintech business, in general, the ‘fake it till you make it’ idea is a real ethos. In that sector, that is an acceptable way to grow.”

“In the fintech business, in general, the ‘fake it till you make it’ idea is a real ethos,” Alt explains. “In that sector, that is an acceptable way to grow.” The now famous Mark Zuckerberg quote: “Move fast and break things” typifies the thinking.

While that saying, which is the internal motto at Facebook and the title of a 2017 book, is an aspiration among those who want to be among the cool kids, Alt says it doesn’t play so well in the halls of banking regulation.

She’s had to explain such things to fintech aspirants seeking banking charters. The facts of bank regulatory life, according to Alt:

“You know what regulators like least? Fast-moving things breaking things. That’s not what they’re interested in. They are not interested in somebody who is faking it. They are not interested in scary growth. The are interested in profitability. Many fintechs are revenue-focused and not so much profit-focused.”

Fintech leaders are used to a world with mammoth funding rounds and a laser focus on solving financial challenges or friction points. When they decide to seek a charter, they have to step out of their comfort zone.

“Often, what I wind up doing is saying, ‘OK, so let’s slow down a little bit here’,” says Alt in an interview with The Financial Brand. “Let’s get clear on what problems you are seeking to address, what solutions you are seeking to provide, and how you can do it in a way that is acceptable to bank regulators.”

So, while they may no longer end up running away, says Alt, they still have to accept that to some degree they will have to be willing to come into the fold.

That shift isn’t easy.

“I’ve had clients say, ‘Are you kidding? They actually want me to slow down the projected growth we expect?’,” says Alt. “And the answer is, ‘Yes, because regulators get very concerned about fast growth, particularly in the de novo period because it raises concerns about what controls are in place to manage the risk of that growth’.”

Two Different Worlds:

There’s a significant difference between an investor pitch deck and the business plan that regulators must approve.

Among other things, while investors will tolerate growth over profit for years, a new charter’s de novo period runs for three years, and Alt stresses that regulators expect management to hit profitability within that time.

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Fintechs Face a ‘Big Lift’ When They Seek Charters

For some of the new players who have obtained charters, it will take some time to reach profitability. At yearend 2020, Varo Bank, which received approval to become the first fintech national bank in the summer of that year, reported a $65.2 million loss. It’s estimated that Varo spent in the neighborhood of $100 million to get the charter.

“It’s an incredibly big lift to get a bank charter … It is not for the faint of heart.”

“It’s an incredibly big lift to get a bank charter, and that has been a deterrent for a long time,” says Alt. “And fintech applicants are raising the question, why is this so hard?”

Alt is not advocating for liberalization, by the way.

“It’s a big lift for some good reasons,” says Alt.

First, she says, regulators have concerns for the impact on the rest of the banking system. As a result they carefully examine any applicant’s capital, financial projections, business plan, management capabilities and more.

“That’s an extensive review that takes a lot of resources,” says Alt.

And the process takes time because multiple agencies typically are involved. Alt points out that Varo needed the charter from OCC, deposit insurance from FDIC, and had to make its parent, Varo Money, a bank holding company under the Federal Reserve. That’s three separate applications, all of which typically go through much negotiation and multiple iterations before they are officially filed and considered.

“I’ll leave for another day how the process could be simplified,” says Alt. “It’s enough to say that it is not for the faint of heart.”

When Patience Evaporates:

Many applicants lose interest when they realize they’re not going to be able to open their doors in six months or even in a year.

Given the rigors of getting a full banking charter, many of Alt’s clients first seek an industrial loan charter in Utah. Industrial banks, an entity permitted in 11 states but most prevalently in Utah, have appeal because they provide broad banking powers but keep the parent company out from under the Bank Holding Company Act.

“That is usually initially a very appealing premise to many would-be applicants,” says Alt, “but that lift is also high. There’s a lot of controversy with that charter and a lot of opposition.”

Most of the firms that come to Klaros are fintechs, rather than commercial firms seeking to break the banking-commerce wall. Alt says that that issue remains a political “third rail.”

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What Washington Changes Could Mean for Fintechs and Charters

To date, the OCC’s fintech charter, proposed in 2016 and finalized in 2018, and opposed multiple times in court, has yet to produce one actual institution. Alt doesn’t think it ever will. But she says this often controversial concept served the purpose of putting charters for nontraditional players on the table.

“It certainly got people talking,” says Alt. “And it turned what used to be a pretty sleepy area of banking law into a very hot topic.”

OCC Raised Key Questions:

Who should be in the banking system? What obstacles prevent companies from entering the banking system? Are those obstacles merely traditional or do they serve important policy objectives?

“Ultimately regulators make the rules and fintechs have to play by them, they are not going to change them,” says Alt. “But I will say, very clearly, and OCC is a good example, that the agencies have been very committed to understanding and welcoming innovative business models.”

“So, for example, we are no longer having conversations like we were in 2016 about what it means to store things in the cloud,” says Alt.

Brian Brooks, when he was Acting Comptroller in the latter days of the Trump administration, pushed the fintech charter and proposing expanded payments versions of it.

“The question I’m routinely asked is, now that Brooks has gone, has the welcome mat rolled up? No, it has not.”

— Michele Alt, Klaros Group

That said, it may be some time before the Biden administration appoints a new Comptroller.

“At OCC, what we are likely to see, at least until a new Comptroller’s been placed, is a more deliberate pace going forward,” Alt says. “Brooks moved very quickly, and I think OCC staff now is going to take stock of what it’s done to date and move carefully going forward.”

Various states have introduced specialized charters — such as New York’s limited purpose trust charter and Wyoming’s cryptocurrency charter. Alt thinks interest in state offerings may pick up.

Even once the new administration and new Comptroller focus on banking charters, Alt thinks the full national charter will be where much of the action comes. For many players the advantage of federal preemption is essential for mounting national marketing efforts.

Alt doesn’t see the issue fading away.

“No, I think we’ve seen a permanent change,” she says. “I think eventually we will stop talking about it, because it will become commonplace. I think it will become like any other type of regulatory approval.”

A final question: With banks and credit unions often complaining about regulation, why on earth do fintechs want to join them?

Quips Alt: “My go-to answer whenever I’m asked why do fintechs want to be banks is that it’s like the bank robber Willie Sutton said: ‘Because that’s where the money is’.”

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