Supreme Court Rulings May Shake Up Banking Entry Decisions in Fintechs’ Favor

Will Bank Charter Trend Be Rejuvenated?

One of the areas where we could see change is with regard to bank charters.

Under the Federal Deposit Insurance Act, the Federal Deposit Insurance Corp. is required to consider seven relatively straightforward factors in determining whether to approve an application for bank deposit insurance. Three concern the proposed bank’s finances, two relate to the bank’s potential risks; one concerns the legal permissibility of the bank’s activities; and one addresses the bank’s community.

Reading the statute, one could be forgiven for thinking that a company with a strong financial history and condition, adequate capital, strong earning prospects, experienced management, a sound risk management framework, bank-permissible activities, and plans to serve its community’s convenience and needs would be a shoo-in for a bank charter.

But that is not how it has worked for the last few years at the banking agencies.

The banking agencies have interpreted the seven factors to require a lengthy, complex and byzantine application process at which few would-be charterers succeed. Lawyers and advisors who practice in the bank application space understand that an applicant must satisfy the particular policy preferences of agency leadership in order to be approved.

The statutory approval factors do not include a requirement for plain vanilla community banking, but lately, that is the only type of bank model the FDIC’s board seems comfortable with.

Read more: Should Fintechs Buy or Build Their Way into Banking Today?

Two Parallel Cases with Divergent Conclusions

The recent experiences of two applicants for industrial bank charters illustrate this trend.

On June 14, the Utah Department of Financial Institutions approved two industrial bank applications — one submitted by General Motors and the other by Thrivent Financial for Lutherans, a nonprofit fraternal order.

On June 21, the FDIC approved Thrivent’s application for deposit insurance for the proposed industrial bank. FDIC board member and Acting Comptroller Michael Hsu noted that "The proposed bank would look a lot like a community bank."

GM, in contrast, withdrew its application — three and a half years after filing its application and just days after Utah’s approval.. Why? Presumably, GM’s bank would not look much like a community bank, and FDIC gave GM the option to voluntarily withdraw its application or have the agency publicly deny it. This is a common FDIC tactic, allowing an applicant to avoid public embarrassment and the agency to avoid appearing to block new bank formation.

But blocking new bank formation is exactly what the banking agencies have been doing. The Supreme Court’s recent decisions may mean the courts will break the logjam.

Read more: Hoodies and Suits: Can Banks and Fintechs Learn to Speak the Same Language?

Granting of Master Accounts May Open Up Now

In the wake of the federal barriers to bank entry, states have grown creative, authorizing a range of alternative bank charters not subject to federal supervision and for which deposit insurance may not be required. These charters have not gained much traction, however, because of the Fed’s reluctance to grant them master accounts.

A Fed master account is a financial institution’s deposit account at a Federal Reserve Bank that, among other things, enables direct access to the Fed’s payment systems, including Fedwire and the Fed’s real-time payments network, FedNow.

Because master accounts are connected to each other at the Fed, having one allows the completion of all types of payments (like those between consumers and merchants) by different banks using different payment systems.

Institutions must apply to the Fed to receive master accounts. Similar to the FDIC’s affinity for banks that look like community banks, the Fed typically quickly approves such applications for traditional banks.

By contrast, nontraditional applicants can face prolonged delays. Custodia Bank (a Wyoming Special Purpose Depository Institution) and The Narrow Bank (a Connecticut Uninsured Bank) waited years — only to have the Fed deny their master account applications in the end.

While their applications were pending, the Fed adopted master account access guidelines that classify banks into three tiers. State-chartered banks like Custodia and The Narrow Bank, which are neither subject to federal supervision nor federally insured, are placed in Tier 3 and subject to the strictest level of scrutiny.

Custodia is mounting an aggressive legal challenge to the Fed’s actions. Although the trial court held that the Fed has the discretion to grant or deny master accounts to otherwise legally eligible depository institutions, "friend of the court" briefs in the appeal are already citing the Supreme Court’s Loper Bright decision as support for their position that the trial court erred.

Former Solicitor General Paul Clement, for example, argues that "Allowing the decision below to stand will enable politically unaccountable federal officials to exercise broad discretion to place massive and unwarranted obstacles in the path of state-chartered financial institutions."

Regardless of the FDIC’s appetite for bank charters, if Loper Bright and the other recent cases ultimately make it easier for institutions to obtain Fed master accounts, alternative bank charters that don’t require deposit insurance could become a more compelling path forward.

Read more:

• 9 Lessons Banking Has (or Should Have) Learned from Fintechs
• 7 Lessons Fintechs Can Learn From Banks

What’s Next in the Wake of the Rulings Under a New ‘Administrative Czar’

Banking regulators have used their discretion to practice industrial policy, creating administrative barriers to entry and picking winners (like Thrivent) and losers (like GM, Custodia and The Narrow Bank).

Until recently, courts have deferred to these exercises of discretion. As a result, those who were turned away at the regulatory gates generally did not bother to challenge these administrative decisions.

Now, however, as Justice Elena Kagan memorably put it in her Loper Bright dissent, the Court has "turn[ed] itself into the country’s administrative czar," giving "itself exclusive power over every open issue — no matter how expertise-driven or policy-laden — involving the meaning of regulatory law."

That means courts are more likely to second-guess the agencies’ industrial policy-making, which in turn should create opportunities for companies that seek entry into the regulatory fold.

About the Author
Michele Alt is a partner at Klaros Group and a frequent contributor to The Financial Brand. She served for more than two decades in the law department of the Office of the Comptroller of the Currency.