The Comptroller of the Currency first raised the idea of a special purpose fintech charter in 2016, and since the charter was adopted in mid-2018, exactly none have been issued — zero. The main reason is multiple court challenges brought by state regulators.
Yet fintechs have pursued their way into banking circles in other ways.
In a Deloitte white paper [PDF], “So, You Want Approval to Become a Bank?,” the expectations of banking regulators for robust risk management and governance is reviewed. But the paper also points this out: “Quite often, examiners will leave behind a significant to-do list before final approval is granted. One particular challenge this poses to fintech companies is their ability to bridge the gap between the agile, less formal fintech governance culture and the formality expected by the regulators.”
Moving a fintech company to a banking charter involves not only legal and operational change, but also cultural change.
This article will examine some of the avenues fintechs are taking. One of the most significant, the industrial bank charter, would seem most ominous for traditional players because it lacks the restrictions on commercial firms’ acquiring banking powers that other avenues include.
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1. Bank Charters Via De Novo Expansion and Via Acquisition
Biting the bullet to pursue a banking charter requires recognizing it will take time and money to obtain. Deloitte poses these questions for fintechs mulling this route:
- Does the current business model depend on a bank?
- Does the business plan rely on continued access to low-cost insured deposits for profitable operation?
- Would a stable funding base like deposits and access to the Federal Reserve discount window significantly improve the company’s ability to face financial stress?
- Is direct access to the payment system critical to profitability and competitive ability?
- If competitors make the move to a charter first, will this hurt the fintech’s ability to prosper without a charter>
- Would the fintech’s product line be complemented by traditional deposit and lending products?
In a statement explaining its purpose in seeking a national bank charter, Figure Technologies succinctly explains the appeal: “Figure has over 100 state licenses to support [its] products. Inconsistencies across state licensing creates confusion for Figure applicants and members. For example, without a national bank charter, Figure might be able to offer loans to most applicants in Indiana, but only super prime borrowers in Illinois. A national bank charter creates uniformity of our products and services across the country.” (Figure does not intend to seek insured deposits for funding and so at this point FDIC insurance is not an issue.)
Much of the attention has centered on full-service national bank charters granted by the Comptroller’s Office. After a long process, fintech Varo Money obtained a new national charter and became Varo Bank, N.A. SoFi originally set out to obtain its own new national charter, but in March 2021 announced that it had agreed, subject to regulatory approval, to purchase a small community bank with a national charter to hasten the process. So the company changed its application from a de novo charter request to a change of control filing.
National bank charters are not where all the action will be. In March 2021 Revolut, the London-based fintech, announced that it would seek a state charter in California.
Recognizing the appeal of a national bank charter for fintechs, the state regulator trade group, the Conference of State Bank Supervisors, crafted a multi-stage effort called Vision 2020 to increase the attractiveness of state charters for fintechs. One key step so fare has been the development of a “one company, one exam” policy to permit money service businesses operating nationally to have a single exam that would fulfill many states’ requirements. Another was “harmonizing” money service licensing among 28 states. In March 2020 the one exam concept was expanded to nationwide payments firms.
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2. Industrial Loan Company Charter with FDIC Insurance
Industrial loan companies, also known as industrial banks, are over a century old. They are only legal in a handful of states, and only one — Utah — actively encourages them so far.
The industrial bank charter may turn out to be the route of choice for fintechs — and perhaps also big techs — desiring to become banks.
Since 1980 these state-chartered institutions have been eligible for FDIC deposit insurance. Square’s bank charter, Square Financial Services, which went live in March 2021, is actually a Utah industrial bank charter. Likewise Nelnet Bank obtained an industrial bank charter for its student and consumer lending programs, which went live in November 2020.
The new institutions are notable because the applications for federal deposit insurance for both were approved in March 2020 — one day after the insurance agency proposed a codification of requirements for companies seeking to insure an industrial loan bank.
The rule, now in place, is seen as reversing effective FDIC policy in place for almost 14 years to not approve insurance for industrial banks owned by commercial interests. (A three-year moratorium on deposit insurance applications for industrial banks expired in 2013.)
Why FDIC’s Rule Matters:
A key issue is the role of an industrial bank’s parent company as a “source of strength.”
Industrial bank’s owners are not subject to Federal Reserve regulation and FDIC has typically required them to hold higher capital amounts than other insured institutions and required their owners to financially backstop them. For example, Square is required to maintain a 20% leverage capital ratio and Nelnet a 12% ratio. The leverage ratio compares “core” capital to total assets. For a community bank under $10 billion in assets, absent regulatory issues, the minimum is 9%.
Traditionally in the U.S., banking and commerce have been kept separate, and several loopholes have been closed over the years, but not the ILC loophole. Commercial companies can own an industrial bank. That is where things become interesting, or worrisome, for traditional players. Under current law, Apple, Amazon and other big techs could buy or start industrial banks and obtain deposit insurance.
Not so much as a rumor of such a move has been heard yet, possibly because examination of the parent is possible under an industrial bank charter. However, Rakuten, an ecommerce firm sometimes described as Japan’s Amazon, has had an application to start an industrial bank in Utah since mid 2019. In January 2021, in the wake of FDIC’s new regulation, Rakuten re-filed for federal deposit insurance. General Motors Financial Co., GM’s captive finance wing, filed an application for an industrial bank charter in late 2020, proposing a national digital entity that would raise deposits from all interested consumers. In February 2021 Thrivent, a not-for-profit financial conglomerate that already owns a credit union, filed to open a Utah industrial bank.
“Rakuten, an ecommerce firm sometimes described as Japan’s Amazon, has had an application to start an industrial bank in Utah since mid 2019.”
In early 2021 Walmart announced that it would create a fintech with Ribbit Capital, a leading fintech investment firm. This is interesting in the context of industrial bank charters because Walmart, as well as Home Depot, attempted to obtain such charters in 2005 and 2006, respectively. They, and the accompanying applications for FDIC coverage, were withdrawn after much negative publicity.
In February 2021, Brex, a business-oriented fintech startup, applied for insurance as it applied for a Utah industrial bank charter. Brex is based in California, one of the handful of states that permit industrial banks. Currently there are only three there.
However, in January 2020 California’s Department of Financial Protection and Innovation, the state’s financial regulator, announced plans to open an Office of Financial Technology Innovation to work with new industries — i.e., fintech — to drive innovation as well as job creation in the state. This may involve reinvigoration of the state’s industrial banking charter in a state that’s home to many fintechs.
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3. Banking as a Service and Bank-Fintech Partnerships
Banking as a Service is a term used by different players in different ways. A good working definition comes from a white paper by Oliver Wyman:
“Banking as a service is enabled by the seamless integration of financial services and products into other kinds of customer activities, typically on non-financial digital platforms. … A non-financial business can thus distribute financial products under its own brand, so that the customer experience is of buying a product from that brand — but the financial product is actually provided by a financial institution.”
What It Means:
Banking as a Service represents a simpler way for a nonbank to get into financial services without going down the road of obtaining some sort of charter.
The Oliver Wyman paper notes that many nonbank companies have established significant digital operations that enable them to serve many consumers at a low cost.
“They can easily embed financial products as part of their digital platforms, e.g. taking out a loan when you are checking out of an e-commerce store,” the paper suggests. For traditional financial institutions, this opportunity resembles indirect lending, such as through auto dealerships.
Beyond being able to increase distribution of the institution’s loans or other services, the BaaS arrangement can lower the cost of obtaining and servicing a new customer, according to the paper. Wyman indicates that acquiring a new customer usually costs between $100-$200, versus only between $5-$35 when teamed up. Wyman projects that if even only a very small percentage of customers of digital platforms selected the BaaS products, millions could be made by participating institutions, even after sharing a portion of revenue with the nonbank operators.
Some banking institutions have been providing white-label banking services for nonbanks for years. One example is Metabank, which Walgreens announced in March as a partner, along with InComm Payments, in a digital banking account to be offered to its customers. The accounts will tie into the customer loyalty program Walgreens revamped in late 2020.
BaaS is also offered by a growing number of new players among traditional institutions, many of them community banks extending the use of their banking powers in this way.
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4. Rent-A-Charter Enables Interstate Lending by Fintechs
Similar to BaaS is the rent-a-charter option. This is specifically a lending strategy.
As explained in an entry on The FinReg Blog, banks are exempt from other states’ usury limits when they lend across state lines. This power is available only to traditional banks, and fintechs on their own must comply with the usury rules in every state they operate in and be licensed in each state they do business in as a lender.
However, a bank can be the lending engine behind the fintech and the fintech can purchase those loans. So long as the bank is the lender of record, the blog recounts, it can pass along the rate privilege to the fintech.
Among the banks working with fintechs in this way are WebBank, Celtic Bank and Cross-River Bank. LendingClub worked extensively with WebBank prior to its successful acquisition of Radius Bank. Now LendingClub is a bank.