For bankers and credit union executives, the advent of the special-purpose national bank charter for fintech companies from the Office of the Comptroller of the Currency has been like a business meeting you dread that somehow keeps getting put off.
For state banking regulators, the charter, finalized and offered up for use by the federal agency in July 2018, has been a target for rhetoric and lawsuits for longer than that. One of the potential attractions for fintechs has been an element of simplicity. A national bank charter of any kind provides preemption from many state laws, giving a fintech with broad ambitions a single set of rules and regulatory scheme to follow instead of one for each and every state and territory entered. There has long been a “creative tension” between state chartering authorities and the OCC. The OCC fintech charter allows a fintech to become a special purpose national bank that can pay checks or lend money but the institution cannot take deposits nor can it use FDIC insurance.
For fintech companies, the fintech charter, first proposed in 2016 during the Obama Administration, has been a potential option that looked attractive at first consideration. But while many organizations have weighed it, becoming regulated financial institutions is a step many have decided not to take.
OCC made clear that the charter was no end run around banking compliance, and one top federal regulator once joked that when fintechs got a full appreciation of that, they ran screaming from his office.
A pause that may not mean final victory. Early attempts by state regulators to block OCC in court, when the charter was a proposal, were dismissed as premature by judges who basically said they couldn’t stop an agency from doing something it hadn’t actually done yet. However, in October 2019, a federal judge ruled for the New York State’s Department of Financial Services in its suit to stop OCC. The state banking regulator claimed OCC had no right under the National Bank Act to offer a fintech charter. OCC’s position all along has been that it could, citing other types of special charters it has granted, such as national credit card banks.
It ain’t over until … OCC has already said that it will appeal the ruling and there is speculation that this matter could go so far as the Supreme Court.
In the meantime, business marches on.
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Fintech Chips Were Never All on the Fintech Charter
Fintech companies have sought partnerships with chartered institutions for some time, with a small group of banks making a special business line of working with the tech firms. The state regulators, coordinated by their association, the Conference of State Bank Supervisors, have been working to streamline licensing for fintechs to simplify doing business in multiple states, and work with a large advisory committee of fintechs.
Currently two fintech companies have applied for full-service national bank charters.
One is Robinhood Markets, which aborted an earlier attempt to launch a banking operation to compliment its mobile app, using insurance coverage from the Securities Investor Protection Corp. The attempt was dropped after SIPC made it clear that it only covered money slated to be used to buy securities, not funds held as deposits. In April 2019 Robinhood applied for a full-service national banking charter. (Update: In late November 2019, the company dropped its application.)
The other is Varo, which initially considered going for an OCC special purpose charter but then decided to apply for a full-service charter. Varo has preliminary approval from OCC and awaits approval of its FDIC deposit insurance application. Below, we look at how Lending Club, the online marketplace consumer loan platform, is exploring chartering options.
Something traditional institutions may not know about, a lobbying coalition in Washington called Financial Innovation Now. The organization has become involved in payments issues and has also supported the Financial Services Innovation Act of 2019, introduced in October 2019, which seeks “to improve regulatory coordination among federal financial services regulators and promote new entrants,” such as fintechs, according to FIN.
FIN’s membership includes Amazon, Apple, Google, Intuit, PayPal, Square and Stripe.
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Focus on Lending Club’s Thinking About Charters
In early November 2019, Lending Club, one of the oldest marketplace lenders in the U.S., made two announcements. After a period of difficulty, the company had returned to profitability. The other announcement: The company is “actively assessing options to obtain a national bank charter to enhance Lending Club’s ability to serve its members, grow its market opportunity, increase and diversify earnings, and provide both resilience and regulatory clarity.”
“We believe that we want to offer a broader set of services, part of it driven by deposits.”
— Anuj Nayar, Lending Club
Before the official announcement, The Financial Brand interviewed Anuj Nayar, Head of Comms and Financial Health Officer, who discussed the company’s plans for a banking charter. The conversation provides a good indication of the thinking that other fintech companies may be going through in the current landscape.
Nayar says that Lending Club, established in 2007, reviewed the OCC fintech charter concept early on and decided it wouldn’t be a good fit. From that point on, going for a full-service national bank charter made more sense to Lending Club management. Currently the company funds the loans on its platforms through partnerships with investors, including banks.
“We believe that we want to offer a broader set of services, part of it driven by deposits,” says Nayar, a communications veteran at PayPal and Apple previously. He explains that the bulk of the company’s business has been personal loans, which have chiefly been used to consolidate credit card debt to lower-rate obligations. This role has suggested to Lending Club that it can expand its scope towards becoming “America’s Financial Health Club.” Nayar says giving people lower-cost options than credit cards would benefit from a charter.
Nayar explains that Lending Club is considering multiple paths to a charter, which could include acquiring an existing charter that could be adapted to its purpose. Investor groups and others have been doing this in recent years, sometimes taking the charter and moving operations — save a home branch — far from the original bank’s home territory.
Lending Club is a platform and does not generate loans itself. They are brought to the company’s sites by banks and investors buy them. Nayar says that being able to raise deposits would expand the company’s options. Lending Club envisions becoming, in his words, “a marketplace bank,” which management intends to be branchless. Lending would still be a big part of Lending Club with a charter, he says, but deposits would help.
“The marketplace model would always be central to Lending Club’s reason for being,” says Nayar.
“Going this way solves a real-world problem,” says Nayar, “which is that people have gotten into a lot of debt.” The company’s intent is to move into other tools beyond the classic consolidation loans.
“Credit cards are a wonderful way to spend,” says Nayar, “but a horrible way to borrow money.”
A Lesser-Known Path That’s Been Around for Years
There is nothing inherently sexy about the chartering of financial institutions, and what made the fintech charter a draw for financial media assuredly was the “fintech” part of it.
“This isn’t the first time the industrial bank charter has rocked the traditional banking industry’s boat.”
Less likely to make headlines by itself is an avenue that has been around for decades, the industrial loan company, more typically known as the industrial bank. This is a type of state-chartered institution that is not legally a bank under the Bank Holding Company Act. Industrial banks only exist in a handful of states, mostly Utah today, where there are 15 active ones. What sets them apart from other types of charters is that industrial banks carry FDIC insurance but they can be owned by commercial companies, as well as financial companies. Because industrial banks are not banks under the holding company law, their owners are not subject to Federal Reserve supervision, unless they are financial holding companies. One restriction: While industrial banks can make both consumer and commercial loans, they cannot accept demand deposits if they have more than $100 million in assets.
The industrial bank charter has become controversial because fintechs and others have become interested in the option. But this isn’t the first time the specialized charter has rocked the traditional banking industry’s boat. In 2006 multiple industrial bank deposit insurance applications were pending with FDIC, including one from Walmart and Home Depot. The matter became so controversial that FDIC put a moratorium on approvals and then in 2010 the Dodd-Frank Act imposed a statutory moratorium, which lifted in 2013.
“There are thousands of U.S. fintech firms deeply involved in non-financial commercial activities,” the Independent Community Bankers of America warned in an early 2019 white paper calling for permanent legislative closure of the loophole permitting their special status. “Many of these would no doubt welcome the opportunity to obtain an [industrial bank] charter with deposit insurance in order to obtain low-cost deposit funding while retaining and expanding their commercial ventures.”
While the recent applicants for the industrial bank charter have been relatively smaller firms, ICBA has expressed concerns that if they obtain charters, “it is only a matter of time before large technology firms like Google, Amazon, Facebook, Apple, or Microsoft apply.”
There haven’t been thousands of applications, nor even a dozen, but the handful that have been pursued in the last year or so make it clear that the industrial bank charter really is an alternative to the OCC’s fintech charter for some players, especially if the deliberations in court drag on as appeals are made.
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‘Amazon of Japan’ Applies for Industrial Bank Charter
In summer 2019, Rakuten, which some have called “the Amazon of Japan” and which already owns a major Japanese internet bank, applied for a Utah industrial bank charter. Among those attacking the application were ICBA, the American Bankers Association and the Bank Policy Institute, a large-bank organization. The latter two groups, in a joint letter to FDIC, opposed the continued ability of nonfinancial companies to obtain industrial bank charters.
Among the specific complaints about Rakuten’s business plan is that information about customers of the proposed industrial bank would be available to Rakuten’s non-financial affiliates. Interestingly, in this regard, without naming Amazon specifically, the associations point to the preferential pricing available for Amazon Prime consumers at its Whole Foods Market subsidiary as an example.
Other organizations beyond Rakuten have looked at the industrial bank route. Square Financial Services, for example, filed an application, withdrew it, and filed again. That application remains pending. A Connecticut brokerage company applied for a charter in November 2019. Others have filed applications and withdrawn them.
Precedent exists for Congress closing the industrial bank loophole. In 1999 the “unitary thrift loophole,” which allowed commercial firms to own a single S&L, was closed. One notable use of that loophole had been a casket company using it to operate an S&L to make casket loans. Earlier there was the “nonbank bank loophole,” which had originated literally because of a comma in a statute that let commercial companies own institutions that either dropped commercial lending or checking accounts and thus became “nonbank banks.” Discover Bank, now a large direct bank, originated when Sears purchased a community bank named Greenwood Trust to issue the Discover Card, originally a Sears product. Congress closed that loophole in 1987.
What Congress will do under current circumstances is anyone’s guess.
Capital: One Word, Two Different Meanings
One point that sometimes gets lost when bank and credit union executives generalize about the fintech charter is that OCC doesn’t see it in any way as a “regulatory lite” charter.
As stated in 2019 testimony by Beth Knickerbocker, Chief Innovation Officer at the Comptroller’s Office: “The OCC has stressed that a fintech company that receives this type of special purpose national bank charter would be supervised like a similarly-situated national bank, including with respect to capital and liquidity requirements.”
That underscores a bit of a terminology gap between traditional banking investors and venture capitalists and others who like to invest in fintech companies.
Fintech players, especially in their early days, rely on regular infusions of money in funding rounds that they make a point of publicizing. As they burn through earlier rounds of investment, being able to tell the world that they’ve received a fresh slug of capital makes it clear that someone, or multiple someones, has faith in the fintech’s idea and execution. That is, at least enough to put up millions of bucks.
But in their world, “capital” means rocket fuel, funds to burn to get an idea off the ground. FDIC Chairman Jelena McWilliams made the point at a regulatory symposium that successfully navigating bank chartering is a struggle for many fintechs “because a lot of them have equity but not really capital. And a lot of them are profitable on paper but not really profitable.” She said this has been an issue in weighing deposit insurance in relation to industrial bank charters.
In banking, capital isn’t considered fuel in the same sense. Yes, capital provides underpinning for loans, but you can’t let it all out the door. Some must be retained as a buffer and it is subject to extensive and complicated regulation. Running low on capital is a serious regulatory matter.