Will Regulators Stuff the Fintech Genie Back into the Bottle?

Acting Comptroller of the Currency Michael Hsu calls for a 'leveling up' between 'synthetic banking' players (aka fintechs) and traditional institutions. But the level playing field banks have long lobbied for may wind up higher for everybody. 'Banking as a service' programs are going to get deeper scrutiny. And more coordinated federal-state regulation is in the offing.

The Biden administration has peeled off a few more cards from its financial regulatory deck and the outlook for fintechs and for banks that provide them with “banking as a service” help looks cloudier. And traditional financial institutions may be impacted as well. Disruptive innovation may find itself under greater government oversight and control in the years ahead.

In a speech to the American Fintech Council, a key industry policy group, Acting Comptroller of the Currency Michael Hsu criticized “synthetic banking providers” that “operate out of the reach of bank regulators and free of bank rules, such as capital requirements, bank consumer protection laws and the Community Reinvestment Act.”

Hsu was referring to organizations that operate by unbundling and rebundling banking services traditionally handled under one roof: lending, deposit-gathering and payments.

All Players Face More Regulation:

Acting Comptroller Michael Hsu is calling for more even treatment of fintechs and similar companies with banks’ treatment. But he also envisions more scrutiny and requirements for traditional financial institutions too.

No company names were mentioned, but it was clear that the acting regulator was referring to the whole tribe of fintechs and other organizations that often operate without the licensing and related supervision that traditional financial institutions face. He also criticized the way crypto has grown to the point where some activities of larger firms are regulated and others unregulated.

“In regulatory-speak,” said Hsu regarding both, “they sit outside of the so-called regulatory perimeter. The full implications of this will likely only become apparent over time. While the convenience and benefits of rapid innovation can be enjoyed immediately, the risks and harms to consumers and business of engaging in financial activities with fewer controls tend to emerge only later.”

Fintech is an industry that has basked in a pro-innovation, pro-customer spotlight for about a decade. They’ve been the cool kids of finance and many banks have tried to emulate them. Hsu took his fintech audience down a peg, with a zinger to a point of fintech pride:

He noted that fintech leaders often cite how quickly fintechs distributed Paycheck Protection Program funds. “More recent evidence, however, shows higher rates of customer dissatisfaction and of fraud with PPP loans facilitated by fintechs versus those facilitated by traditional banks,” said Hsu.

Much of what Hsu says needs fixing will, he said, require coordination and cooperation with other federal financial regulators as well as state banking regulators. He suggested that unsupervised synthetic banking could lead to runs under the right circumstances.

While much more coordination is necessary, he said, elements of this are already occurring. He said the Comptroller’s Office has increased its focus on banks that provide services to large fintechs and “facilitate synthetic banking outside of the bank regulatory perimeter.” He said this connects to the Consumer Financial Protection Bureau’s order demanding intensive information from six big tech’s policies and practices in handling consumer financial data. His agency is also working with the Federal Reserve and FDIC on interagency guidance governing fintech partnerships and other third-party relationships.

A Skeptic and An Activist

Over recent decades Acting Comptrollers of the Currency have come from both outside the agency as well as from staff. Hsu is an outsider who immediately before served as Associate Director in the Division of Supervision and Regulation at the Federal Reserve and has also been a financial economist at both the Treasury Department, OCC’s parent, and the Securities and Exchange Commission. Often outside acting Comptrollers come in to use the “bully pulpit” but Hsu is an activist Comptroller.

Much of what Hsu has been saying sounds more like a formal appointee’s voice, even though the name of the nominee for the job, Saule Omarova, went up to Capitol Hill in early November. From the start at his post, Hsu has expressed skepticism about liberalizations that came out of OCC during both Democratic and Republican administrations.

“We need to ‘level up’ banking and finance,” Hsu said in the speech. “I am using ‘level up’ in both senses of the term — that is, to increase something in order to remove a disparity, and to progress to the next level.”

Elaborating, he explained what this means: “We need to remove the disparity between the rights and obligations of banks and the rights and obligations of synthetic banking providers by holding [them] to banking standards.

“At the same time, we need banks, fintechs and crypto firms to step up and make the business of handling other people’s money an ultra-high trust endeavor, where the needs of all customers are met in a reliable and consistently safe, sound and fair way.”

The overall intent, according to Hsu, would to be avoid consumer harm and endangerment of the financial system. More specifically, he said that such groups as the underbanked, communities of color, rural communities and small businesses have felt that banks serve them poorly.

“I want to be clear: everybody needs to level up, including banks. .. We regulators need to level up, too.”

— Michael Hsu, Acting Comptroller of the Currency

Chartering Policy to be Clarified

Hsu also indicated that the leveling up would help clarify OCC policy on bank charters and cryptocurrency-related interpretive letters. A review of these matters has been completed and he said that pending bank charter applicants will be receiving communications. Similarly, an interagency review of crypto issues has been concluded and an announcement is coming.

Hsu said the content of the upcoming communications would be in synch with the “vision for the bank regulatory perimeter” outlined in his speech.

This comes in the wake of a major interagency report urging bank-like regulation of stablecoins, which Hsu endorsed in a separate statement, and a pending Federal Reserve System project concerning central bank digital currencies.

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