Fintech companies focused on payments or lending activities continue to seek solutions to minimize barriers to entry presented by myriad and disparate state licensing requirements. These efforts have given rise to numerous approaches, including, most notably, fintech-bank partnerships structured to avoid state licensing regimes. While another obvious option is a bank charter, few fintech firms have seriously considered bank charters due to a number of cost, compliance and other factors that make becoming a bank too burdensome. Recent developments, however, suggest that the bank charter option may be worthy of reconsideration. This article explores the opportunities, costs, risks and other factors that fintech firms should weigh in considering a bank charter and various charter options currently available or in development in the US. Notably, the scope of this article does not include non-US charter and similar options, of which there are a number of alternatives, including in the UK, Singapore and other jurisdictions.
Introduction
What once was old is new again. The fintech ecosystem that sprung up in the wake of the 2008 financial crisis has grown and matured. The early companies developing and marketing fintech applications (fintechs) set out to disrupt or displace traditional banks. But fintechs have largely come to see banks as partners in providing innovative products and services, helping even to modernize banks’ internal systems. Now, partly due to the challenges of operating under a patchwork of state and federal laws and regulations, fintechs are considering becoming banks themselves. Following an interesting year of regulatory developments in 2017 and looking forward to 2018, fintechs have a range of viable bank charter options to explore in the US.
The Regulatory Landscape
In the ten years since the financial crisis, fintechs have helped revolutionize the financial services marketplace—from the scope of products and services available, to how they are delivered. By developing and leveraging mobile applications, big data, machine learning, distributed ledgers and other technologies, fintechs have spurred innovation in offering credit, facilitating payments, providing advisory services, settling transactions, contracting for services, fraud prevention and cybersecurity and a wide range of other areas that now touch our everyday lives, including even our concept of money. In so doing, fintechs have also brought more unbanked and underbanked populations into mainstream financial services—an area in which traditional financial service providers often struggle–and, overall, have raised the bar on consumer expectations for what, how, where and when financial products and services are structured and delivered.
The history and evolution of banking and financial regulation in the US is complex and too broad to cover in this article. The result, however, is a regulatory snarl of overlapping federal and state agencies whose jurisdictions vary based on both the nature of the financial activity, product or service involved, and on the corporate charter of the regulated entity.
Banks are regulated entities that obtain their authorization to do business from, and are regularly examined by, a state and/or federal bank regulatory agency. Companies that are not banks also are often subject to the authority of a banking or financial regulatory agency if they provide financial products or services, particularly to consumers. In general, however, if a company wants to engage in the "business of banking," which can include a wide range of financial products and services but at its core revolves around deposit-taking, it must first apply for and receive a bank charter.1
A company that provides other financial services (without taking deposits) can be organized under any type of corporate charter, but it might need to obtain a license (or licenses) in each state where it intends to operate. The financial services that require a license are generally those that involve making loans (e.g., mortgages, personal, auto or small-dollar) or transmitting money on behalf of others (e.g., money transmission or payroll processing). Each state has its own laws and requirements for these licenses, some of which are vastly different in scope and regulatory focus.
Most of the consumer products and services developed by fintechs involve activities (payments and lending) that require state licenses if conducted directly by a fintech. Fintechs that operate predominantly online and have customers throughout the US often need to obtain licenses in all 50 states and the District of Columbia. The process of getting licensed in every state is costly and time consuming—requirements are inconsistent, state regulators' financial and technical sophistication can vary significantly, filing fees can be costly and states do not always prioritize the processing of applications. Once licensed, companies are generally subject to periodic exams or audits of their regulated activities by the issuing agency.
2017 Developments in Brief
While some start-up fintechs and commercial enterprises with fintech business lines have explored the possibility of organizing or investing in a bank as a means to reduce their state licensing burden, the general view is that becoming a bank is an arduous process. Receiving regulatory approval to form a new bank (a "de novo" bank) is difficult even for companies seeking to operate a traditional bank. From 2011 through 2016, there were five de novo charters granted, all for a traditional bank model.2 Thus, right or wrong, there has been a strong and persistent perception that the de novo prospects for a fintech that does not fit the typical business-of-banking model are even more challenging. Whether it was due to the hurdles to de novo formation, the challenge of getting regulators comfortable with novel business models, the difficulty in maintaining bank-like capital and liquidity, or the desire to avoid bank examinations, most fintechs that have considered the issue have quickly dismissed the option of becoming a bank.
Recent changes to the regulatory landscape, including agency leadership changes and greater focus and agency awareness on fintech and regtech issues and opportunities, as well as bipartisan recognition on Capitol Hill regarding the promise of fintech for financial services providers and consumers, suggest that 2018 may be a new day for fintechs regarding consideration of the viability of operating through a bank or bank-like charter. Presaging this new thinking and approach to a fintech’s bank charter analysis and decision making calculus were a number of formative developments, including the following:
Proposed federal charter for fintechs. In late 2016, the Office of the Comptroller of the Currency (OCC), the federal regulator that charters and supervises national banks and federal savings associations, issued a report (Fintech Whitepaper), outlining the agency's exploration of a possible special purpose national bank charter for fintech companies (fintech charter).3 The OCC recognized that the need to obtain multiple state licenses could inhibit fintech development and that "institutions with federal charters [should] have a regulatory framework that is receptive to responsible innovation and the supervision that supports it."4 In 2017, the OCC published draft licensing procedures describing the application requirements for a fintech charter.5 As discussed below, the OCC's proposed requirements are potentially easier to satisfy than a 50-state licensing regime and more tailored to fintech business models. Also as discussed below, the fintech charter has been challenged in court by state financial regulators who see it as infringing on their jurisdiction and beyond the OCC’s authority under the National Bank Act.
More de novo banks. 2017 also saw renewed interest in de novo banks of all types, but particularly in classic charter types, which fintechs could also seek to use. The Federal Deposit Insurance Corporation (FDIC) has, at times, received criticism for how few de novo banks it approves.6 To help ease the application process, the FDIC published a Handbook for Organizers of De Novo Institutions in April 2017,7 and an updated Deposit Insurance Applications Procedure Manual in June 2017.8 Whether due to the new publications or a change in its regulatory posture, the FDIC approved six de novo applications in 2017,9 but none to a fintech or fintech-inspired model.
ILC applications. During 2017, the FDIC received two applications from fintechs seeking to form banks chartered as industrial loan companies (ILCs).10 An ILC charter is a state charter that permits a company to conduct many of the same activities as other state-chartered banks. ILCs are required to obtain FDIC insurance, but as discussed below, they are not treated as banks under the Bank Holding Company Act (BHCA), which means the parent company of an ILC is not subject to federal banking supervision. This feature could be a boon to fintechs that are often owned by corporate parents that are commercial firms (and not eligible to own a bank), rather than banking or financial companies.
Increased state coordination. States themselves recognize that requiring different licenses in each state could inhibit development of the fintech market. In May 2017, the Conference of State Bank Supervisors (CSBS) announced Vision 2020, a coordinated initiative among state regulators designed to "make[] supervision more efficient and recognize[] standards across state lines."11 Vision 2020 is partly a response to the OCC fintech charter proposal, and one of its main focuses is to have increased harmonization and uniformity of licensing, regulations and examinations across states.12
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1 See, e.g., 12 U.S.C. §§ 21 and 26; and N.Y. Bank. L. §§ 2, 96, and 1002.
2 See Statement of Martin J. Gruenberg, Chairman, Federal Deposit Insurance Corporation on De Novo Banks and Industrial Loan Companies before the Committee on Oversight and Government Reform (July 13, 2016), available at: https://www.fdic.gov/news/news/speeches/spjul1316.html. See also, FDIC Decisions on Bank Applications, available at: https://www.fdic.gov/regulations/laws/bankdecisions/depins/index.html.
3 OCC, Exploring Special Purpose National Bank Charters for Fintech Companies (December 2016), available at: https://www.occ.gov/topics/responsible-innovation/comments/special-purpose-national-bank-charters-for-fintech.pdf.
4 OCC Press Release (Oct. 26, 2016), available at: https://www.occ.gov/news-issuances/news-releases/2016/nr-occ-2016-135.html.
5 OCC, Comptroller's Licensing Manual Draft Supplement: Evaluating Charter Applications From Financial Technology Companies (Mar. 15, 2017), available at: https://www.occ.gov/publications/publications-by-type/licensing-manuals/file-pub-lm-fintech-licensing-manual-supplement.pdf.
6 Lalita Clozel, FDIC defends right to charter new banks against OCC criticism, American Banker (Aug. 4, 2017), available at: https://www.americanbanker.com/news/fdic-defends-right-to-charter-new-banks-against-occ-criticism.
7 FDIC, Applying for Deposit Insurance, A Handbook for Organizers of De Novo Institutions (Apr. 2017), available at: https://www.fdic.gov/regulations/applications/handbook.pdf.
8 FDIC, Deposit Insurance Applications, Procedures Manual (June 2017), available at: https://www.fdic.gov/regulations/applications/procmanual.pdf.
9 FDIC Decisions on Bank Applications.
10 Forming an ILC requires a company to apply to a state for a charter and the FDIC for deposit insurance. Social Finance (SoFi Bank) submitted applications to the Utah Department of Financial Institutions (UDFI) and the FDIC on June 6, 2017, and Square Inc. submitted applications to the UDFI and the FDIC on September 17, 2017. SoFi Bank withdrew its application for reasons unrelated to the viability of an ILC charter for fintechs, and Square’s application is still pending. See UDFI, Application Status, available at: https://dfi.utah.gov/general-information/application-status.
11 See CSBS Press Release (May 10, 2017), available at: https://www.csbs.org/csbs-announces-vision-2020-fintech-and-non-bank-regulation.
12 Id.
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