Fintech Review - Granting national bank charters to fintech
/Special purpose national bank charters
The US Treasury Department has relaxed its approach to financial technology (fintech) industry and issued a set of recommendations under the title of “A Financial System That Creates Economic Opportunities: Non-bank Financials, Fintech, and Innovation.” The Office of the Comptroller of the Currency (OCC) has subsequently announced it will start granting national bank charters to non-depository financial services companies with immediate effect. Fintech firms can apply for and obtain special-purpose national bank charters effective August 2018, with more relaxed “financial inclusion” standards than those required by Community Reinvestment Act (CRA). The OCC's special purpose charter is to complement and, possibly, replace a more fragmented state licencing regime. Non-depository fintech firms previously had two options for compliance: (1) apply for individual state licenses, or (2) go through the Nationwide Multi-state Licensing System, a platform for state regulators to record licensing and registration.
Opposition from banks and credit unions
The new charter gives non-banks an avenue that could potentially hurt conventional banking providers albeit it is too early to form a strong view about it. Lawsuits from various interests looking to protect legacy money center banks, credit unions and community banks had indeed attempted to kill the fintech charter proposal while it was still in the making, but federal judges dismissed the cases and labeled them as “premature” because no charters for fintech had been granted at the time. Similar lawsuits may resurface as various non-depository finance firms may begin applying for the new special charters. The critiques of the new charter for non-depository financial companies include the Conference of State Bank Supervisors, New York Department of Financial Services, the American Bankers Association and the Independent Community Bankers of America (ICBA). Some modifications to new regulation are possible; but the substance of the OCC's special charter is unlikely to change.
Fintech reluctance - thanks, but no thanks
What is more important is whether the fintech companies are ready to move ahead and apply for special charters. In fact, the decision to issue national bank charters to fintech enterprises had not been an easy one to make for the U.S. Treasury and the OCC because of lack of any consensus within the fintech industry itself. The interest in a charter among non-depository firms has dwindled since the OCC first proposed the idea. Some fintech companies have opted out and chosen to partner with traditional financial institutions to circumvent registration procedures. As a matter of fact, several fintech enterprises with operations ranging from payment systems to online loan marketplaces have built their business models around the concept that they will form partnerships with national banks.
Some fintech companies are still skeptical about applying for a national bank charter. There are two reasons why they say "thanks, but no thanks." First, there is the increased cost of regulation and other requirements, which could be substantial and may require a fresh round of funding with uncertain prospects especially for startups. Second, establishing a bank charter earlier on would dampen the prospects for having a money center bank with strong capital base on board as a strategic partner, which remains a key objective for the founders/shareholders of many startups.
Bank charter as a commercial proposition
Granting bank charters to enterprise fintech may be a good compromise for regulatory reasons. Yet, a bank charter to run a more competitive financial technology business is probably overstated as a commercial proposition. It is not impossible to envisage a two-tier financial services industry, one still with more stringent rules over credit and another with a more flexible approach making use of data.
Financial technology (fintech) typically targets markets which are under-served by mainstream financials institutions. The target markets for fintech entrepreneurs may and do include credit, which prove costly to approach for money center banks. Fintech develops and grows in market segments where money center banks are still reluctant to get into. Small enterprise loans, on-line payments and invoicing, credit scoring analytics, student loans, sub-prime commercial loans, low-cost brokerage, and lines of credit for businesses with short credit history among many others.
Fintech companies in online loan business tend to earn higher margins on loan originations than money center banks do. This is because fintech loan enterprises are more lenient on credit risk. Conventional banks exercise more rigid rules when it comes to selection. Income and employment history are among the banks’ most important credit selection criteria while online loan providers use a much wider array of information. For example, a borrower shopping for credit without a reasonable track record of employment and income may still get her credit approved if she has a long history of online shopping, say, with Amazon. This latter may not directly enter as an input into a bank’s credit decision. Fintech companies may charge higher interest rates on loans to adequately reflect the credit risk – higher risk of selecting bad credit, which is why they tend to generate higher margins and higher rates of non-performing loans.
Fintech is more "tech" than "fin." It employs a different talent pool while banks, except for some specialty business, operate a more balanced talent.