Are states gaining upper hand in fintech charter battle?

WASHINGTON — With fintech firms seemingly stuck in neutral in their efforts to gain banking charters, alternative state licensing options could get another look in 2020.

The past year was another series of fits and starts for financial companies trying to streamline a licensing process that now requires them to apply to multiple state regimes. More fintechs sought a banking charter, but none succeeded in obtaining one. And a specialized federal charter tailored just for them, once so close, has never felt more out of reach.

A glacial, murky legal process is nothing new for fintechs that have struggled for years to get access to the banking system. But as their path continues to be fraught, observers say states are trying to fill the void, developing options to improve multistate regimes.

"States are looking at how difficult the federal landscape can be, and based on their current laws, they're looking for ways to attract companies — either through their current regulations or even by introducing new legislation,” said Mike Nonaka, a partner at Covington. “There's a lot of space to offer interesting charters and licenses, and you'll see more of that in 2020."

In 2019, the industrial loan company — an FDIC-insured banking charter offered by states such as Utah — continued to draw attention from firms wanting a nationwide digital banking platform. New ILC applicants included the Greenwich, Conn.-based Interactive Brokers Group and the Japanese e-commerce giant Rakuten, while the student loan servicer Nelnet refiled.

Meanwhile, the full-fledged national banking charter for fintech firms technically is available from the Office of the Comptroller of the Currency.

But several firms pursuing either options have struggled to gain approval or have thrown in the towel. The payments-focused fintech Square has been trying since 2017 to get ILC approval from the Federal Deposit Insurance Corp. Varo Money has received conditional approval from the OCC, but not yet from the FDIC. In November, the financial services startup Robinhood said it was withdrawing its application for a federal banking charter.

At the same time, the OCC's special-purpose fintech charter, which would allow fintechs to operate nationally without having to apply to the FDIC for deposit insurance, has not yet attracted any applicants. Agency officials say some firms are put off by the regulatory requirements of the charter, while the charter itself was recently struck down by a federal judge in a case brought by the New York State Department of Financial Services. (The OCC has filed an appeal.)

To some extent, fintechs' pursuit of more streamlined chartering options grew out of frustration with having to answer to multiple state regulators. But now states that have been trying to adapt their models see an opening.

“There’s a real incentive for states to do this kind of thing — bring in jobs, display some innovation,” said Cliff Stanford, a partner at Alston & Bird. But for a company seeking "anything needing deposit insurance, it’s going to need to talk to the FDIC.”

For the last few years, the Conference of State Bank Supervisors has been focused on proposals that would streamline the state approval process, such as multistate licensing agreements.

It’s critical for state regulators to “collaborate and divide the workload so the licensing period can become that much shorter,” said Margaret Liu, senior vice president and deputy general counsel of the CSBS.

“States have always been licensing these companies,” she added. “What we’ve been focused on is making sure it’s a modern and efficient process.”

Observers expect more efforts on the part of states to craft common regulatory standards that can be applied to multiple regimes, as well as model legislative language for states to adopt to streamline multiple regimes. Meanwhile, more states could develop so-called sandboxes to let fintech firms test products without fear of violating licensing and consumer protection rules — building off of frameworks already introduced in Arizona, Wyoming and Utah.

When the OCC's special-purpose fintech charter was first introduced in 2015, there was hope that it could allow firms to avoid an uneven patchwork of state regulations. But after years of litigation from the New York financial services department and the bank supervisor conference challenging the OCC's authority, the business sentiment toward the charter has shifted.

“Any company that files an application for it would become Exhibit A in the ongoing litigation,” Stanford said. “There are just too many clouds on the horizon to seek out the charter in the absence of clarity over whether or not it's viable.”

The charter’s legal drama could stretch on further. The OCC is challenging the decision in the New York case. The CSBS has sued the Comptroller's Office twice over the charter, and twice the case has been thrown out with the judge citing the lack of an applicant. But if an applicant does appear, it’s hard to imagine the CSBS won’t take aim again.

But there’s another factor weighing on the special-purpose charter’s viability: It may no longer be that useful to many fintech firms.

“When the OCC first asked the industry about this, what they heard was that fintechs wanted a narrow-purpose charter that did not include deposit insurance,” said Rob Morgan, vice president of emerging technologies at the American Bankers Association. “Now, more and more fintechs are looking for charters that they can use to get deposits. It’s an important part of the customer relationship, and companies are building their business models around that.”

Nonaka of Covington says interest in the new charter was not that strong in the first place beyond payments-focused companies.

“The one thing I've worried about with the charter is that there was a small population of groups that are interested and eligible for it in the first place,” he said. “Without FDIC insurance, it's limited, and the longer it's on ice, the number of companies interested is going to keep shrinking."

The OCC has disputed the claim that the charter is an overstep of the agency’s authority. Yet the regulator has also said the charter is not meant for everyone. More recently, officials say that firms initially interested in a federal charter that avoided certain requirements, such as deposit insurance, now believe it may not be possible to avoid those extra steps.

“A number of these [fintechs] realize they’re going to be bank holding companies and they’re going to be insured,” said Steve Lybarger, deputy comptroller for licensing at the OCC on a panel discussion in November.

Many firms see the ILC as an alternative to the embattled OCC charter. Yet the former example has also drawn consternation from community bankers and others who say it provides banking powers without the regulatory limits faced by more traditional institutions.

“I’ve always looked at the ILC as a bit of a third rail,” said Colin Walsh, CEO of Varo Money. “There’s just a lot of concern, particularly among community banks — a lot resistance.”

Still, the ILC may hold stronger appeal for fintechs if a pending applicant such as Square is able to cross the finish line. And unlike the OCC's limited-purpose charter, the ILC option allows fintechs to accept insured deposits.

"A bank charter, federal deposit insurance, that’s what brings credibility to the institutions,” said Gilbert Schwartz, a partner at Schwartz & Ballen. Companies that can display the FDIC’s seal will benefit from the agency’s trustworthiness, he said. “It’s a public credibility issue.”

Nonaka said the ILC is "an attractive way for fintechs to enter the banking system, but it’s not the exclusive way."

“There are other fintech companies that haven't opted for the ILC charter. It's not the consensus favorite," he said.