Will Facebook be too much for states to handle?
Facebook’s plan to launch a cryptocurrency has raised concerns that state banking regulators may not have sophisticated enough tools to oversee large, international companies.
States are the primary regulators of technology firms, at least when it comes to payments. Facebook, Google, Apple and Amazon each have money transmitter licenses in more than 40 states and the District of Columbia.
Yet it's not clear the states have the resources to oversee those firms, which represent a tiny fraction of the total companies the states are expected to supervise and examine. At the moment, states also don't seem to have an easy way to share information with each other about what they do find. Though state examiners currently conduct from 20,000 to 30,000 examinations of nonbanks every year, there is no nationwide system to share examination findings of nonbanks.
Even scheduling state exams has become a Herculean task. Every quarter, members of a task force of 10 state banking regulators spend several hours on a conference call looking at spreadsheets and coordinating their schedules.
“With so many companies under supervision and so many exams to take place, we literally fall over each other,” said Chuck Cross, senior vice president of consumer protection and nondepository supervision at the Conference of State Bank Supervisors. “There has been no technology to allow us to have an understanding of where other examiners are at any moment in time.”
State regulators are in the process of trying to change that.
After the Office of the Comptroller of the Currency first proposed in 2017 to create a charter for fintechs — one that could potentially be used by large tech firms — the states responded by filing a lawsuit (which is still pending) and attempting to resolve the hassles of being overseen by multiple states. They developed a 50-state examination system to simplify supervision and examine nonbanks like Facebook, PayPal and Venmo.
This fall, up to a dozen states will take part in a pilot project modeled on the CSBS’ Nationwide Multistate Licensing System, which was created in 2008 for mortgage oversight after the financial crisis. A nationwide release of the state examination system is expected in early 2020.
The system is part of a larger effort to upgrade technology and create data analytics tools that states can use to flag high-risk products and companies.
“It will facilitate an exchange of information and data between the states to make it easier for the states to share examination data, which is good for industry participants too,” said Mark Quandahl, director of the Nebraska Department of Banking and Finance, who chaired the CSBS’ payments and innovation task force.
When it comes to overseeing Facebook, however, states like Nebraska have their work cut out for them. Nebraska has 34 examiners responsible for the oversight of 156 state-chartered banks, 3,900 mortgage loan originators and 139 sales finance companies, plus credit unions, trust companies, delayed deposit services and small loan companies. The state hired its first examiner of money transmitters last year, Quandahl said.
Facebook is licensed as a money transmitter in 42 states and the District of Columbia, but the depth of exams and supervision on the state level varies significantly.
“What is hamstringing the states' efforts is not only are the states trying to track fast-moving innovation and keep up, it is complicated by different state laws, and banking agencies that are less than fully staffed and are trying to keep their heads above water,” said Clifford Stanford, a partner in Atlanta at Alston & Bird. "The tension between Silicon Valley time and regulators' time —that's a real issue and a frustrating one."
Thomas Curry, the former comptroller of the currency who is a partner at Nutter McClennen & Fish, agreed. He launched the OCC’s fintech charter in an effort to give fintechs one set of rules. But that effort is still being challenged in the courts.
“What’s really out there is a patchwork of rules and different types of licenses,” Curry said. “It is crying out for standardization and the choice is do you do it through a re-engineered state system or do you do it through the national bank system?”
States argue that the OCC is overstepping is legal authority, and many bankers fear a large technology firm like Facebook could use the OCC's charter to become another megabank. They say that with the improvements state regulators are making to their processes, fintechs and others don't need a national charter.
“There is a lot of oversight going on,” said David Cotney, a former Massachusetts banking commissioner and senior adviser at FS Vector, a fintech consulting firm in Washington. “Each state has been doing a good job at protecting consumers. What you’ll see is a much more coordinated approach to supervision and the states will be able to raise the bar in terms of ensuring from a safety and soundness perspective that" the nonbanks "are well regulated.”
No fintech license
Nonbanks operate under a number of different licenses that may not exactly reflect their business. For example, payment processors typically operate under money transmitter licenses, though their business is really about alternative payment systems.
But Facebook’s Libra currency creates its own issues for states. Most states do not even have specific laws regarding cryptocurrencies.
"States have a very challenging and difficult time to put their arms around a dynamic, fast-moving, fast-changing industry," said Tony Alexis, head of Goodwin Procter’s consumer financial services enforcement practice and a former assistant director and head of enforcement at the Consumer Financial Protection Bureau. "When you look at something as simple as money transmitters, it varies so much from state to state that it can be an incredible point of confusion and worry for a company as they launch their fintech products."
States have varied capital and bonding requirements in addition to so-called permissible investment requirements, which determine whether a payment processor like Facebook can hold capital in U.S. dollars or in cryptocurrency. Some state laws governing money transmitter licenses, meanwhile, have not been updated in a century.
At the same time, states also have seen a near-doubling in the volume of nonbank licensing applications, many of them from nonbank mortgage lenders. The proliferation of nonbank fintech firms has put more stress on the multistate system, Cross said.
The question is whether the efforts underway to standardize oversight will be enough to alter that. So far, nearly half of all state regulators have agreed to uniform standards for processing licenses for money transmitters and money-services businesses. Another CSBS initiative still in development is a model money-services-business law that would smooth out the differences in state-by-state laws.
“The risk is that someone walks in with cash or some other means of paying and the money does not arrive at its destination,” Cotney said. "There are far more consumer protections for lending, including usury limits, than for payments."
It's also a question of whether state regulators are willing to use the powers they have — and how others will be able to judge what they've done. States often resolve violations nonpublicly, which typically results in restitution for affected consumers, but no penalties.
Because supervisory and exam information is confidential, there is a dearth of publicly available performance data on the frequency of exams and how many enforcement actions of big tech companies are being done at the state level. It is a felony for a state regulator to divulge information about a state exam. Regulators said they were hard-pressed to think of any large fintech company that had received a public enforcement action in the past five to 10 years.
Still, state regulatory officials contend they have a plan for the future that will lead to more effective examination and enforcement.
"It’s an evolution that might amount to a revolution," said Cross. "Just like fintech has changed the way industry has done business, regtech has changed the way we do business. So regulators can touch more companies more efficiently, share the information and not repeat the same stuff."