As states and OCC keep butting heads, does innovation suffer?
WASINGTON — Legal squabbles between federal and state regulators have been a staple of the dual banking system for decades. But the disagreements have escalated due to the emergence of fintech companies trying to navigate a regulatory maze.
In 2017, multiple state parties began challenging the Office of the Comptroller of the Currency's fintech charter. This summer, states also sued both the OCC and Federal Deposit Insurance Corp. over rules enabling loan buyers to avoid state interest rate caps. Most recently, state regulators criticized the OCC's push to tailor a specialized federal charter for payments firms.
“Everyone wants to be the regulator in charge, but it has definitely ramped up in the last few years between the states and federal regulators,” said Howard Schickler, a partner at Katten.
State backers say protests of recent OCC moves stem from concerns about the Trump administration's deregulatory agenda. They argue an expansion of federal chartering power limits states' ability to fill the consumer protection void.
"How these products flow through the system and on what terms, and who has the right to be a watchdog on this — these are really important policy decisions," said Chris Odinet, a law professor at the University of Iowa. "It trickles down into how people buy homes, cars, use credit cards, all the transactions that make life work every day."
But industry advocates say the rising tide of litigation by states accusing federal bank regulators of overreaching could impede financial innovation. For example, since state lawsuits put the OCC's fintech charter under a legal cloud, no company has formally applied for the charter.
“There's no question that this is hampering innovation,” said Scott Pearson, a partner with Manatt who frequently consults with fintech firms on their path into the financial system.
Pearson said the legal challenges ultimately slow down financial firms' efforts to develop new products.
“A huge part of the consideration is the litigation happening right now," he said. "It could really change the risk calculus for these companies. Realistically, we’re not going to have certainty on these issues for several years.”
The latest court drama focuses on the principle known as "valid when made." The OCC and FDIC issued rules earlier this summer affirming that a bank loan's original interest rate is and remains valid even when the loan is sold through a partnership with a nonbank in a state with lower rate cap.
Consumer advocates and some state authorities say the policy undercuts local efforts to protect consumer from sky-high rates.
In July, the OCC was sued by California, New York and Illinois, accusing the national bank regulator of facilitating rent-a-bank partnerships and flouting procedural requirements. Then, in August, those same states plus Massachusetts, Minnesota, New Jersey, North Carolina and the District of Columbia similarly sued the FDIC.
Meanwhile, the New York State Department of Financial Services won its case challenging the OCC's fintech charter last fall, when a federal judge ruled that the national bank regulator did not have the authority to issue charters without deposit insurance. The case is currently before the Second Circuit Court of Appeals. The Conference of State Bank Supervisors also attempted to get the charter thrown out in court, but its cases were dismissed.
The OCC has not been deterred. Since coming to office in May, acting Comptroller Brian Brooks has announced a flurry of new fintech initiatives, including a charter supposedly designed for payments companies. In an interview with Politico this week, he said his agency would be prepared to receive applications for a payments-focused fintech charter as early as this week.
“We’ve satisfied ourselves that we don’t need a new regulation or a new statute on it,” Brooks told the publication.
But the war of words between the OCC and state regulators has only intensified over the proposed payments charter.
"The OCC’s proposed payments charter is no different than the fintech charter already rejected in federal court and subject to a nationwide order preventing the OCC from accepting applications from a company that does not take deposits," CSBS President and CEO John Ryan said in a statement Monday. "State regulators are opposed to this unconstitutional expansion of power."
Financial regulators under the Trump administration have often pressed for the need for robust financial innovation; internationally, the U.S. is frequently cited as a laggard in crafting sophisticated regulatory models to foster fintech.
“We’ve fallen behind on the kinds of financial technology we’re seeing globally,” said Michael Brauneis, managing director and leader of the North American financial services industry practice at the consulting firm Protiviti.
The perils of such a lag range from a slow, clunky payments infrastructure to the more existential threat of losing an edge to international competition, Brauneis said.
The CSBS frequently highlights the Nationwide Multistate Licensing System, a platform that allows companies to streamline the application process for several common types of financial service licenses across 27 states, as a way to cut down on compliance burden without undercutting state authority. But analysts are sometimes skeptical that such a system could ever replace a national solution.
The current uncertainty is most damaging for fintech firms in the earliest stages of development, Brauneis said. “If you’re just forming a fintech — absolutely, uncertainty is a huge hurdle. It affects the foundation of the company, whether they’re a payments company or a lending company,” he said.
Pearson said the litigation brought by states’ attorneys general on the valid-when-made rules could reinforce companies' regulatory concerns about bank-nonbank partnerships. The OCC and FDIC regulations were meant to remove the legal cloud over interstate loan sales after the 2015 Madden court decision raised questions about such transactions.
“The purpose of the rules issued by the OCC and FDIC was to reduce uncertainty, and the challenges to those rules sustain the uncertainty,” Pearson said.
At the heart of the lawsuits brought by states is the limits of federal authority. Both the FDIC and OCC were authorized by acts of Congress to regulate and supervise banks. But today, with an increase in tech-savvy nonbank lenders performing many of the services traditionally done by banks, the question of oversight has become more ambiguous — particularly when it comes to bank and nonbank partnerships.
That could change if Congress chose to clarify whether a fintech firm and its partner activities with banks ultimately fall under federal or state jurisdiction.
“A lot of things can speed this up. Congressional action is the easiest way in theory,” Pearson said.
But without that clarity from Congress, other analysts argued, the Trump administration and its bank regulators’ have already overstepped their authority.
“Going about this the way the federal regulators have has likely impeded innovation,” said Odinet. “No one really knows what the rules are going to be because the federal regulators are going about this on their own and not in concert with the states or with Congress.”
Odinet said that the push from the federal bank regulators to assert authority over fintech partnerships was just the latest front of an aggressive turf battle with state authorities. He pointed to the early 2000s, when many states attempted to limit banks’ ability to engage in subprime mortgage lending and install strict limits against predatory loans, only to have federal regulators at the OCC and now-defunct Office of Thrift Supervision preempt those rules.
“What we’re seeing now is another resurgence of attempts by the federal banking regulators to exercise what in my view is a very muscular interpretation of their legal power in an overreaching way,” Odinet said.
Odinet was also skeptical that innovation for innovation's sake was a strong enough rationale to expand banks’ national preemption of state laws.
“Subprime mortgages with adjustable rates and negatively amortized terms — that was considered to be very innovative at the time and in line with consumer preferences,” Odinet said, “because you could refinance more easily and pull out more equity, have more freedom with it. We have to be careful about innovation and just saying we want to be competitive for competition’s sake.”
But other analysts say that federal regulators are not coming from nowhere with their latest crop of rulemakings, particularly for the OCC, which supervises an estimated 70% of the banking industry by assets.
“I don't see this as an issue of the OCC's authority swelling like it was never there before,” said Pearson. “The pendulum is swinging back towards where it was before Dodd-Frank was passed, when there was an effort to reduce federal preemption.”
“I don't see anything today that's unprecedented,” he said.
In a statement, OCC spokesperson Bryan Hubbard said the outcome of recent litigation could result in more clarity.
Litigation "is a natural and important part of the process when important changes are being implemented that involve novel legal questions," Hubbard said. "Over time, litigation contributes to regulatory certainty regarding the interpretation of law and policy."
In the interim, however, there are already efforts underway from states to clarify their authority to supervise bank-fintech partnerships.
In Colorado, state regulators crafted a “landmark settlement” with multiple banks and online lenders in mid-August after three years of litigation that effectively amounts to a regulatory guide for nonbank lenders and their bank partners operating the state. The parties must agree to certain terms, including a 36% rate cap.
“Colorado gave the fintech industry a good road map for other state attorneys general to settle cases and put together what's basically a safe harbor framework under which bank-fintech partnerships can operate,” said Schickler.
Such a safe harbor agreement, he said, could be replicated by other states that are keen to keep an eye on nonbank lenders under their jurisdiction.
"For the states, it really comes from a sense of wanting to protect consumers in places where certain attorneys general are more empowered than others,” Schickler said. “But some states are starting to feel like the federal regulators haven’t been doing their jobs, so they’re going to do the job.”