WASHINGTON — Fed up with the hassles of applying for a multitude of state licenses and relying on bank partners, fintech firms are increasingly interested in applying for a national bank charter — and federal regulators are considering ways to accommodate them.
The Office of the Comptroller of the Currency is contemplating a "limited-purpose" charter designed for fintech companies, a move that could propel them into the banking system and help resolve questions about their regulatory structure.
"Determining whether a national bank charter is right for these companies requires answering many important questions," said Kay Kowitt, a deputy comptroller at the OCC who heads an agency team dedicated to looking at fintech issues. "Are these companies providing products and services that banks are authorized to offer? What are the prudential requirements for these types of institutions? Does a more limited-purpose charter make sense?"
Kowitt, in a statement to American Banker, made it clear that the decision has yet to be made and offered no details about what a limited-purpose charter might look like. But one thing is clear: Depending on how it's structured, a number of firms are likely to be interested.
The financial-health startup Varo Money indicated last week that it would seek a bank charter, and many other firms have considered the option.
"If we had a preference today, we would like to be a bank," Steve Carlson, chief executive of the online lender Ascend, said in an interview.
Currently, most fintech firms face two choices — either partner with an existing bank or register as a money-services business and strike out on their own. But both models have drawbacks.
Partnering with banks, a model adopted by firms like Prosper, can be costly because institutions have high compliance standards for the companies with which they associate.
"There are a lot of regulatory hurdles there to be able to prove to the banks that they've got the controls and data security," said Jo Ann Barefoot, a consultant who has advised both fintech companies and regulators.
Moreover, there are not enough banks in the space compared to the growing number of fintech companies.
Some fintech firms couldn't exist without bank charters. Take ZenBanx, a startup founded by former ING Direct chief Arkadi Kuhlmann that lets customers hold funds of up to five different currencies in a single account. The multicurrency account was in development for more than two years but couldn't launch until ZenBanx found a bank partner that would allow it to accept deposits. It launched in September in partnership with WSFS Financial in Wilmington, Del.
But some fintech firms see partnerships as a self-defeating strategy for the industry, as it creates companies that are beholden to traditional banks.
"Effectively, the technology platform never holds any part of that loan," Carlson said.
As a result, firms like Ascend have charted a different path by licensing themselves — as a money-services business and lender — in various states. But this is a painstaking process, because each state has its own rules. "You go state by state," said Carlson, whose company is authorized to do business in six states so far.
This regulatory maze has the effect of slowing down the growth of online companies, which are built to be accessible everywhere; and making their business model uneven, with customers facing different rates depending on where they live.
"Every state has different rules and regulations in place," Carlson said. In some states the regulatory burden is actually disqualifying, he added. "I can't offer anybody in Virginia my loan today, simply because the law requires the lender to have a physical footprint," he said.
The time, money and energy fintech companies expend on the licensing process often clips their wings in the early stages.
"Time is death," Barefoot said. "If something takes a year instead of three months, that's going to kill a bunch of them right there."
A national bank charter, particularly a limited-purpose one, could solve the problem of complying with a multitude of state standards.
"The industry is discussing a national charter for nonbank financial technology companies because they recognize the value of having a uniform set of standards that applies across the country and a single primary regulator," the OCC's Kowitt said.
But the OCC still needs to work through several issues, including what kinds of prudential requirements would be put in place and the agency's own chartering powers.
"If a national charter makes sense, are existing chartering authorities sufficient or does it require new authority?" asked Kowitt. "These are the sorts of questions that the OCC framework for responsible innovation will help answer, at least for the federal banking system."
In March, the agency released a white paper detailing how it plans to address innovation and asking for public comment on several initiatives that could benefit the growing fintech industry.
That same month, OCC Chief Counsel Amy Friend announced that the agency had received queries from fintechs, including one virtual currency firm, about applying for a bank charter.
A limited-purpose charter could solve a key problem of chartering a bank: the difficulty in getting approved by regulators.
"It's nearly impossible to become a bank," Carlson said.
Regulators have approved only a handful of de novos in recent years, though the agencies argue that is primarily due to lack of demand. Still, the Federal Deposit Insurance Corp. announced in April that it would reduce the period of heightened regulatory scrutiny for newly chartered banks from seven years to three years.
And the cultural gap between the fintech and banking worlds is slowly closing.
"For many of these entrepreneurs they see the benefits but they're not aware of what being a bank actually means," said Alex Acree, a partner and general counsel at Fenway Summer who has advised several young fintech companies. Usually, he added, they drop the idea when they find out about the regulatory burdens they would need to face as a bank. "It's a very interesting progression," he said.
Fintech companies are attracted to bank charters for a number of reasons. One, the venture capital-driven industry is hungry for low-cost funding, with which banks are flush. Through their deposit business, banks also gain a more direct access to potential borrowers.
"It's generally more easy for banks to acquire customers," Barefoot said. "The established banks have a customer base and then you can bring them your new exciting product."
The move to develop a unified regulatory framework for fintech companies could benefit not just the industry, but also regulators. The agencies have struggled with how to supervise the burgeoning industry. The Treasury Department is expected this week to issue recommendations for how to oversee marketplace lenders after a year of taking comments on the issue.
"We have a very bank-centric regulatory system," Barefoot said. As a result, fintech companies are "less closely scrutinized and they're proliferating and nobody knows exactly what's going on in that complex landscape."
But a bank charter is not the only potential solution. States could also step up to the plate by creating a more welcoming landscape for fintech companies.
One such effort underway is the Uniform Law Commission's work in drafting a model state rule for digital currency companies.
Another possibility is a two-tiered system that would allow fintechs to establish their credibility within a state and eventually move up to apply for a federal license. This would reduce the cost to federal agencies.
The prospect of fintech startups establishing themselves as official banks in the years to come is likely to send chills down the spine of many bankers. But it doesn't have to, experts say.
There are functions for which fintech companies will likely always have to rely on banks, said Cliff Stanford, a partner at Alston & Bird who has advised both fintech startups and banks.
For "taking deposits and settling accounts through the interbank settlement of money system," he said, "even the PayPals of the world have to go through banks."
And certain business models have endured for a reason: their anchoring with local customers.
"There is always going to be a role for the traditional community bank that takes deposits in the community and transfigures that into loans," Stanford said.