This month could be a turning point in fintech regulation

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WASHINGTON — Fintech firms are awaiting several regulatory actions this month that could help shape the future of the industry.

Yet while more feedback from regulators appointed by President Trump could give the industry a sense for where fintech regulation is likely to be headed in coming years, recent activity at one banking agency underscores the challenges that could be looming for a budding industry starting to make its way in Washington.

The payments processor Square got its first taste of the regulatory difficulties ahead when it affirmed this week that it had withdrawn its application to form a depository bank with Federal Deposit Insurance Corp. in order to “strengthen” it, with plans to refile it at a later date.

At the same time, Comptroller of the Currency Joseph Otting said he would take a position in July on whether to offer a special bank charter for fintechs, and soon the Treasury Department is expected to release its highly anticipated report on fintech companies that may help inform the activities of regulators.

Many observers said the banking agencies are likely to move forward on bringing the fintech industry into a more modern, regulated space, but Square’s withdrawal shows just how tough getting there can be.

“There’s a very real shot that what happens here in July is a culmination, or cycle, of regulation that’s not a bang but a whimper,” said Brian Knight, director of the program on financial regulation and a senior research fellow at the Mercatus Center at George Mason University. “It’s potentially a very important period for the fintech industry, but we’re going to have to see what all this stuff looks like.”

Square, of San Francisco, was the second fintech firm to apply and then withdraw from forming an industrial loan company, a controversial charter that allows a company to have insured deposits without having to follow Bank Holding Company Act requirements. Social Finance also applied for an ILC charter last year but quickly withdrew when an internal scandal involving the company's leadership made news.

Square’s withdrawal was different in that the company plans to refile after it bolsters is application, Square confirmed to American Banker on Thursday.

“We have been engaged in constructive dialogue with the FDIC, and our decision to withdraw and refile was a procedural step in the review process that will allow us to amend and strengthen some areas of our FDIC insurance application,” a spokesperson said.

But observers cautioned not to read into Square’s withdrawal as a signal that Trump's regulators are going to be less friendly to fintech.

“I do think the leaders are forward leaning on fintech,” said Jo Ann Barefoot, CEO of Barefoot Innovation Group and a co-founder of Hummingbird Regtech. But “I would not be surprised by the challenges because it gets complicated.”

Yet Square’s case has raised more questions about what regulators need in order to let fintech firms become banks, especially as interest in ILC charters picks up. Regulators and Congress placed moratoriums on the charter several times in the past decade, with no applications filed between 2010 and 2017, when SoFi first made its bid, followed by Square. In addition to SoFi and Square, the student loan servicer Nelnet filed an ILC application last month.

Other groups will still be interested in filing for an ILC charter as well, Barefoot said.

“It’s pretty recent that there’s been a feeling of receptivity by the regulators of ILC charters,” she added.

Many observers point to recent comments made by the new FDIC Chairman Jelena McWilliams in which she said the FDIC “has a duty to the public to actually proceed” on its bank depository applications.

Meanwhile, the industry is awaiting other signs from Trump officials that could help shape the future of fintech, including the Treasury's report and Otting's decision on whether his agency will offer fintech firms special charters.

But even if the OCC moves forward, that process could face its own hurdles. Thomas Curry, who previously ran the OCC under President Barack Obama, said it will be particularly difficult for any fintech firm to be the first to get approved as a bank by either the OCC or the FDIC.

“Anyone who is the first applicant out of any gate — whether it’s through the OCC as a full service bank or ILC or a special-purpose bank — is really going to have to have everything in place,” said Curry, now a partner of the corporate and transactions department at the law firm Nutter and a co-leader of it banking and financial services group .

Curry was the first federal bank regulator to begin considering whether fintechs should have a national bank charter. But state regulators later sued the OCC over its plan, arguing it was overreach. The debate has largely been at a standstill since he left office last year, leaving the industry in limbo for now.

Otting has repeatedly said that times have changed since Curry first made the proposal in that many fintech firms that once looked to “disrupt” banks are instead partnering with them. During a banking conference last month, Otting joked that fintech firms often leave “skid marks” from the OCC building after hearing the requirements, such as maintaining capital and liquidity, that could be involved in becoming a bank.

But despite the potential challenges involved, the industry is likely to keep pushing for avenues to enter the banking system to avoid the cumbersome state-by-state licensing process that currently exists. This has spurred many fintech firms to shift to partnering with banks in order to lower funding costs and gain a national reach, although that strategy also raises its own regulatory concerns.

“Time is of the essence to come up with a comprehensive policy process for regulating fintech firms,” Curry said. “What we have now are fintech firms trying to enter the banking system through the back door, through partnership agreements that may or may not be fully vetted or seen by the regulators.”

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Fintech regulations ILCs National Bank Act Digital banking Joseph Otting Thomas Curry Jelena McWilliams FDIC OCC