Fintech is going through its own version of college basketball’s March Madness.
In recent weeks, the Office of the Comptroller of the Currency released its draft requirements for nondepository fintech firms to become national banks. State regulators oppose the charter. They fear the OCC will send them packing like a 16-seed school going against a powerhouse like the North Carolina Tar Heels.
However, the state regulators can still turn the game around. The OCC’s draft charter requirements, while well-meaning, appear too cumbersome to help the firms most likely to benefit from more consistent regulations. The agency’s misfire presents the states with an opening to come back, but they will need to change their playbook — and will likely need to ask Congress for a little help.
So far states have objected to the OCC’s fintech charter on technical and substantive grounds. The states’ primary technical argument is that the OCC lacks the authority to offer charters to fintech firms, an assertion the OCC disputes. The court may end up resolving the question.
But there are more interesting arguments against the OCC’s charter, which generally fall into three categories: the charter is dangerous, it is unnecessary or it violates state sovereignty.
The “dangerous” argument holds that a federal charter will preempt state consumer protection laws and replace them with inferior federal laws or the more lenient laws of the bank’s home state. The “unnecessary” argument holds that states are better positioned to facilitate innovation and growth by fintech firms and the OCC would muck things up. The “state sovereignty” argument holds that the OCC charter represents an inappropriate intrusion by the federal government into state jurisdiction.
All three arguments — which I explore more in depth in recent Mercatus Center research — have issues with them.
First, as the OCC points out, national banks are still subject to many state consumer protection laws as well as federal consumer protection laws. Fraud, discrimination and unfair and deceptive practices are all prohibited and the OCC will perform regular examinations on national banks. Furthermore, banks are able to provide a consistent product nationwide, and extending that ability to fintechs would improve access and provide competitive equity between firms offering similar products.
The argument that states are better positioned is also dubious. While some firms may find state-by-state regulation adequate, others clearly chafe under it as acknowledged by some state regulators. This is primarily the case for nonbanks. Despite Congress’ explicit desire that states harmonize their money transmission laws, those laws remain an ever-changing maze that requires constant monitoring of more than 50 different sets of rules. Conversely, the situation is better for commercial banks; there is greater consistency between federal and state law, and therefore greater consistency between national and state-chartered banks.
As for state sovereignty, fintechs engage in interstate commerce. So absent a revolutionary shift in Supreme Court jurisprudence, the federal government has the authority to federalize the industry. Also, as Heather Gerken, a professor of law, and Ari Holtzblatt, a lawyer, point out in a paper, the purpose of federalism is not state sovereignty in itself, but a well-functioning democracy. State supremacy must be justified by a benefit to the people, not to the state. If — as is likely — the benefits of state-by-state regulation are outweighed by the loss of opportunity and access imposed on consumers, federal involvement can be justified.
Further, our current system already allows some states the de facto authority to regulate the entire country. Large states or states uniquely important to the financial system, such as New York, have outsize influence on what products and services can be provided. Companies need to build their product to meet bigger states’ regulations to remain competitive — effectively allowing large states to limit the options of the citizens of smaller states.
Instead of trying to block progress, states could try collectively to create a better regulatory environment for fintechs.
States could seize this opportunity themselves via the adoption of uniform codes — banding states together to pass consistent laws — but past history of lending and money transmission regulation fails to encourage optimism that this will happen. Even if states could come together, there remains the need for firms to continually monitor all the states for changes, limiting the benefit of this approach.
There is another option for states, though: Work with the federal government. First, make state bank charters with appropriate requirements available to fintech firms. This would likely require the cooperation of the Federal Reserve or Federal Deposit Insurance Corp. — the federal overseers of state-chartered banks — if states could convince those agencies.
Another option is asking Congress, which has expressed reservations about the OCC charter, to create more consistency. Congress could federalize the aspects of lending or money transmission regulation that interfere with the national market without completely taking over. For example, it could mandate that a money transmitter license in one state must be accepted by the other states.
There is precedent. State-chartered banks enjoy the same ability to export their home state’s law governing interest as nationally chartered banks thanks to the Depository Institutions Deregulation Act. It took federal law to ensure clarity and stability for state banks, but the states remain the primary regulator. A similar congressional effort to provide state-licensed fintechs clarity and stability where disparate state regulation is the most burdensome, while leaving the rest to the states, could provide the best of both worlds.
The OCC is heavily favored to offer a fintech charter, but the agency’s effort is looking vulnerable. States can make a comeback, but the clock is ticking and they better not miss their shot.