No free pass for fintechs
Innovation is a key driver in the community bank industry and has been a significant focus of the Independent Community Bankers of America for quite some time. In fact, as I’m writing this, I’m on a flight to Little Rock, Ark., where we’re celebrating our inaugural demo day for our ThinkTECH accelerator program in partnership with the Venture Center.
Community bankers are embracing innovative fintech products and services, and the ICBA ThinkTECH accelerator is proof of that. The fintechs coming out of this community bank-focused program will partner with our industry to help create the high-tech, high-touch future that is community banking.
And while we continue to spur innovation opportunities, the community bank commitment to a level regulatory playing field is fundamental — as shown during years of advocacy to achieve regulatory and tax parity between banks and credit unions and Farm Credit System lenders.
Online lenders and their representatives in Washington might be forgiven for thinking the regulations they face are more than enough, but the fact remains that their regulatory workload is relatively light compared to full-service banks.
Let’s start with the industrial loan company charter. There’s no secret why fintech companies like Square, SoFi and Nelnet are so interested in this rather obscure charter — because of its significant regulatory advantages. A loophole in the federal Bank Holding Company Act allows commercial and tech companies to own or acquire ILCs without being subject to Federal Reserve consolidated oversight or the act’s prohibitions on engaging in commercial activities.
This loophole not only puts ILCs at a distinct advantage to their fully regulated competitors, it also subverts the goals of holding company oversight. Consolidated supervision allows the Fed to understand and monitor holding companies to avoid risks to their subsidiary depository institutions. Parent companies are expected under U.S. banking law to serve as a “source of financial strength” to their subsidiaries. Conversely, regulators must ensure that parent companies experiencing difficulties will not drain their banks’ liquidity to prop themselves up — creating systemic risks for the banking industry while exploiting its federal safety net.
Another fatal flaw of the ILC charter is that it violates the nation’s policy of separating commercial activities from banking. ILCs are the functional equivalent of full-service banks. Federal law prohibits all other such entities, whether federally or state chartered, from being owned by commercial companies. The fact that ILCs are the fashionable charter of choice these days for tech firms seeking to benefit from the federal safety net and reduced oversight demonstrates the need for policymakers to close off this loophole with a permanent moratorium on new ILC charters.
While the ILC loophole dates to 1987, community banks are meanwhile seeking to ward off additional regulatory inequities before they are implemented. The Office of the Comptroller of the Currency’s proposed special-purpose national bank charter for fintech companies would subject online lenders to more oversight than they currently have, but it raises questions concerning the regulatory framework that will govern the supervision of these firms.
Under the OCC proposal, these companies would be subject only to limited safety and soundness supervision and examination and would not be subject to the Community Reinvestment Act. Further, it remains unclear whether the owners or affiliates of OCC-chartered fintechs would be regulated in the same way that the Bank Holding Company Act restricts the commercial activities of bank holding companies — raising the same concerns over banking and commerce as the ILC charter.
A series of recent earnings, underwriting and compliance problems at online marketplace lenders illustrates the need to ensure their regulatory, capital and liquidity requirements are no less stringent than those that apply to insured depository institutions. This would help ensure not only regulatory consistency among providers, but also a safe and sound financial system — particularly with the introduction of entities that have had serious funding and capital issues despite not yet having experienced a serious economic downturn. Finally, the OCC should obtain statutory authority from Congress to create the special-purpose fintech charter and issue rules subject to notice and comment that prescribe its scope and requirements — ensuring it proceeds on a sound legal footing.
In lieu of these flawed charter options, fintech companies could instead follow the lead of Varo Bank, a mobile-only fintech whose application for a full national bank charter was recently approved by the OCC. If fully approved, Varo Bank will be subject to full array of national bank regulation and supervision. If Varo Bank has a holding company, it will be subject to consolidated Fed examination and oversight, as would any other de novo national bank. This is what regulatory consistency looks like.
To ensure a fair and open financial services marketplace, community banks advocate a regulatory framework for fintechs that is no less stringent than that which applies to insured depository institutions. It is the only way to ensure the responsible growth of tech innovations and a customer-friendly financial system.