What's missing from the OCC's fintech charter
A version of this post was previously published on the Federal Financial Analytics blog.
The Office of the Comptroller of the Currency recently finalized its controversial decision to authorize a special-purpose fintech charter.
Although the OCC emphasizes that it’s holding these special-purpose charters to standards equivalent to those demanded of national banks, this is only sort of true with regard to the named prudential requirements, and it looks to be completely incorrect on critical restrictions on competitive and financial risk. These omissions have significant consumer protection, safety and soundness and structural impacts. Absent egregious violations, a charter granted cannot be revoked. The OCC should be sure it isn’t a shadow-bank enabler before it hands out these high-powered charters.
If other U.S. regulators follow the OCC’s example and grant charters or authorize ground-breaking activities before these policy questions are fully considered, a lot of embedded risk could quickly confront both consumers and the overall financial system. The OCC says that it’s for “responsible innovation.” But to spur this kind of innovation, agencies need to go into depth on structural policy questions, not decide them on a case-by-case basis in the dark corners of each charter approval.
The first structural problem we’ve spotted deals with the fact that bank capital and liquidity standards (let alone most other structurally significant prudential ones) cannot be applied in like-kind fashion to fintech, because most fintech charters will not be anything like most national banks. For all the work around fintech’s edges, national banks are first and foremost financial intermediaries. This means that most risk comes from extensions of credit or, for larger ones, trading exposures, and most funding comes from the deposit or debt market. All of the post-crisis rules are founded on this basic proposition.
Yet fintech risk is different. One case in point: Very few fintechs are capital intensive. Instead, they handle transactions or interfaces, making money through cross-selling, advertising, add-on fees or other strategies. As a result, the most important risk for many fintechs is operational. Would the big-bank operational risk-based capital framework work here? It doesn’t even work for the banks for which it was designed. The Basel brush-up — which is retrospective — is even worse-designed for fintech ventures. Is capital even the right way to ensure fintech operational resilience? It would be good to know before there are a lot of special-purpose banks. Cyber risk, for example, isn’t exactly an afterthought here.
Secondly, what exactly will these fintechs do in relation to parent companies and/or partner institutions? Banks are under a lot of restrictions here, starting with all the disclosures customers have to get to be sure that they know a nontraditional product isn’t backed by the Federal Deposit Insurance Corp. I know fintechs aren’t allowed to take insured deposits, but any company with “bank” in its name could be easily understood to do so. Bank holding companies are also barred from tying products so that individual and business customers are forced to get something they don’t want in order to get a desired service. Bank holding companies also cannot offer a deeply subsidized price on one product to encourage customers to get others available without ties on the open market.
Banks bristle at these cross-selling bans, but they are barred by them. Yet since fintech parents are unlikely to be bank holding companies, no such anti-tying prohibitions apply. Given the tied offerings already evident by fintechs seeking nonbank bank charters, this market power is clearly desired. Should it be allowed?
Finally, will fintech parents stand by their special-purpose banks or throw them to the wolves under stress? Bank holding companies can’t do so and the Dodd-Frank Act extended this source-of-strength requirement to nontraditional charters. The general theory here is that there is a need to ensure parent-company shareholders take the pain as well as gain from ownership of an insured depository, a theory that doesn’t apply to fintech special charters. Are there other risks that warrant a source-of-strength obligation?
What about the competitive power of fintech parents not forced to bear any capital or liquidity costs for the activities that otherwise consolidate into their earnings? When can fintechs upstream earnings given that they are not to be covered by stress tests even though the OCC says its standards are banklike? Who loses and what financial-stability risk might result from fintech operations of different sizes, business models or interconnectedness? If the OCC does not condition new charters on the parent company responsibilities it thinks prudent, it can’t retroactively change its mind without a rulemaking that will take time and could prove too late.
These questions are critical not only to fintech special-purpose charters but to the broader thrust of the OCC’s policy statement. It establishes a broader principle: The OCC can establish a category of special-purpose national banks when it thinks a policy or market benefit would ensue. All sorts of ventures are possible. I like the idea of equality-focused charters, but what about special ones for, say, commercial real estate development otherwise barred for national banks under most circumstances? What about other activities on the fuzzy barrier between banking and commerce with powerful advocates? If the OCC doesn’t build out its special-purpose charter policy, we’ll get a lot more innovation at the cost of a lot less responsibility.