FINANCIAL INGENUITY, DEJA VU, & ENSUING CHAOS WITH A DASH OF OPTIMISM
The balance between fostering innovation and protecting the public and overall financial system is a recurrent theme in the history of financial regulation. Prior to the Civil War, the U.S. banking system was unreliable and highly fragmented. At that time, the standards for bank charters varied across states and there was no single federal currency. In this sense, a merchant doing business on both the east and west coasts would need to convert his local currency to the acceptable form in the region he was transacting in. From a business perspective, banks wanting to conduct interstate operations were faced with fragmented state regulatory requirements as there was no federal bank charter available. As such, a uniform financial system was needed.
In a similar manner, because there is no federal bank charter specific to fintech entities, these entities must also conform to an expensive and fragmented approach to engage in banking-related activities, such as lending. However, this is expected to change as the Treasury Department looks to foster a more innovative environment by offering a federal bank charter that preempts state banking laws. In effect, fintech companies can bypass state laws concerning the state-by-state bank charter application process and, arguably, many state consumer protections laws.[1]
The Office of Comptroller of the Currency (OCC) announced, under the authority of the National Bank Act (NBA), that fintech companies can now apply for a special purpose national bank (SPNB) charter that would allow these entities to take advantage of the federal preemption benefits available to full-service national banks. Most commonly, trust banks and credit card banks are the types of business entities that operate in the SPNB sphere. To qualify, the entity must be engaged in fiduciary activities, receive deposits, pay checks, or lend money. Because the application of an SPNB charter is new in the fintech context, the implications are uncertain, yet not entirely unfamiliar.
From a consumer and systemic safety perspective, as discussed in a previous article (here), fintech companies engaged in lending activities would not need to partner with a bank to circumvent state-mandated usury laws. They can commit usury without engaging in legal gymnastics. Additionally, as long as the entity does not take deposits, it would fall outside the scope of the Federal Deposit Insurance Act (FDIA) and would not need to seek insurance through the Federal Deposit Insurance Corporation (FDIC). Moreover, because the SPNB entity is uninsured, the Bank Holding Company Act (BHCA) would not apply to a parent-holding entity and in-turn the parent-holding entity would not be subject to Federal Reserve oversight.[2] All of this is not necessarily a bad thing; however, a heightened sense of awareness is appropriate given the economic history of U.S. financial ingenuity.
On the other hand, granting fintech entities access to a federal charter brings uniformity and a sense of transparency to this emerging market since an entity holding the SPNB charter is required to be a member of the Federal Reserve System, subject to oversight as a member bank. In general, the SPNB is subject to the same laws, regulations, examination, reporting requirements, and ongoing supervision as other national banks.
Looking forward, one could argue that the fintech SPNB charter and overall challenge to legacy banking is a good thing for the consumer in the long-term. Arguably, fintech has offered broader participation and accessibility to capital markets and financial products, all of which is good for the consumer so long as systemic risk is mitigated.
As we watch history unfold, we will see how the pendulum will swing—from cultivating creativity, protecting consumers and the financial system to observing greed take its recurrent form and cause the pile of cards to come crashing down.