(New York, NY): All eyes are on FinTech following the announcements last month from the Office of the Comptroller of the Currency (OCC) and the U.S. Treasury Department supporting financial services innovation. The OCC’s decision to start taking applications for a new Special Purpose National Bank (SPNB) charter for FinTech companies is particularly intriguing. While the new OCC charter represents an opportunity for FinTechs to gain national bank powers, there is a long path ahead for any organization wishing to explore this option. Potential challenges include understanding the legal underpinnings of interest rate exportation, weighing the relative value of taking deposits, understanding the impact, if any, of the Bank Holding Company Act, and evaluating the advantages and disadvantages of a bank partner model. For those FinTechs that elect to pursue a bank charter there is the prospect of a lengthy regulatory review process and the challenge of integrating a complex compliance framework into a technology platform.
While the OCC SPNB charter may be the newest way to facilitate FinTech lending, it isn’t the only option. Other choices include the “State Finance Company” model, in which companies must comply with the usury laws and regulations of each state in which they operate, the “Bank Partner” model, as well as the recent reemergence of the Industrial Loan Company (ILC).
Each FinTech now finds itself at a regulatory Rubicon: To either take control of its destiny by embracing one of the available bank charters, with all of the attendant compliance and regulatory challenges; or to remain a non-bank technology company, dependent on a bank partner or subject to multi-state laws.
Here are four of the most important factors for FinTechs to consider now:
All models with the exception of the State Finance Company model enable the exportation of interest rates, to some extent. FinTechs need to compare the strengths and weaknesses of the exportation rights available through the OCC SPNB model, the Bank Partner model, and the ILC charter model.
In recent years, there have been challenges to the legal framework that supports the Bank Partner model. The claims raised in recent lawsuits allege that when a non-bank entity purchases or funds a loan, the originating bank in fact is not the lender, but that rather, the non-bank entity is the “true” lender, notwithstanding that the bank did in fact underwrite and originate the loan in question. Courts are reaching conflicting conclusions in these cases: Some have identified the originating bank as the true lender while others have ruled that the non-bank is the true lender.
If rate exportation is important to a FinTech, thinking through the advantages of all models and charter options in detail will be paramount.
The FinTech models for lending, including “peer to peer” and “marketplace” lending, do not require deposit funding. This type of pass-through model, which has the benefit of a much lower capital requirement, needs only a “warehouse” type of funding which can be supplied by other banks or capital market participants. But some FinTechs have concluded that building a large portfolio of on-balance sheet loans in an aggregation facility may allow them to access even lower-cost securitization funding. For such FinTechs, deposit funding could be very advantageous.
FinTechs will need to decide if FDIC-insured deposit-taking ability is a critical need. The bank charter options vary – for example, the ILC model provides deposit taking, but the SPNB does not.
In the US, there has been a longstanding concern over mixing commerce and banking. Under the Bank Holding Company Act (BHCA), a private equity firm that holds a controlling interest in a bank may be deemed a bank holding company, which may result in restrictions on other business investments. For a FinTech with private equity or venture capital investors, the BHCA restrictions may be a deal killer.
Having an ability to export interest rates or to take deposits may be hugely beneficial, but if it comes at the expense of raising equity capital it may be a non-starter. ILCs operate under an exception to the Bank Holding Company Act and have been established by some of the major US industrial businesses, such as General Motors, Ford, GE Capital and others.
Obviously, the Bank Partner model does not impose BHCA restrictions on investors in a FinTech business. With regard to the SPNB charter, the US Treasury Department has encouraged reconsideration of the definition of “control” under the BHCA. If properly addressed, this could free some SPNB investors from the constraints of the BHCA.
The Bank Partner model has a long and successful track record, but a FinTech that relies upon a Bank Partner is always at risk of exogenous events impacting the Bank Partner and curtailing the FinTech business. Some FinTechs may choose to address this by having more than one Bank Partner. Ultimately, a FinTech must decide how much control over its own destiny it requires.
How Auriemma Can Help
For FinTechs weighing the options, there are numerous considerations on the road ahead. Auriemma executives have experience working with regulators to successfully obtain necessary approvals with respect to various types of bank charters. Auriemma is actively exploring the nuances of these charter options to assist FinTechs in making the best possible strategic decisions.
In addition to identifying whether to pursue a charter and pinpointing the advantages and disadvantages of each model, FinTechs must also develop policies and procedures and operational infrastructure that align with their chosen direction and strategy. As a result of our decades long industry roundtable practice, we have extensive benchmarking data and “best in class” operational know how which can help new lenders.
About Auriemma Group
For more than 30 years, Auriemma’s mission has been to empower clients with authoritative data and actionable insights. Our team comprises recognized experts in four primary areas: operational effectiveness, consumer research, co-brand partnerships, and corporate finance. Our business intelligence and advisory services give clients access to the data, expertise and tools they need to navigate an increasingly complex environment and maximize their performance. Auriemma serves the consumer financial services ecosystem from our offices in New York City and London. For more information, call John Costa at (212) 323-7000.