The future of American fintech may hang in the balance of a pitched battle that has grown in intensity over the past four months. An obscure request for comments on regulatory standards, released by the Office of the Comptroller of the Currency (OCC) last March, has since evolved into a complex turf war between the states and Washington, DC.
Caught in the middle is the entire online finance industry, raising the question of just what a “fintech” business really is. Though it hasn’t made many national headlines, this fight may determine the future of innovation, competition and survival in the fintech world.
The debate centers around a proposal made in December by Thomas J. Curry, the Comptroller of the Currency, in which the OCC details a program for fintech companies to apply for charters as “special purpose national banks.” The charter, which is optional for fintechs, is meant to provide companies with a stamp of approval from the OCC for having generally strong compliance practices. This would essentially be a way for Washington to separate the well-run, “safe” fintech businesses of the world (e.g. PayPal) from the shady, exploitative ones (e.g. check cashers and payday lenders.)
In theory, the idea has a lot of merit. Though fintech can still be thought of as a relatively young industry, it is growing quickly enough that it may soon determine how most people save, exchange and invest their money. This proposal comes at a time when the world — from the U.K. to Germany to India to Korea — is evaluating what kind of guard rails the fintech sector needs.
When the industry is all grown up, consumers will want protections in place that prevent bad actors from misleading them, misusing their private information or stealing their money. And even if individual fintech businesses look to be compliant on their own, some national oversight might be needed to get ahead of the same kind of collective practices that brought about the financial crash in 2007.
With this in mind, the OCC wants to take the first step to create a uniform, nationwide set of standards for fintechs. But what should have been an uncontroversial first step instead unearthed a slew of objections from a complex web of stakeholders. These parties quickly raised concerns about stifling innovation, overstepping the limits of federal authority and understanding the nuances of fintech, among many others. At the very heart of this battle is the question of what fintech really is. And as evidenced by the debate, that question is much harder to answer than it may seem.
The history of finance, technology, the OCC and the need for regulation
The idea of fintech regulation is nothing new or novel. The OCC was itself established by the U.S. government in one of the first efforts to create standard national banking practices. Before the Civil War and the National Bank Act of 1863, states had the freedom to issue their own legal tender. Often, this meant the dollars someone was paid in one state wouldn’t be accepted in the next state over, or would be worthless if the currency reserves of the issuing state became insolvent. Some states, such as Wisconsin, outlawed banks altogether, while others like Michigan let anyone open a bank and suffered massive fraud as a result.
It was only after the Civil War that Washington began enforcing national financial consistency, a move that generated massive protests at the time from states, who saw the move as a federal overreach to consolidate power over local government.
In many tech fields today, as the industry grows, so do the questions about regulation. The questions of “whether Airbnb hosts should be subject to hotel laws” or “whether Uber drivers are employees or contractors” are just two notable examples in a long history of technology’s legal debates. Fintech, at the intersection of finance and technology, is obviously more poised for regulatory discussion than most tech.
It’s easy to see why fintech worries regulators and the public alike. As long as finance has existed, so have bad actors looking to take advantage of unwary counterparties. Julius Caesar set one of the first interest rate caps — at 12 percent — for the Roman Empire to combat loan sharks.
The early Quran still sets the standard for many Islamic banks, which must conduct Sharia-compliant finance. In the antebellum U.S., private lenders charged up to 500 percent interest to borrowers due to a dearth of banks and government regulation.
Financial malpractice is just as pernicious today. In its first five years, from 2011 to 2016, the new Consumer Financial Protection Bureau (CFPB) received more than 900,000 consumer complaints about financial services providers.
Fintechs themselves have not been free from fraud and scandal. The publicly traded TrustBuddy, based in Sweden, was forced into bankruptcy for massive misappropriations of investor funds. Cincinnati-based SoMoLend came under similar fire for misleading investors. And China’s peer-to-peer lending sector has spent years battling its way out of the shadow of massive fraud that has tainted the industry.
Given the natural tendency of unscrupulous actors to exploit regulatory loopholes in finance, it’s no wonder the OCC wants to strike first to prevent the next financial apocalypse. That’s why, in March of last year, it released a whitepaper on innovation in financial services detailing eight “guiding principles” it would use to foster a healthy fintech sector, including, among others:
Encourage responsible innovation that provides fair access to financial services and fair treatment of consumers.
Encourage banks of all sizes to integrate responsible innovation into their strategic planning.
Collaborate with other regulators.
Yet in November, when Thomas J. Curry announced the OCC’s plan for a national charter, all hell broke loose.
The controversy: turf wars, anti-competition and solutions for problems that don’t exist
The OCC’s call for a national charter has been, to say the least, controversial. The proposal itself, only 16 pages in length, designates fintech firms as “special purpose banks,” which would be subject to minimum requirements around governance structure, capital, liquidity, compliance, financial inclusion and continuity strategy. This all sounds pretty benign — who would want to give their money to a company that didn’t have those safeguards in place?
As it turned out, the proposal caused a firestorm among numerous fintech industry stakeholders. Weirdly enough, fintech companies, which will arguably be the most impacted by the charter, have been relatively quiet. The strongly vocal opponents of the charter have been an alphabet soup of state regulators, who view this move as a broad overreach of federal authority:
New York: DFS Superintendent Maria T. Vullo in January released a stern public comment letter to the OCC. In it, she argued that banks with national charters don’t have to abide by some state lending rules, and this charter could allow payday lenders to sign up for protections meant for tech companies. As she commented, “Fintech may be a catchy new word, but the concept of online finance isn’t new.” New York plans to move forward with its own rule proposals for fintech businesses.
Florida: OFRC Commissioner Drew Breakspear called the charter a “solution to a problem that does not exist.”
Ohio and Oregon: Senators wrote in to the OCC saying this would complicate existing state fintech laws and initiatives.
California: Jan Lynn Owen, the commissioner of the CA DBO, argued that the proposal would complicate the DBO’s efforts to compile data on online marketplace lenders — such as fintech firms SoFi, Lending Club, Funding Circle and Prosper — in order to separate them from payday lenders.
The list of states goes on. It’s fair to say they feel threatened by the proposed charter’s impact on their authority. But is it just a territorial spat, a turf war over who gets to oversee the fintech industry? Brian Knight, writing for American Banker, does an excellent job summarizing and rebutting the states’ positions:
The “Dangerous” Argument: Federal laws will pre-empt states’ abilities to regulate fintechs within their borders.
As Knight 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.”
The “Unnecessary” Argument: States can already enact better laws to regulate fintech, so the OCC’s authority in the matter is redundant and unnecessary.
As per Knight, “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.” (Morning Consult also points out that, where states like North Carolina have been very friendly to fintechs, states like New York and Connecticut have been much tougher — a feature that allows fintechs to engage in regulatory arbitrage across state lines.)
The “State Sovereignty” Argument: The OCC is overstepping their authority by overruling states that should be able to freely impose their own regulations.
“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.”
Knight’s analysis exposes the states’ arguments for what they are: self-defense against a perceived territorial encroachment by the OCC. Even so, to give some credit to regulators, there are still very real reasons this charter could easily hurt the not-nascent-but-not-yet-matured fintech sector in many ways:
Bureaucracy: The OCC has granted only one national bank charter in the last six years. Would it move quicker to enable fintechs? It’s difficult to see how it would.
One-size-fits-all: Fintechs are too diverse to be included in a charter generally drafted to legitimize deposit-holding institutions. As The Hill notes, this charter could lump together “payday lenders, marketplace lenders, and peer-to-peer payment companies” with robo-advisers, bank service providers, insurance tech, stock market apps, etc… Should they all be treated as banks?
A competitive moat: Though the charter could narrow the gap between fintechs and banks, allowing fintechs to compete nationally instead of applying for state-by-state licenses, it could also lead to a “thinning of the herd” by being too cumbersome or expensive for young companies. This could easily stifle innovation.
More compliance risks: Fintechs could find themselves written into a narrower and narrower regulatory box, increasing the chances they’re shut down for benign compliance missteps.
Balkanized regulators: Similar to the CFPB’s “no action letter,” which promises the bureau won’t take action against companies that meet its standards, gaining a charter from the OCC still won’t shield fintechs from other regulators who may have different rules.
Predictably, it seems national regulatory agencies such as Moody’s are in favor of the charter. Credit unions, which see the charter as a way to level the playing field with fintechs, are also in favor. The Conference of State Bank Supervisors is against it. It seems everyone but fintechs themselves has an opinion on the charter.
In light of all the controversy around establishing a national fintech charter, can a compromise be reached?
The path forward: what would a good fintech charter look like?
Despite the heated pushback against the OCC’s charter plan, there are still very good reasons for centralized, consistent and national oversight of the fintech industry. As ex-Treasury Secretary Tim Geithner notes in Stress Test, his excellent memoir of the financial crisis, one of the reasons the Great Recession was so bad was that the “safeguards for traditional banks weren’t tough enough […] but what made our storm into a perfect storm was nonbanks behaving like banks without bank supervision or bank protections.”
If the fintech sector continues to grow as its leaders project it to, it may one day affect the lives of most Americans. It’s important to put the guard rails in place now to make sure a systemic shock doesn’t leave those Americans footing the bill.
The OCC’s proposal is probably the wrong solution. But, contrary to Florida OFRC Commissioner Breakspear’s assertion, that does not mean the problem does not exist. By launching a discussion of a national charter, the OCC has taken an important first step.
The state-by-state system has failed us before. As Geithner notes, it “led to venue shopping and other forms of regulatory arbitrage, as well as blind-men-and-the-elephant problems where no regulator had a truly comprehensive view of an institution or the responsibility for monitoring it.” And its Balkanization impairs the kind of federal oversight needed to detect nationwide trends as they develop: credit defaults in California could affect consumers in Texas, digital currency scams in Florida could inform regulators in New York, etc…
Then what would a good set of national fintech regulations look like?
It would set basic underlying consumer protections. For instance, no fintech firm should be allowed to misrepresent its fees — and this is something that shouldn’t vary by state.
It would preserve state sovereignty. States don’t have to all agree to one usury limit. But they can agree to a framework for how to establish usury limits that prevents lenders from cross-border regulatory arbitrage.
It would recognize the heterogeneity of fintech. Most fintechs disintermediate banking services, each tackling only one of a wide range of services. On top of that, some fintechs (Zopa, SoFi) are themselves starting to build banks, while others (Moven, Monzo, Atom) want to be “bank-lites.” A banking charter runs the risk of being too broad (and weak) or too narrow (and inflexible). Regulation should be flexible enough to encompass new fintech models as they develop, without risking losing its teeth.
It would promote innovation while following the Hippocratic Oath of first doing no harm. This could mean eliminating the burden fintechs face today of having to apply for 50 state licenses, while not imposing an onerous federal licensing cost and burden on them.
It’s unclear whether the OCC is the best organization for the job. Many other federal organizations, such as the SEC, FINRA and the embattled CFPB, also have overlapping interests in the fintech industry. Maybe, as Brian Knight suggests, states can take the initiative by banding together to form a set of national rules, or maybe they can work with Congress to establish a new fintech regulator independent of the OCC. The Hill points out that one good example to follow is that of The Fed in its study of the payments industry.
At the same time, it’s notable that one of the voices least present in this debate is that of fintechs themselves. While I won’t claim to have any more comprehensive of a perspective on the issue, my background comes from five years in the fintech industry (since before “fintech” was a common phrase). I’m surprised that commentators haven’t picked up on some great guiding examples already set by the fintech sector:
The Marketplace Lending Association and the Small Business Borrowers’ Bill of Rights are two industry organizations established for online lenders to self-regulate by adhering to high standards of transparency, fairness and consumer protection. (Full disclosure: One of the founders of these organizations is my former employer, Funding Circle.) In the U.K., online lenders (including Funding Circle) petitioned the Financial Conduct Authority to regulate the industry, which it began doing in April 2014. These examples can be instructive for U.S. regulators seeking to get their arms around the large and messy industry.
This month, Thomas J. Curry will step down from his post in charge of the OCC. The CFPB is under fire from Republicans and the Trump administration and may not survive much longer. It is unclear whether the push for federal oversight of fintech will survive this debate or simply die out, but striking down attempts at federal regulation ends up legitimizing illegitimacy.
Like many black markets, alternative finance and shadow banking would be safer if it were brought into the light and monitored. As Geithner says, during the banking crisis, “The financial cops weren’t authorized to patrol the system’s worst neighborhoods.” We can prevent the next financial crisis today… but we need to be willing to take the first step.