The Office of the Comptroller of the Currency (“OCC”) is embarking on a dual-track regulatory effort that may result in a comprehensive overhaul of the relationships between the fintech industry and regulated financial institutions. On the first track is the OCC’s proposal to allow fintech companies to obtain Special Purpose National Bank (“SPNB”) charters. On the second track is the OCC’s enhanced scrutiny of banks that partner with third-party entities, in particular fintech companies. This regulatory effort may alter the now-common practice of large financial institutions, including banks subject to OCC regulations, partnering with fintech companies. Specifically, agreements between banks and marketplace lenders for the purchase of loans originated through the marketplaces as a means of obtaining funding for additional lending on the marketplace.
As explored below, the calculus underlying these relationships may begin to change as the OCC and FDIC recently have moved to increase their oversight of the relationships between banks and fintech companies. The confluence of both increased regulatory oversight of bank relationships with fintech companies and the potential to use chartering as a means of alleviating regulatory scrutiny may cause banks to prefer certain institutions. Such bank preferences may lead some fintech companies to obtain a charter in order to obtain access to capital at competitive rates while causing other companies to tailor their operations to more discrete products and geographic locales.
The OCC’s Proposed Fintech SPNB Charter
In December 2016, the OCC released its paper Exploring Special Purpose National Bank Charters for Fintech Companies, which proposed that SPNB Charters would be available for certain eligible fintech companies. The release of this proposal has resulted in intensive speculation as to its impact on existing fintech business models and, as evidenced by a lawsuit filed in April 2017 by the Conference of State Bank Supervisors, the authority of the OCC to even issue SPNB charters.
In March 2017, the OCC furthered the SPNB process by releasing its draft fintech licensing manual. Under the proposed guidelines, the OCC will consider, among other things, whether the entity seeking a charter:
• has organizers and management with appropriate skills and experience;
• has adequate capital to support the proposed business, volume, and risk profile;
• has a business plan that articulates a clear path and timeline to profitability; and
• includes in its business plan, if applicable, a financial inclusion plan that has an appropriate description of the proposed goals, approach, activities and milestones for serving the relevant market and community.
Obtaining a SPNB charter likely will allow fintech companies to take advantage of certain privileges available to national banks. These privileges are perhaps most impactful for the marketplace lending industry, which may be allowed to assert the lending privileges of national banks to export interest rates and avoid state licensing requirements.
The OCC’s Third-Party Management Guidance
On a parallel track, in January 2017, the OCC released its Supplemental Examination Procedures for Risk Management of Third-Party Relationships, in which the OCC updated its examination procedures to enhance the scrutiny of relationships between banks and third parties, including fintech companies. In part, the guidance examines whether a bank
• “buys bonds, whole loans or notes from third-party lenders (e.g., marketplace lenders);”
• “has a written agreement with third-party lenders to purchase loans or pool(s) of loans on a future date that meet predetermined criteria, such as interest rate, average loan amount, weighted average credit score, and weighted average life;”
• “is investing directly or indirectly in a third-party lender;” or
• “is providing warehouse lines or other credit facilities to third-party lenders.”
If so, the OCC instructs examiners to examine whether the bank:
• has “performed robust counterparty credit risk analysis of the third-party lenders;”
• has “determined if the loans meet the bank’s underwriting standards;”
• has a “process to determine whether the third-party arrangement meets OCC regulatory investment and lending limits;” and
• has “a process for ensuring that the bank properly records revenue and expenses associated with third-party lending activities in the bank’s financial reports.”
With respect to diligence conducted by a bank on a third party, the OCC examines whether the bank’s management reviewed, among other things, a third party’s:
• Compliance management systems;
• Financial condition;
• Business experience and reputation;
• Information security protocols; and
• Ability to respond to service disruptions.
Clearly, the OCC is keenly aware of the relationships between banks and fintech companies and will review bank operations to ensure such relationships are consistent with the OCC’s regulatory expectations.
The OCC is not alone in its endeavors to monitor the relationships between banks and fintech companies. In July 2016, the FDIC proposed revised third-party management examination protocols designed to address relationships between depository institutions and fintech companies. The proposed FDIC procedures are similar to those promulgated by the OCC and instruct examiners to analyze whether a depository institution has reviewed a third party’s policies and procedures, knowledge and experience, information security, and quality of loans, among other things.
Potential Market Impact
In light of the enhanced regulatory oversight of relationships between banks and fintech companies, a company’s decision to pursue or forego an OCC SPNB charter may color a bank’s decision on whether to invest in or engage with the company, and, if so, on what economic terms. It is unlikely that entering into a relationship with a chartered fintech company will absolve a bank of all of its diligence requirements. However, it does appear that many of the areas the OCC has stated it will examine in the charter process are similar to areas the OCC will examine when reviewing a relationship between a bank and a fintech company. For example, both the OCC’s draft chartering guidelines and the OCC’s third-party monitoring guidance assess the fintech company’s skill and experience, the company’s financial stability, and the sufficiency of the company’s business plans.
With these overlapping examination areas, banks may conclude that entering into relationships with chartered fintech companies and forgoing relationships with non-chartered ones will reduce the regulatory scrutiny of such relationships by the OCC and/or the FDIC. This may be particularly true if there are multiple chartered alternatives in a fintech company’s operating space that present economically viable alternatives. If a bank chooses to enter into a relationship with an unchartered fintech company, the economic terms of the relationship may differ from those offered to chartered companies because of the increased regulatory burden.
While the full impact of these regulations remains to be seen, regulatory realities may force changes to the fintech industry that results in those entities that can obtain a charter doing so to take advantages of (a) cheaper access to capital to fund growth and (b) more stable business partners. Those that do not obtain a charter may find it advantageous to focus on more discrete geographic areas and/or product lines.This article was co-authored by the following:Jarrett L. Hale
and Gregory G. Hesse
are partners and Eric W. Flynn
is an associate in the Financial Services Litigation and Compliance team of Hunton & Williams LLP.