Fintech Charters: What Does the Future Hold?

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Wharton’s David Zaring speaks with Wharton Business Daily on SiriusXM about what’s ahead for fintech.

Financial technology firms, or fintechs, are facing a crucial time with regulators questioning plans to give them charters that would enable them to offer products similar to those of banks, but with relatively fewer regulatory requirements. “Fintech charters” were first proposed by the banking regulator, the Office of the Comptroller of the Currency (OCC), during the Obama administration; the Trump administration announced that it would accept applications. The charters aimed to allow fintechs to offer lending or payment products without insurance from the Federal Deposit Insurance Corporation (FDIC) and have federal oversight instead of complying with state banking regulations.

In oral arguments before the U.S. Court of Appeals for the Second Circuit on March 8, the New York solicitor general opposed the plan for fintech charters, arguing that it would allow companies to evade state regulation, such as interest rate caps, according to a Bloomberg Law report. Potential beneficiaries of regulatory relaxations include Walmart and technology companies such as Apple, Google and Amazon, which have already launched bank-like offerings or have announced plans to do so.

Allowing Big Tech and other large corporations to set up banks would fundamentally alter the banking landscape in the U.S., according to David Zaring, Wharton professor of legal studies and business ethics. “If these really big businesses got into financial services, there would really be an erasure of the separation between commerce and banking, which has been around a long time,” he said on the Wharton Business Daily radio show on SiriusXM. (Listen to the podcast at the top of this page.) “We don’t let banks, for the most part, open commercial businesses. And we don’t let commercial businesses open banks.”

While there are several reasons for that separation of roles, “some of it is distrust of banks,” Zaring continued. “If firms like Walmart, and then following them, the big online firms started doing the business of banking, that would be a real change in the way that people get their banking services in the U.S.”

The OCC wants to help fintechs overcome current requirements of securing state-level licenses with a “special bank charter” that would allow oversight by a single federal regulator, but a 2019 court ruling limits the OCC’s chartering ability to deposit-taking banks. Fintechs are currently not allowed to accept deposits or secure insurance coverage for them from the FDIC.

“If these really big businesses got into financial services, there would really be an erasure of the separation between commerce and banking, which has been around a long time.” –David Zaring

The proposed charters would introduce “serious risks” to the economy, banking trade groups said in a joint letter to the OCC last July. Although the OCC has encouraged fintechs to apply for the charter, no applications have been filed yet, the appeals court was informed in the latest hearing.

Even as the regulatory outlook for fintechs remains uncertain, some aspirants like Walmart are getting their decks ready. Zaring noted that the retailer recently hired two bankers from Goldman Sachs who ran the investment bank’s “pretty successful” online consumer banking arm. Earlier, in January, Walmart had announced its plans to set up a fintech startup. Zaring wondered if the retailer planned to set up a consumer bank, and if others that might follow on that path include Apple, Google and Amazon. “They have big wallets. Amazon has a ton of information about vendors on its site. It could make loans to those vendors. It has started to do some of that,” he said.

The Biden Era

Recent efforts to provide fintechs more business latitude began during the Obama administration, which tried to develop a special charter that would let financial technology firms get some of the benefits that banks get when they obtain a banking charter, Zaring recalled. The agency finished rules on fintech charters in 2017 under former Comptroller Joseph Otting, a Trump appointee, the Bloomberg Law report noted.

The Trump administration took that forward and invited applications for special fintech charters. But that move triggered multiple lawsuits “over whether the government has the legal power to give special charters to fintech or treat fintechs like banks,” he said.

A decisive direction on the issue from the Biden administration hinges on the appointment of a new head of the OCC; the agency is now headed by Acting Comptroller Blake Paulson.

It is not clear if the Biden administration would take a different approach than the Trump administration to granting special fintech charters, Zaring continued. Meanwhile, Biden is facing opposition to his rumored choice to head the OCC, Michael Barr, who previously served in the Obama administration as a senior treasury official. Critics have said that Barr became too “cozy” with fintech firms after leaving the Obama administration; he later served on the boards of fintech firm LendingClub and the crypto payments company Ripple Labs.

Zaring wondered if the Biden administration would support fintechs getting into banking services by buying banks. He noted that LendingTree last year announced a deal to buy Radius Bank. “If the Biden administration wants to encourage fintech competitors to incumbent banks, those kinds of licenses will be easier for those financial technology firms to get.”

Complex Regulatory Questions

Zaring said he expects the Biden administration to favor higher levels of regulation for fintechs. But the key issue is about who will regulate them, he added. “The question is, do we want financial technology firms to be regulated at the state level, which might be a different set of regulations, with a lot of consumer protection concerns and some interest rate limitations on what a fintech could charge for a loan or something like that?” he asked. “Or do we want it to be regulated at the national level, which has some appeal to companies doing business on the internet because, of course, the internet doesn’t know state borders?”

“One of the things that banks are very good at, because the government makes them be very good at it, is anti-money laundering.” –David Zaring

Zaring raised more questions over the prospect of federal regulation of fintechs. “Will the federal government be as worried about protecting consumers as the states can be? Or does the federal government just have more capacity to regulate these kinds of firms than states do?” Those are questions fintechs must weigh as they think about the future of regulation in their industry, he added.

One concern Zaring had is about the affinity for the regulatory rigor in banking among fintechs, especially as it relates to anti-money laundering mechanisms. “One of the things that banks are very good at, because the government makes them be very good at it, is anti-money laundering,” he said. With their know-your-customer (KYC) apparatus, banks “are used to picking up fraud and ferreting it out,” he added. “They help the government fight terrorism and prevent money from going to countries that we don’t like.”

Fintechs may not have the wherewithal to take on those roles, according to Zaring. “One risk fintech firms and incumbents like Walmart face if they get into the business of banking is that they will miss some people who use their institutions to launder money or [similar activities],” he said. “And they may not be as attuned as financial institutions are to helping the government uncover that kind of stuff. Tax evasion is another big issue.” If fintechs fail on that score, they could attract hefty fines and be the subject of “really embarrassing stories about being taken advantage of by narco traffickers.”

Other concerns have to do with consumer protection, especially because fintechs disburse small-dollar loans, he added. “It just creates a complicated regulatory environment for financial technology firms to deal with.”

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