By Kristina Russo
These high adoption rates have both national and state bank regulators stepping up to regulate these “non-banks” in order to protect the American economy and consumers. The implications for businesses using fintech services are substantial as regulators try to balance protecting consumers while still encouraging market innovation and collaboration.
Banks—the traditional institutions that take customer deposits and paychecks and extend loans—are licensed and highly regulated because of their importance in the economy, with deposited funds insured by the Federal Deposit Insurance Corporation (FDIC). Non-banks—financial companies that provide some, but not all, banking services—are not bound by the same licenses and regulations as banks. Non-banks have coexisted with banks for years, performing services such as check processing and digital payment processing. Because most fintech companies focus on singular functionality, such as peer-to-peer lending, mobile payments, digital wallet services, and robo-advising, they, too, are considered non-banks.
That functional definition and regulatory gap have given fintech services the freedom to grow and innovate. However, as fintech companies expanded their offerings—for example, adding merchant financing together with consumer payment applications—the functionality gap has narrowed.4
At the same time, traditional banks have begun to collaborate with fintech companies to provide their customers with the latest tools and conveniences. For fintechs, such partnerships provide them with more customers, established regulatory processes, often cheaper financing capital to the table, and wider exposure (and revenue) for their products.5
These bank-fintech partnerships further blur the line between banks/non-banks and put increased pressure on national and state bank regulators to step up their involvement.
James Bullard, president of the St. Louis Federal Reserve, recently told Reuters, “I am concerned that fintech will be the source of the next crisis.”6 He is not alone, and the worry is two-pronged.
First, regulations such as capital requirements and FDIC insurance are meant to avoid structural collapses in the financial markets. As non-banks, fintech has not been subject to these requirements.
Second, regulations regarding security and privacy are focused on protecting consumers. While fintech databases contain sensitive financial and personally identifiable information (PII) similar to banks, they are not subject to the Bank Secrecy Act protocols and consumer protections that traditional banks are, simply because of the fintech business model.7
Officials worry that fintech companies may sacrifice proper risk management in the pursuit of growth or innovation in the currently unsupervised environment. As a result, many believe they are a target for data thieves, especially in a macro environment where that activity is on the rise concurrent with the rise in online records containing PII.8
Given the borderless nature of Web-based fintech systems, the question of whose jurisdiction regulation falls under is a key challenge. Non-banks have been primarily regulated at the state level, whereas federal agencies address national policy.
The key regulatory parties involved for fintechs are the Office of the Comptroller of the Currency (OCC), an independent bureau of the U.S. Department of the Treasury, and the Conference of State Banking Supervisors (CSBS), an organization of state bank regulators from all 50 U.S. states and territories. Other regulatory bodies, such as the Commodity Futures and Trading Commission and the Consumer Financial Protection Bureau, have also created offices to assist with fintech innovation areas.9
The OCC offers fintechs a “special purpose national bank charter” (SPNBC), which allows participation in payments and loans nationally, but not retail deposits. It has the same regulations as full-service national banks, such as capital, liquidity, and risk management requirements.10 The SPNBC is the OCC’s attempt to recognize the evolution of banking and the institutions that provide banking services, and provide them with the same opportunity to obtain a national bank charter as traditional companies.11 While adhering to these requirements might seem burdensome, the SPNBC is a big win for fintech because it eliminates the cumbersome state-by-state licensing requirement of traditional banks.
The CSBS established its Fintech Advisory Board in 2017 as part of its overarching CSBS Vision 2020 initiative “…through which state regulators are working to modernize the financial regulation of non-banks, in part by moving towards harmonization of multistate licensing and supervision.”12 In February 2019, 14 recommendations from the advisory board were supported by the CSBS, mostly centered on driving adoption of the Nationwide Multistate Licensing System & Registry (NMLS) across all 50 states.13
The NMLS is not a nationwide banking license, but rather a cohesive, coordinated, consistent set of forms, guidelines, and data repository with reciprocity across all 50 U.S. states and four territories.14 In addition to eliminating the barriers of state-by-state licensing, other NMLS benefits include coordination of state examinations and listing in licensing databases accessible by nationwide consumers.
However, progress for unifying regulation stalled when the CSBS filed a complaint against the OCC, seeking to prevent it from granting SPNBCs to entities that operate as non-banks. The CSBS is arguing that such charters exceed the OCC authority granted by Congress.15 Together with the New York Department of Financial Services, the CSBS contends that since fintechs do not take deposits, they are non-banks, and all non-bank licensing is within its jurisdiction, in addition to some secondary territorial legal arguments.
The OCC’s position is that it is authorized by the Treasury Department and is following the core principles for regulating the U.S. financial system as established by a 2017 presidential executive order.16
Current thinking by experts in the field is that the OCC will be endorsed and move forward with issuing SPNBCs, arguing past precedent regarding other financial institutions that are considered non-banks.17 As of this writing, the case remains open.
The U.S. has a large fintech industry whose innovations have been well-received by consumers to the point where traditional banks are partnering with fintechs and bringing their products into their fold. However, the void in existing regulations may pose risks, including structural collapse, data security, and consumer privacy. Time will tell whether national and state bank regulators can work together to create a regulatory framework that allows fintech partnerships with banks to continue while safeguarding the financial markets and consumers.
Kristina Russo is a CPA and MBA with over 20 years of business experience in firms of all sizes and across several industries, including media and publishing, entertainment, retail and manufacturing.
1. A Financial System that Creates Economic Opportunities, U.S. Department of the Treasury; https://home.treasury.gov/sites/default/files/2018-08/A-Financial-System-that-Creates-Economic-Opportunities---Nonbank-Financials-Fintech-and-Innovation.pdf
2. “Why are Fintechs Getting a Regulatory Pass?,” American Banker; https://www.americanbanker.com/opinion/why-are-fintechs-getting-a-regulatory-pass?tag=00000159-ad66-d644-af5f-eff61aca0000
3. “Fintech Firms Want to Shake Up Banking, and that Worries the Fed,” Reuters; https://ca.reuters.com/article/businessNews/idCAKCN1P80C0-OCABS
4. “5 Global Fintech Trends in 2019,” ABA Banking Journal; https://bankingjournal.aba.com/2019/01/five-global-fintech-trends-in-2019/
5. Fintech in the United States: Overview, Association of Corporate Counsel; https://www.cov.com/-/media/files/corporate/publications/2018/12/fintech_in_the_united_states_overview.pdf?_ga=2.236039233.1787670285.1552938569-2021228036.1552938569
6. “Fintech Firms Want to Shake Up Banking, and that Worries the Fed,” Reuters; https://ca.reuters.com/article/businessNews/idCAKCN1P80C0-OCABS
8. “Why are Fintechs Getting a Regulatory Pass?,” American Banker; https://www.americanbanker.com/opinion/why-are-fintechs-getting-a-regulatory-pass?tag=00000159-ad66-d644-af5f-eff61aca0000
9. Fintech in the United States: Overview, Association of Corporate Counsel; https://www.cov.com/-/media/files/corporate/publications/2018/12/fintech_in_the_united_states_overview.pdf?_ga=2.236039233.1787670285.1552938569-2021228036.1552938569
10. Five Key Points from the Treasury’s Fourth Financial Regulation Report, PWC; https://www.pwc.com/us/en/financial-services/regulatory-services/publications/assets/treasury-fintech-regulation-report.pdf
11. “Policy Statement on Financial Technology Companies’ Eligibility to Apply for National Bank Charters,” Office of the Comptroller of the Currency; https://occ.gov/publications/publications-by-type/other-publications-reports/pub-other-occ-policy-statement-fintech.pdf
12. “State Financial Regulators Embrace Recommendations from Fintech Advisory Panel,” CSBS; https://www.csbs.org/state-financial-regulators-embrace-recommendations-fintech-advisory-panel
13. Vision 2020 Fintech Industry Advisory Panel Recommendations and Next Steps, CSBS; https://www.csbs.org/sites/default/files/2019-02/FIAP%20Chart%20and%20Next%20Steps.pdf
14. “Nationwide Multistate Licensing System,” CSBS; https://www.csbs.org/nationwide-multistate-licensing-system
15. “CSBS Sues OCC Over Fintech Charter,” CSBS; https://www.csbs.org/csbs-sues-occ-over-fintech-charter
16. A Financial System that Creates Economic Opportunities, U.S. Department of the Treasury; https://home.treasury.gov/sites/default/files/2018-08/A-Financial-System-that-Creates-Economic-Opportunities---Nonbank-Financials-Fintech-and-Innovation.pdf
17. DFS vs OCC, Consumer Finance Monitor; https://www.consumerfinancemonitor.com/wp-content/uploads/sites/14/2018/10/DFS-v-OCC.pdf