Second Guidance Memo on the Fintech Bank Charter

• Posted on Sep 13, 2018

By Petra Hrachova, CRCM, CAMS, Compliance Director

OCC Begins Accepting National Bank Charter Applications from Financial Technology Companies

On July 31, 2018, the Treasury released its long-awaited Report on Nonbank Financials, Fintech, and Innovation¹ endorsing the creation of  such a charter. The OCC followed suit within hours by announcing the acceptance of Special Purpose National Bank Charter applications² and the CFPB responded within a week by creating a Global Financial Innovation Network (GFIN)³ to provide regulatory guidance on launching a new product or service in the market, a network for regulatory collaboration and sharing and to provide a forum for joint policies and discussions.

This step, referred to by industry observers as a “game changer,” should provide an alternative to fintechs, already regulated by 50 different entities and often required to meet additional obligations imposed by its banking partners. According to the OCC, “Companies that provide banking services in innovative ways deserve the opportunity to pursue that business on a national scale as a federally chartered, regulated bank.” Comptroller Otting stated that, “Providing a path for fintech companies to become national banks can make the federal banking system stronger by promoting economic growth and opportunity, modernization and innovation, and competition.” Despite this statement and all available information many questions remain about the application process, the capital and liquidity requirements, and the impact of the regulatory oversight on fintech companies.

OCC Special Purpose National Bank Charter High-Level Details

The OCC confirmed the challenged statutory authority, regulations, and policies governing its review and decision making with respect to chartering national banks, including special purpose national banks. That authority to grant a charter includes companies that engage in one of the core banking functions (paying checks, lending money, or taking deposits), and is described in 12 CFR 5.20(e)(1). That authority does not require the bank to take deposits within the meaning of the Federal Deposit Insurance Act⁴ and therefore would not require insurance from the Federal Deposit Insurance Corporation.

The OCC Comptroller’s Licensing Manual Supplement Considering Charter Applications From Financial Technology Companies⁵ issued in conjunction with the OCC’s announcement provides detail on the application process, key considerations in the OCC’s review of the application and the supervision process.

The document describes the OCC’s approach applicable to fintech companies engaged in paying checks or lending money relying on funding sources different from those relied upon by insured banks and, therefore, not insured by the Federal Deposit Insurance Corporation. The OCC views the National Bank Act as sufficiently adaptable to include fintechs facilitating payments electronically and would consider the product as the modern-day equivalent of paying checks. Any applicants proposing to engage in activities not already addressed in the statute, regulation, or OCC precedent are encouraged to consult with the OCC. Fintechs that take deposits are required to obtain FDIC insurance and, therefore, would need to apply for a full-service national bank charter.

The OCC’s application process for a national bank consists of four phases:

1. A prefiling phase, in which potential applicants engage with the OCC in formal and informal meetings to discuss the proposal, the chartering process, and application requirements.
2. The filing phase, in which the organizers submit a complete application to the OCC.
3. The review phase, in which the OCC reviews and analyzes the application to assess whether the proposed bank has a reasonable chance of success, will be operated in a safe and sound manner, will provide fair access to financial services, will promote fair treatment of customers, will ensure compliance with laws and regulations, and will foster healthy competition.
4. The decision phase, in which the OCC decides whether to approve a charter application. The decision phase includes the preliminary conditional approval stage, in which the OCC imposes requirements and conditions for receiving a charter; the organization stage, in which the bank raises capital and prepares for opening; and the final approval stage.

The OCC encourages potential applicants to contact the OCC and learn about the application process and the OCC’s requirements and expectations well in advance of filing. A dialog to discuss the charter should be initiated followed by additional meetings to discuss the proposed bank’s business plan, including a description of the proposed activities, the underlying marketing analysis supporting the business plan, the capital and liquidity needed to support the business plan, as well as a contingency plan to remain viable under significant financial stress. The fintech should also be prepared to outline its commitment to financial inclusion and how it will be achieved.

The OCC may provide feedback on the proposal and discuss any legal, policy, or supervisory issues that may be relevant to the proposal and that would need to be resolved in connection with the final application. The OCC will determine whether the organizers should submit a draft application before filing a formal application.

The OCC will start the review when an application is filed and consider whether:

• the proposed bank has a reasonable chance of success,
• will be operated in a safe and sound manner,
• will provide fair access to financial services, will promote fair treatment of customers, and
• will ensure compliance with laws and regulations.

Additional considerations include whether the proposed bank can reasonably be expected to achieve and maintain profitability and whether approving its charter will foster healthy competition. The OCC will consider the applicant’s business model and proposed risk profile. It will also consider, among other factors, whether the proposed bank has a business plan that articulates a clear path and timeline to profitability, has adequate capital and liquidity to support the projected volume, and has organizers and management with appropriate skills and experience. A fintech company with a special purpose national bank charter will be supervised like similarly situated national banks, including with respect to capital, liquidity, and risk management.

The OCC provides additional resources regarding the business plan available in the “Charters” booklet⁶ of the Comptroller’s Licensing Manual and the OCC’s expectations regarding a bank’s risk management and corporate governance framework in appendix A of the Supplement, “Supervisory Considerations.”

The OCC will require minimum and ongoing capital levels to be commensurate with the risk and complexity of the proposed activities and subject to the minimum leverage and risk-based capital requirements found in 12 CFR 3 that apply to all national banks. The OCC expects that for some fintechs the set floor may not be sufficient for measuring capital adequacy and expect the fintech to propose a minimum level of capital that will be met or exceeded at all times.

The OCC preliminary conditional approval for a charter will include a condition specifying a minimum capital level the fintech must maintain at all times. This amount would be based on the analysis of quantitative and qualitative factors. The OCC expects that capital would increase beyond the initial minimum amount as the size, complexity, and corresponding risks of the bank evolve. Since the fintech will be uninsured and likely to rely on funding that is potentially more volatile in certain environments, the fintech will need to describe how it will be funded and maintain sufficient liquidity under stressed conditions.

Financial inclusion and fair access to financial services and fair treatment of customers will have to be demonstrated as well. The expectations for promoting financial inclusion will depend on the fintech’s business model and the types of planned products, services, and activities it will offer. The OCC expectations for a special purpose national charter with lending activities will likely undergo scrutiny and require fair lending reviews. This concept is well known to all full-service national banks under the Community Reinvestment Act (CRA) and fair lending requirements. Obtaining a satisfactory CRA rating has been a challenge for a number of financial institutions. It appears that the OCC will require fintechs to demonstrate commitment and evaluate the policies and procedures related to the financial inclusion rather than compliance at a level of CRA complexity. The fintechs’ commitment to financial inclusion will be ongoing throughout the life of the charter.

Same as regular bank charters, the special purpose charter banks will have to develop a contingency plan to address significant financial stress that could threaten its viability. The contingency plan should outline strategies for restoring the bank’s financial strength and options for selling, merging, or liquidating the bank in the event that recovery strategies are not effective. The OCC’s final approval will require the bank to implement and adhere to the plan. The fintech will be expected to review the contingency plan annually and update it as needed.

The OCC will seek to make a decision on a complete and accurate application within 120 days after receipt or as soon as possible thereafter. But the OCC gives itself more flexibility and provides for additional time and scrutiny if needed. We will not know what the average processing time will be until we have a history of approved applications.

Analysis of Several Key Features

The OCC’s policy statement and Comptroller’s Licensing Manual Supplement stresses the following key requirements and expectations that applicants should consider:

• Every application will be evaluated on its unique facts and circumstances.
• Fintech companies that apply and qualify for, and receive, special purpose national bank charters will be supervised like similarly situated national banks, to include capital, liquidity, and financial inclusion commitments as appropriate. Fintech companies will be expected to submit an acceptable contingency plan to address significant financial stress that could threaten the viability of the bank. The plan would outline strategies for restoring the bank’s financial strength and options for selling, merging, or liquidating the bank in the event that recovery strategies are not effective.
• The expectations for promoting financial inclusion will depend on the company’s business model and the types of planned products, services, and activities.
• New fintech companies that become special purpose national banks will be subject to heightened supervision initially, similar to other de novo banks.
• The OCC has the authority, expertise, processes, procedures, and resources necessary to supervise fintech companies that become national banks and to unwind a fintech company that becomes a national bank in the event that it fails.

The Comptroller’s Licensing Manual Supplement clarifies that it is applicable to applications from fintech companies to charter a special purpose national bank that would engage in one or more of the core banking activities of paying checks or lending money but would not apply to those that take deposits, and would not be insured by the Federal Deposit Insurance Corporation (FDIC). Keep in mind that fintechs that seek a national bank charter and plan to take insured deposits are not eligible for this special purpose bank charter and would be required to obtain FDIC insurance and apply for a full-service national bank charter.

Special purpose national bank charters will be supervised by the OCC as all other national banks, under a scheduled supervisory cycle, including on-site examination and periodic off-site monitoring. The OCC sets high expectations for new charters, and as such, they will be subject to rigorous ongoing oversight to ensure that the bank’s management and the board of directors are properly executing their business strategy and the bank is meeting its performance goals. The charter will be subject to the same ratings framework, including applicable specialty ratings, as other national banks. The rating system, commonly referred to as CAMELS, assesses components of a bank’s performance including capital adequacy, asset quality, management, earnings, liquidity, and sensitivity to market risk, as well as specialty areas such as information technology, trust (if applicable), and consumer compliance.

While the OCC will review the application and issue the charter, depending on the structure of the fintech, other regulators, in addition to the OCC may have oversight and supervisory roles. There should not be surprises as the OCC should coordinate, as appropriate, with other regulators to facilitate consideration of any applications or approvals that may be required by those regulators.

Update on State Money Transmitter Licensing

The State Regulators continue to fight against the federal charter and work towards improving the state licensing process. While there have been certain improvements such as the standardization of parts of the licensing process related to IT, cybersecurity, business plan, background check and Bank Secrecy Act compliance by several states including Georgia, Illinois, Kansas, Massachusetts, Tennessee, Texas and Washington through the acceptance of findings of one of these states, and even as more states have migrated to NMLS, the initial state licensing and license maintenance still continues to be a regulatory maze and an expensive process.

On March 22, 2018, Arizona enacted a “regulatory sandbox program” to enable fintechs to obtain limited access to the market in the state to test innovative financial products or services without obtaining a license or other authorization that otherwise might be required. On July 18, 2018, Paul Watkins, who was formerly in charge of fintech initiatives at the Arizona Attorney General’s office, was named by CFPB Acting Director Mulvaney to serve as Director of the CFPB Office of Innovation.

The New York Department of Financial Services (NYDFS) lawsuit challenging the OCC’s fintech charter filed on May 12, 2017 was dismissed in December 2017, leaving a possibility that the New York Regulator could re-sue the OCC if it were to create a fintech charter in the future. On July 31, 2018, Mrs. Vullo, the DFS superintendent, issued a statement confirming NYDFS fierce opposition to the Department of Treasury’s endorsement of regulatory “sandboxes” for financial technology companies and the OCC decision to begin accepting applications for special purpose national bank charters from non-depository financial technology companies.

The Conference of State Bank Supervisors (CSBS) launched a complaint in the US district court alleging that the OCC was over-reaching its authority to grant charter status to non-banks, but the case was also dismissed on April 30, 2018.

In June 2018, the CSBS issued Vision 2020 as an initiative to modernize state regulation of non-bank financial institutions. By 2020, state regulators have committed to adopting an integrated 50-state licensing and supervisory system by leveraging technology and smart regulatory policy to transform the interaction between industry, regulators and consumers.
Vision 2020 focuses on 6 major initiatives to transform state supervision of non-bank and fintech companies:

1. The Fintech Industry Advisory Panel provides industry input to help states: modernize regulatory regimes; identify points of friction in licensing and multi-state regulation; and discuss a wide array of solutions. The panel will focus on payments and money transmission; lending; and community banks and innovation.
2. Redesigned Nationwide Multistate Licensing System (NMLS) – the common platform for state regulation – will transform the licensing process thru data/analytics; automate most new applicants; and enable states to focus more on higher-risk cases while streamlining state regulation on a multi-state basis.
3. Harmonize Multi-State Supervision by establishing model approaches enhancing uniformity in examinations; facilitating best practices; and identifying and reporting non-bank violations. The CSBS is also building a new technology platform for state exams.
4. Assist State Banking Departments, through education programs, analytics and stronger standards, the CSBS is helping state departments: identify their weaknesses; put expertise where it is most needed; update supervisory processes; compare and learn from other states; and validate higher performance thru accreditation.
5. Enable Banks to Service Non-Banks, through enhanced industry awareness campaigns to address de-risking practices – where banks are cautious about doing business with non-banks – the CSBS is increasing industry awareness that non-banks have strong regulatory regimes for compliance with laws for money laundering, the Bank Secrecy Act, and cybersecurity.
6. Improve Third Party Supervision through the CSBS’ support of federal legislation to amend the Bank Services Company Act to allow state and federal regulators to better coordinate supervision of TSPs and, in turn, produce an easier supervisory experience for fintechs and other non-banks.

The Treasury followed with a somewhat lenient response and provided an additional year (total of three years) to the state regulators to “achieve meaningful harmonization across their licensing and supervisory regimes” before Congress gets involved.

The battle over who gets to supervise fintechs and the pressure to act just got even more intense.

Recommendations and Action Points

A special purpose national bank charter is a new option to be evaluated by fintechs pursuing or already maintaining state banking charters or in partnerships with other federal or state financial institutions. The special purpose charter is likely an option limited to fintechs that have significant capital. The option needs to be considered in the context of each fintech’s business model.

Consider the following in your decision-making process and assessment of the benefits of the charter:

the charter is only applicable to fintechs that do not take deposits within the meaning of the Federal Deposit Insurance Act,

• the OCC has not yet specified requirements for capital, liquidity, and risk management but they will be significant,
• the OCC expects national banks to have expertise, financial acumen, and a risk management framework that includes governance and well-defined roles among the bank’s business units, support functions, and the internal audit function.
• the OCC expects the board of directors to have a prominent role in the overall governance structure by participating on key committees and guiding the bank’s overall strategy and risk management framework. Board members also must actively oversee management, provide credible challenge, and exercise independent judgment.
• the OCC requires a contingency plan that includes options to sell itself, wind down, or merge with a nonbank affiliate, if necessary.
• the OCC will impose assessments as a condition of approval and the special purpose bank will also be subject to periodic assessments, just as other national banks are. The OCC has modified the assessments it charges to other special purpose national banks to account for the banks’ activities and the assets they hold.
• the OCC will supervise approved fintechs, as it does all other national banks, under a scheduled supervisory cycle, including on-site examination and periodic off-site monitoring. The OCC sets high expectations for the entities it supervises. Like all de novo institutions, newly chartered fintechs will be subject to rigorous ongoing oversight to ensure that management and the board of directors are properly executing their business strategy and the bank is meeting its performance goals.
• the OCC will not approve proposals that include financial products and services that have predatory, unfair, or deceptive features or that pose undue risk to consumer protection or would be inconsistent with law and policy. It will be up to the applicant to document in the application that none of these risks are present.

Chartwell has experience with both bank and non-bank financial institutions, the applicable regulatory requirements and expectations, and industry best practices. While we don’t have statistics on professionals changing careers from non-banking financial institutions to banks or vice versa, it is clear that the regulatory requirements have been strikingly more difficult and involved for banks and one cannot seamlessly cross from one to the other. The sophistication of a bank regulated compliance program versus a program required by state regulators cannot be compared. While going through a 50-state application process is quite the endeavor; it is nothing compared to submitting an application for a bank charter. I had the opportunity to witness the process of opening a de novo OCC chartered bank 11 years ago. The process was very involved requiring contracting with an experienced third party to complete the application. In 2017 there were 4,910 FDIC insured commercial banks in the US. There were no new charters added in 2015 and only 5 in 2016.⁷ The OCC chartered one new bank in October of 2017, which was the first new OCC charter since the financial crisis.

The BSA/AML/OFAC regulatory requirements and expectations faced by banks are generally not mirrored even by the regulated money service businesses regardless of how much pressure is added by the banking partners themselves. The OCC will not hire and train staff to regulate fintechs differently and will set high expectations for the entities it supervises. Charters will be subject to the same high standards of safety and soundness and fairness that all federally chartered banks must meet. The regulatory approach will be risk-based meaning the bank will not know what to expect. That is where the regulatory subjectivity will play out. The banking examiners will apply the same methods and, as difficult as it may be for them to adjust their expectations for small community banks struggling with resources compared to large financial institution with all the bells and whistles, the expectations and standards will likely be similar for the special purpose charter. This means that any currently licensed MSBs considering the special purpose charter will have to devote significant resources to apply for, receive and maintain the charter. Instead of state exams the oversight and exams will be of an intensity and of a depth and coverage unknown to currently licensed MSBs.

Our recommendation would be to take the “wait and see” approach if you have already acquired state licenses. State regulators will continue to challenge the charter and while there clearly is a consensus at a federal level, we may experience an effective push back that will again slow down the process. Being the guinea pig will likely bring on significant challenges. If you are considering the benefits of the charter also weigh in the potential for publicity and the special attention that will likely be given by the OCC in creating precedents. If you are entering the regulated space and deciding whether to go with state licenses or the special purpose bank charter, we would recommend contacting the OCC to start a discussion to find out what it would take for your special bank charter to get approved.

For more information, please contact Petra Hrachova: petrahrachova@chartwellcompliance.com.

¹https://home.treasury.gov/news/press-releases/sm447

²https://www.occ.gov/news-issuances/news-releases/2018/nr-occ-2018-74.html

³https://www.consumerfinance.gov/about-us/newsroom/bcfp-collaborates-regulators-around-world-create-global-financial-innovation-network/

⁴https://www.fdic.gov/regulations/laws/rules/1000-400.html

⁵https://www.occ.gov/publications/publications-by-type/licensing-manuals/file-pub-lm-considering-charter-applications-fintech.pdf

⁶https://www.occ.gov/static/licensing/form-business-plan-v2.pdf

⁷https://www5.fdic.gov/hsob/HSOBRpt.asp