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Analysts Start Weighing In on OCC Fintech Charter

It's been a busy week for folks trying to get a handle around the recently announced OCC fintech charter. Two analysts wrote on the powers conferred by a federal charter, and offered insight into a new one for fintechs. So let's run through their key points.

Chris Odinet is a law professor at the University of Oklahoma. He published his analysis this week in The Hill. You can read the full column here, but here are key excepts:

Recall that the 2008 financial crisis was only a mere decade ago, a time when 'innovative' financial engineering and a hunger for high returns led many to lose their homes, their jobs, and their life savings. Ballouts left the taxpayer holding the bag. It's against this backdrop that we ought to view this [federal] nonbank charter with some skepticism.

The national bank system is premised on the notion that we confer significant benefits on banks in exchange for them providing important financial services to the American people. Fintech firms, however, do not quite fit into this historical framework. In general, fintech firms do not take deposits, which is a traditional hallmark of banking. Further, the OCC says it will subject fintech firms to the same types of liquidity requirements as banks, which might be difficult for lean tech start-ups that typify the fintech world.

It also puts the OCC in the business of trying to ensure that these firms survive, which might always be appropriate. Additionally, OCC asserts that the nonbank charter will have a financial inclusion requirement similar to CRA requirements for national banks. But this may be difficult to do, as fintechs are not tied to specific geographical areas, and it may be difficult to measure financial inclusion for certain types of fintech products. Lastly, the national charter would shield fintechs from many consumer protecting state laws.

Overall, fintechs merit bank-level regulation but not bank-level deference, thus making a national nonbank charter a round hole for only a roundish peg.

So as we move into a world where Wall Street and Silicon Valley become increasingly intertwined, it's important to balance our hopes for how technology can make life better with our need to maintain a conservative approach to how we address financial regulation...If fintech really is a brave new world, it requires us to walk carefully and deliberately on this tight rope. No one wants to see us innovate our way into another crisis.

Karen Petrou knows a thing or two about federal charters. A longtime blogger at Federal Financial Analytics, she has written extensively on the risks posed by federally-blessed entities. Long before Fannie Mae and Freddie Mac ran into trouble, Petrou was discussing the market power and risks of their federal charters. Now she weighs in on the OCC fintech charter. Her are extensive excerpts from her blog:

Although the OCC emphasizes that it's holding these special-purpose charters to standards equivalent to those demanded by national banks, this is sort of true with regard to the named prudential requirements, and it looks to be completely incorrect on critical restrictions on competitive and financial risk. The omissions have significant consumer protection, safety and soundness, and structural impacts...The OCC should be sure it isn't a shadow-bank enabler before it hands out these high-powered charters.

The first structural problem we've spotted deals with the fact that capital and liquidity standards...cannot be applied in like-kind fashion to fintech, because most fintech charters will not be anything like most national banks. For all the work around fintech's edges, national banks are first and foremost financial intermediaries. This means that most risk comes from extensions of credit -- or for larger ones, trading exposures -- and most funding comes from the deposit or debt market. All of the post-crisis rules are founded on this basic proposition. 

Yet fintech risk is different...Very few fintechs are capital-intensive. Instead, they handle transactions or interfaces, making money through cross-selling, advertising, add-on fees or other strategies. As a result, the most important risk for many fintechs is operational. Would the big-bank operation risk-based capital framework work here? It doesn't even work for the banks for which it was designed....Is capital even the right way to ensure fintech operational resilience?...Cyber risk, for example, isn't exactly an afterthought here.

Secondly, what exactly will these fintechs do in relation to parent companies and/or partner institutions? Banks are under a lot of restrictions here, starting with all the disclosures customers have to get to be sure they know a nontraditional product isn't backed by the FDIC. I know fintechs aren't allowed to take insured deposits, but any company with the name "bank" could be easily understood to do so. Bank holding companies also are barred from tying products so that individual customers are forced to get something they don't want in order to get a desired service....

Yet since fintech parents are unlikely to be bank holding companies, no such anti-tying prohibitions apply. Given the tied offerings already evident by fintechs seeking nonbank bank charters, this market power is clearly desired. Should it be allowed?

Finally, will fintech parents stand by their special-purpose banks or throw them to the wolves under stress? Bank holding companies can't do so and the Dodd-Frank Act extended this source of strength requirement to nontraditional charters. The general theory here is that there is a need to ensure parent-company shareholders take the pain as well as the gain from ownership of an insured depository, a theory that doesn't apply to fintech special charters...

What about the competitive power of fintech parents not forced to bear any capital or liquidity costs for the activities that otherwise consolidate into their earnings? When can fintechs upstream earnings given that they are not to be covered by stress tests, even though the OCC says its standards are banklike? Who loses and what financial-stability risk might result from fintech operations of different sizes, business models or interconnectedness?...

These questions are critical not only to fintech special-purpose charters but to the broader thrust of the OCC's policy statement. It establishes a broader principle: the OCC can establish a category of special-purpose national banks when it thinks a policy or market benefit would ensure. All sorts of ventures are possible...What about special ones for, say, commercial real estate development otherwise barred from national banks under most circumstances? What about other activities on the fuzzy barrier between banking and commerce with powerful advocates?

If the OCC doesn't build out its special-purpose charter policy, we'll get a lot more innovation at the cost of a lot less responsibility.

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