Monday, March 20, 2017

National Bank Charters for Fintech:
  Back to the Future?

Image result for fintech companies
credit: Business Insider

After a long and deliberate process of soliciting public input through multiple discussion documents and a forum on responsible innovation, Tom Curry, the Comptroller of the Currency, has just released his agency's draft Licensing Manual Supplement called Evaluating Charter Applications from Financial Technology Companies and a companion document titled OCC Summary of Comments and Explanatory Statement: Special Purpose National Bank Charters for Financial Technology Companies.

These documents are the result of a call for comments on an earlier document issued by the OCC on December 2, 2016 titled Exploring Special Purpose National Bank Charters for Fintech Companies.

In a nutshell, it contemplates the creation of a Special Purpose National Bank (SPNB) charter for the purpose of supporting responsible innovation in the financial technology (fintech) sector.  The charter would be an alternative to state-by-state licensing and, by providing a Federal licensing option, it is consistent with the tradition of the dual-banking system here in the United States.  The proposal, to me, is an honorable and admirable effort to expand the arc of what we call "banking" in order to keep up with the times.

The OCC received over 100 comment letters.  Most were supportive, but several were critical.  Some legal objections were raised, but we can leave that to the lawyers to sort out along the way.  I was more concerned with the regulatory policy decisions; and three, in particular, trouble me:


First, I think the OCC is dodging public accountability through the lack of transparency in a vital piece of the charter approval process - the operating agreements.  For those not familiar with OCC's operating agreements, they are the "guardrails" which newly-chartered banks must steer between during the initial years of their operations.

The operating agreements are a critical part of the synthetic regulatory architecture that the OCC has to custom-build for those SPNBs who otherwise would not be subject to certain important legal requirements affecting "normal" national banks due to the SPNB's lack of deposit insurance and/or bank holding company status.

The OCC plans to announce the existence of an operating agreement, but will not disclose its contents.  That smacks of hiding the ball and provides no way for the public to assess the strength, effectiveness, and durability of the OCC's feat of custom-tailored regulatory architecture.

This layer of "regtech" overlaying the fintech in these SPNBs looks too much like our collective infatuation with the financial engineering craze of the early 2000's that later brought us boomerang products like Collateralized Debt Obligations (CDOs) and other financial derivatives that unexpectedly turned toxic.

The operating agreements for SPNBs need to see the light of day.  The public policy implications of this novel and nontraditional national bank charter demand a higher level of transparency.

The Role of the Fed

Second, is the troubling wink-and-a-nod telegraphing, via footnote 17 in Exploring Special Purpose National Bank Charters for Fintech Companies, of the ability to avoid Federal Reserve Bank membership, and therefore Federal Reserve jurisdiction, by legally domiciling the national bank in U.S. territories and insular possessions.

Geography note: The U.S. has 16 territories, five of which are permanently inhabited by humans - Puerto Rico, Guam, Northern Mariana Islands, the U.S. Virgin Islands, and American Samoa.

Now, Tom, is that any way to treat a regulatory fraternity brother?  The Fed and the OCC need to be co-sponsors here; there are too many cross-jurisdictional issues, payments system impacts, and regulatory arbitrage risks involved with SPNBs for the OCC to go this alone.

Living Wills

Third, is the optionality regarding resolution plans or living wills. They should be required, updated regularly, and reviewed during the ongoing supervision process.  The OCC learned the hard way, with the first batch of internet banks in the late 90's, that entrepeneurial, start-up cultures that are venturing into uncertain business terrain will run into novel and unexpected situations that can complicate the receivership process.

Moreover, as these entities scale up and become more interconnected with the rest of the financial system, the OCC might be stuck with the regulatory equivalent of unscrambling an egg.  Instructive in this respect was the failure of the Penn Square Bank, N.A. in Oklahoma City on July 5, 1982.  Some of America's largest banks were brought to their knees by this small bank located in a shopping mall.

Unlike the situation with the internet banks, where the FDIC ended up holding the bag at the end of the day, SPNBs will be liquidated by the OCC.  Living wills also help reduce the agency's reputation risk.

Back to the Future

Why am I urging these changes?  President Harry Truman once said that "the only thing new in the world is the history you don't know."

Let me take you back in time, to the mid-1990's, when the OCC wanted to support another financial technology innovation - the internet bank.   Internet banks were the latest "new thing" in banking and the OCC was positioning itself to be the premier regulator of this new genre of banks.  I remember our Comptroller at the time, Gene Ludwig, saying frequently that the structure of the banking industry would soon look a lot like the bar scene in Star Wars.

The internet bank charters didn't do so well.   Here's a list, how many can you still recognize?

CompuBank, N.A., chartered by the OCC on August 20, 1997 was the OCC's first internet bank charter.  By January 2001, it was under a formal enforcement action (Compubank OCC Formal Agreement).  By April of 2001, NetBank, Inc. of Alpharetta, Georgia (an internet bank supervised by the Office of Thrift Supervision) acquired all of the deposits of CompuBank, N.A. (which then ceased operations).   The transfer of accounts from CompuBank was a fiasco for customers.  Between 4,000 to 8,000 customers had trouble accessing their deposit accounts.   NetBank, in turn, was closed by the FDIC on September 28, 2007.

The second internet bank chartered by the OCC was NextBank, N.A. on May 8, 1999.  It was subsequently closed by the FDIC on February 7, 2002 in a rare Thursday night closing.  Things were so gummed-up at NextBank, N.A. that not a soul bid for the bank and the FDIC was unable to even guesstimate an initial loss amount to the FDIC deposit insurance fund.  The subsequent assessment of the quality of OCC's supervision of NextBank, N.A. in the Material Loss Review conducted by the Office of the Treasury Inspector General was not one of our finer moments as a bank supervisor.  It remains in the OCC's Pantheon of woodshed experiences.

In the end, the Special Purpose National Bank charter proposal is also an early test of the OCC's newly-minted enterprise risk management function.  Without the changes I'm suggesting, I hope they have the risk pegged as High, and Increasing.