Monday, August 6, 2018

OCC's Tropical Fintech Charter Havens?

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Beautiful St. Croix, U.S. Virgin Islands
Credit: Coastal Living Magazine

On July 31st, the Office of the Comptroller of the Currency (OCC) announced that it would be accepting applications for national bank charters from non-depository financial technology (fintech) companies engaged in the business of banking.

The effort to study the possibility of creating special-purpose national bank charters began with former comptroller Thomas Curry and has been carried forward by the current comptroller, Joseph Otting.  Its formal public debut this week shows some beefing-up of comptroller Curry's effort, but the bones of the original proposal remain largely intact.  

In March of 2017, I posted an analysis of the concept of a special-purpose national bank charter for fintech companies.  Now that the concept of a special-purpose national bank charter for fintechs is our present reality, you can read the analysis right here.

Speaking as a veteran of the OCC's customized charter for "internet banks" debacle in the mid-1990's, this special-purpose national bank charter deserves to have the highest prospects for long-term success.   I was solidly in favor of the concept in March 2017 (and still am), with three caveats:

  • A resolution plan or living will requirement for the fintech charter.  I am pleased to see that, in the new proposal, the resolution plan is no longer optional.

  • Operating Agreements (OAs) for these novel bank charters should be made public.  OAs are the "guardrails" that newly-chartered national banks must steer between during the initial years of their operations.  In the new proposal (and consistent with current chartering policy) the existence of an OA will be disclosed in the publicly-released conditional approval letter, but the OA's contents (sadly) will be withheld from you.

  • The Federal Reserve System (Fed) should be a second set of bank regulatory eyes as these untested special-purpose national banks evolve over time. 

Due to the novelty and infancy of this special-purpose national bank charter, the heterogeneous structure and market foci of the myriad firms in the fintech industry, and the known unknowns and the unknown unknowns that the high-tech world throws at each of us mortals every day; it would only be prudent public policy to have the perspectives of a back-up federal bank regulator.

The ground-level business operations of a financial technology company are different than the traditional banking model.  High-technology, AI-supported, virtual firms move transactions essentially instantaneously, meaning that when "stuff" happens, it happens at the speed of light.  We have been conditioned to troubled banks gradually decaying over time.  Well, in this brave new world, fintech banks are more likely to explode instead... challenging the OCC's bomb-handling skills.

Gaming Back-up Bank Supervision

But, as far as back-up bank supervision is concerned, other federal bank regulatory agencies can easily be kicked to the curb by the special-purpose national bank charter for fintechs.

First, the Federal Deposit Insurance Corporation (FDIC) has been cut out of the picture because these special-purpose national banks would not be taking insured deposits.

Second, bank holding company supervision by the Federal Reserve is not that likely to happen, as the legal definition of a bank, for bank holding company purposes, was changed many years ago from an entity that offered certain enumerated banking services to merely a bank that was insured (with a few very specific exceptions).

Finally, the Fed's remaining tenuous supervisory toehold in this entire picture is the legal requirement that national banks be members of the Federal Reserve System (12 USC 222).  That legal requirement, unfortunately, is not absolute, and therein lies the possibility of fintech companies using Caribbean and South Pacific U.S. territories and insular dependencies as legal domiciles in order to avoid Federal Reserve membership (12 USC 466).

This artful dodge of the Fed's back-up supervision role was telegraphed to the fintech industry by the OCC, via footnote 17 in the OCC's December 2016 publication: Exploring Special Purpose National Bank Charters for Fintech Companies.

The U.S., by the way, 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.

The Fed has been largely silent regarding the OCC special-purpose national bank charters for fintechs.  It is presumably taking a wait-and-see position on the topic.  I can understand a fellow regulator's natural reluctance to stand too close to an early-stage product that could be potentially radioactive.  But, on the other hand, an unintentional epic fail could damage the global financial system, a topic in which the Fed has more than a passing interest.

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