Two faculty members at Duke Law School weigh in on the proposed fintech charter.
Lawrence Baxter, William B. McGuire Professor of the Practice of Law; Co-Director, Global Financial Markets Center, and Lee Reiners, Lecturing Fellow; Director, Global Financial Markets Center, both teach a course titled “FinTech and the Law,” among others.
Q: How would you describe the legal framework a fintech lender currently operates under and how might that be altered if a more defined regulatory environment is introduced?
Lawrence Baxter: Fintech lenders – I assume nonbank – operate in one of three ways. One, they operate under the ownership of a financial institution that is not required to be a bank – for example, an affiliate of an insurance company. Two, they operate in partnership with a national or state chartered bank, which uses its banking powers to extend the loans funded by the fintech across state lines under the umbrella of bank interest rate exportation privileges (so-called “ rent-a-charter” banks). And three, they operate as a company regulated similarly but differentially in all 50 states, though subject sometimes also to federal supervision by the Consumer Financial Protection Bureau and, perhaps, the Federal Trade Commission.
Lee Reiners: With a national bank charter, fintech companies would also be able to export interest rates across state lines and would therefore no longer need to partner with a traditional bank. In other words, the rent-a-charter model would become less prevalent.
Q: What might be the operational pros and cons of a limited purpose banking charter for fintechs?
LB: The biggest advantage a limited purpose banking charter would bring is the ability to operate under a single, consistent set of borrower protection regulations established at the federal level under federal pre-emption powers by the Comptroller of the Currency. The biggest disadvantage would be the fintech firm, operating under a fintech charter, would be subject to much more intrusive safety and soundness regulation than ordinary companies are accustomed to.
LR: Agreed. The requirements to get a charter are very high, and the ongoing compliance with OCC regulations and applicable banking laws are very operationally intensive, as well as costly. Frankly, the charter as currently constituted, would not appeal to very many fintechs because the requirements are just too high.
Q: Community banks are concerned by the creation of another direct competitor that has some real strategic advantages. Do you think that is inevitable given we certainly aren’t going to be getting any less technologically advanced?
LB: Personally, I believe the fintech company would have unfair advantages in being able to avoid state and local consumer protection laws under the cover of what are likely to be less restrictive federal regulations. It is not only possible, but highly likely, that the fintech companies that would take out a limited banking charter would be very large, national organizations. The desirability of further enabling such organizations to play a strong role in finance without the full restrictions of a comprehensive banking charter would probably turn on the specific kinds of businesses the fintech company wishes to undertake.
LR: This is where Lawrence and I disagree. National banks are still subject to very stringent consumer protection laws and regulations and these would also apply to any fintech that received the special purpose charter. Furthermore, many of those opposed to the fintech charter raise the specter of Google or Amazon starting a bank and capitalizing on all the data they have. But the OCC has made it clear they would not grant a fintech charter in these situations. It is true the bar is set so high right now to get a charter that only well-established fintech firms would be willing to apply, but these firms are already competing with community banks in many instances. The rest of the fintech lenders will likely still need to partner with a traditional bank so I actually think this creates opportunities for those community banks that are tech savvy.
Q: What sort of movement in the fintech industry might not be so well known but is something bankers might like to be aware of?
LB: Most fintech companies are “green shoot,” recent startups that are very agile, backed by a diverse range of investors, and have cultures very different to those of banks. Banks should realize their growth and relevance to finance is much more extensive than many bankers seem to recognize, so banks that are not adapting to this new reality are going to find themselves blind-sided quite quickly by companies that are more powerful and quicker to market. The fintech companies also have a much better appeal to younger consumers than do banks. Given that their services take advantage of the kinds of technology with which young people are very familiar (e.g. mobile phones, social media, digital currency), it is possible that community banks could lose very substantial market share. On the other hand, community banks that think strategically and take the trouble to understand their markets and opportunities well should continue to hold their own.
LR: Agree