The OCC will “move forward” with plans to charter limited purpose national banks for companies engaged in Fintech activities, Comptroller of the Currency Thomas Curry announced on Friday. Also on Friday, the OCC released a paper that addresses certain key issues the agency is considering as it implements its decision to entertain applications for national bank charters from Fintech companies. These considerations include permissible activities, capital and liquidity requirements, the interplay between federal and state law, supervisory expectations, financial inclusion and the chartering process. The paper solicits comments from the public on all aspects of the OCC’s plans detailed in the paper, with comments due by January 15, 2017.
Fintech companies engaged in money transmission or lending could potentially benefit from the preemption of state law provided by a national bank charter, which eliminates the need to obtain licenses in multiple jurisdictions and provides uniformity of regulation on a nationwide basis in many respects. In addition, because national banks that engage in lending are permitted to “export” interest at the rate permissible for the most favored lender under the laws of the state where the bank is located to borrowers throughout the United States, even if the interest rate exceeds the rate permissible under the laws of the state where the borrower lives, a national bank charter could be an attractive vehicle through which to engage in marketplace lending activities.
Chartering Authority and Permissible Activities
The OCC has authority under the National Bank Act to grant charters for national banks, which it asserts includes national banks that engage in limited or special purpose activities. Indeed, the OCC noted that it has extensively used its chartering authority to grant limited purpose national bank charters to national trust banks engaged in fiduciary activities and to limited purpose credit card banks. According to the OCC, there is no legal limitation on the type of special purpose for which a national bank charter may be granted as long as the entity engages in fiduciary activities or in activities that include receiving deposits, paying checks or lending money. However, a national bank—including a charter granted for the purpose of engaging in Fintech activities—may only engage in activities permissible for a national bank.
A limited purpose national bank charter could potentially be used to engage in money transmission activities, payments related services or marketplace lending, all of which are variations of traditional bank functions. However, the OCC also indicated that it would be receptive to considering on a case-by-case basis the permissibility of new activities to be conducted through a special purpose Fintech charter. The OCC did not specifically address in the paper whether it would be permissible for a national bank to purchase and sell virtual currency and own virtual currency for its own account, but this activity would appear to be consistent with existing OCC precedent related to the authority of national banks to act as financial intermediaries and facilitate payments.
The OCC’s paper acknowledges that a Fintech company that proposes to accept deposits other than trust funds through a national bank charter would be required to apply for and obtain approval from the Federal Deposit Insurance Corporation (the FDIC) for federal deposit insurance. Fintech companies engaged in payments-related activities—in particular, those seeking a special purpose Fintech charter to reduce reliance on existing bank partners—will need to consider whether their role in the process of facilitating payments or offering mobile wallets means that they will be engaged in accepting deposits, as broadly defined in the Federal Deposit Insurance Act. Obtaining deposit insurance for a bank charter adds complexity to the chartering process, since it requires preparation and filing of a deposit insurance application with the FDIC and because banks that are FDIC-insured are almost invariably treated as banks for purposes of the Bank Holding Company Act of 1956, as amended (the BHC Act). This status means that any company proposing to acquire such a bank would also need to apply for and obtain approval from the Board of Governors of the Federal Reserve System (the FRB) to become a bank holding company (see below for additional considerations relevant to a Fintech company considering bank holding company status). The OCC did not specifically address in its paper whether it would be possible for a Fintech company to acquire an existing FDIC-insured national bank and modify its activities in order to avoid a deposit insurance application, which is a commonly used strategy for companies seeking to conduct business through a bank charter.
Interplay Between Federal and State Laws
For a Fintech company, a potential key advantage of operating through a national bank charter versus another form of entity is federal preemption of state law. The OCC’s paper notes that national banks are generally not subject to state laws that conflict with the authorized powers of national banks under the National Bank Act or to state visitorial powers (meaning a state regulator may not examine a national bank), and the agency confirmed that a special purpose national bank engaged in Fintech activities would be subject to the same standards relative to preemption of state laws as any other national bank.
As noted, Fintech companies engaged in money transmission or lending activities may find a national bank charter attractive since national banks are not subject to state licensing requirements and can charge interest to borrowers throughout the United States at the rate permitted for the most favored lender under the law of the state where the bank is located. This ability to “export” interest may help a marketplace lender address concerns about whether it is the “true lender” for purposes of applying state usury laws. However, it would not address concerns created by the Second Circuit’s Madden v. Midland Funding decision that agreed upon interest may not be enforceable in the hands of a non-national bank transferee if the loan is sold.
Capital and Liquidity
The OCC expects special purpose banks engaged in Fintech activities to satisfy existing standards related to capital adequacy and liquidity. Institutions that engage in deposit taking and/or lending activities, whether through traditional means or by using innovative technology, will need to maintain minimum capital ratios calculated under the OCC’s generally applicable risk-based capital rules and prompt corrective action guidelines. However, the OCC paper noted that the minimum capital required under these regulations may not adequately reflect the risks associated with special purpose banks whose activities may be off-balance sheet. The OCC cited its experience with national trust banks, which are typically subject to specific minimum capital requirements and in some cases a requirement to enter into a Capital Maintenance and Liquidity Management Agreement with the OCC, as an example of how the OCC might approach capital and liquidity requirements for a Fintech charter. However, the agency did not identify any specific minimum capital requirements or metrics that Fintech firms could look to in order to determine exactly how much capital the OCC might require in the context of a specific charter proposal. Historically, the OCC has required at least $2 million - $5 million of initial minimum capital from an applicant proposing to charter a limited purpose national trust bank, and this level of minimum initial capital could be a high hurdle for some entrepreneurs seeking to operate through a national bank charter. Fintech companies will also need to consider whether their capital structure complies with OCC requirements, which generally favor voting common stock and discourage excessive reliance upon preferred equity.
Under the Community Reinvestment Act (the CRA), the federal banking agencies, including the OCC, are required to assess each insured depository institution’s record of meeting the credit needs of its entire community, including low- and moderate-income neighborhoods, consistent with the safe and sound operation of the institution and to take this record into account in the agency’s evaluation of an application for a deposit facility by the institution. However, special purpose institutions that are not FDIC-insured are not subject to the CRA. The OCC paper states that the OCC expects “an applicant seeking a special purpose national bank charter that will engage in lending activities to demonstrate a commitment to financial inclusion that supports fair access to financial services and fair treatment of customers.” The paper also notes that “the nature of the commitment would depend on the entity’s business model and the types of loan products or services it intends to provide.”
The OCC is the chartering authority and primary regulator for all national banks. However, the OCC noted in the paper that a Fintech company seeking a special purpose national bank charter could also be subject to supervision by the Consumer Financial Protection Bureau with respect to compliance with federal consumer financial laws if it has assets greater than $10 billion, and that a holding company for a special purpose national bank engaged in Fintech activities would be subject to supervision and examination by the Federal Reserve Board if the Fintech charter is treated as a bank for purposes of the BHC Act (see below). Since a special purpose national bank engaged in Fintech activities would be a financial institution subject to comprehensive supervision and examination by the OCC, Fintech companies engaged in payments-related activities may find that such a charter offers easier access to the financial system than operating as a nonbank entity.
The OCC also stated that it expects a company seeking a special purpose national bank charter to prepare a detailed business plan that addresses the proposed activities and strategy of the institution, supported by realistic forecasts of market demand, economic conditions, competition and financial projections. The business plan should also address risk management, compliance with consumer protection requirements, how the institution will comply with anti-money laundering requirements and economic and trade sanctions administered by the Office of Foreign Asset Controls, and alternative business and recovery strategies and resolution plans, among other topics. The plan should also describe the experience and qualifications of management. The OCC did not address specifically the minimum qualifications it will require of proposed management, but the federal banking regulators have typically expected proposed management of a depository institution to have relevant experience managing a bank.
Bank Holding Company Act and Control Considerations
As the OCC noted in its paper, national banks that are FDIC insured are typically treated as banks under the BHC Act. A company that acquires control of a bank or bank holding company under the BHC Act will be treated as a bank holding company, which has important implications that any company engaged in Fintech activities should consider. In particular, bank holding companies are subject to limitations on their investments and activities, are subject to supervision and examination by the FRB, must comply with FRB-imposed capital requirements, must serve as a source of financial and managerial strength to their subsidiary banks, and are subject to the Volcker rule. Since many investors in technology companies are engaged in (or invest in companies engaged in) activities that would be impermissible for a bank holding company or a financial holding company under the BHC Act or in activities that are circumscribed by the Volcker rule, the consequences for these investors of acquiring control of a bank or bank holding company can be quite onerous and would generally be undesirable. As a result, technology companies seeking a bank charter must carefully consider whether investors may have control of the company under the BHC Act definition even if the investors own a relatively small percentage of the company’s equity on a fully diluted basis and even if they do not have practical day-to-day control over the company. Any technology company seeking a Fintech charter should also evaluate whether its capital structure will comply with the FRB’s capital requirements if the company will become a bank holding company.
The OCC paper explains that the OCC’s standard chartering process will apply to applications from Fintech companies seeking a special purpose national bank charter. Applicants typically meet with the OCC in a prefiling meeting to discuss the proposal and engage with the OCC staff on issues that may be relevant to the application, following which an applicant may submit a charter application. If a proposal would require an application for federal deposit insurance or would involve the formation of a bank holding company, the applicant should also meet with FDIC and/or staff of the appropriate Federal Reserve Bank before submitting an application for federal deposit insurance or an application under the BHC Act.
Request for Public Comments
As noted, the OCC is soliciting public comment by January 15, 2017, on all aspects of its plans to consider applications to charter national banks engaged in Fintech activities, as detailed in the paper. In addition, the paper lists several specific issues on which the OCC is soliciting comment, including appropriate capital and liquidity requirements, whether the OCC should require a financial inclusion commitment from a special purpose Fintech charter and, if so, how the OCC should evaluate a proposed institution’s commitment to financial inclusion, and whether the OCC should use its chartering authority as an opportunity to address gaps in the protections afforded to individuals versus small business borrowers and, if so, how.
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Goodwin’s Financial Institutions Practice is recognized as a leading provider of banking and consumer financial services legal advice. We counsel our clients on all aspects of bank regulatory and consumer financial services law, including bank chartering proposals and bank mergers and acquisitions. Our attorneys also work with entrepreneurs seeking to establish companies engaged in Fintech activities and with venture capital and private equity firms that invest in these businesses.