Response to the OCC's Proposed Changes to the Licensing Manual regarding Charter Applications from Fintech Companies

Thank you for the opportunity to comment on proposed amendments from the Office of the Comptroller of the Currency (OCC) to the Comptroller’s Licensing Manual regarding evaluating charter applications from fintech companies (the proposal). The Mercatus Center at George Mason University is dedicated to bridging the gap between academic ideas and real-world problems and to advancing knowledge about the effects of regulation on society. This comment, therefore, does not represent the views of any particular affected party or special interest group, but is designed to assist the OCC in creating a regulatory environment that will facilitate increased innovation, competition, and access to financial services to the benefit of the public.

Introduction

The OCC has proposed amending its licensing manual to allow non-depository fintech companies that lend money or facilitate payments to become special purpose national banks (SPNBs). The proposal lays out requirements prospective SPNBs will need to meet to obtain and maintain a charter, and it provides details on the charter application process. The OCC has solicited comment on the proposal. In response, this letter evaluates some aspects of the proposal and suggests improvements the OCC should consider to help the chartering effort achieve its stated goals of providing greater access to higher-quality financial services and strengthening the national banking system, while ensuring appropriate systemic and customer protection.

The OCC should be commended for its efforts to embrace innovation. The OCC should also be praised for its efforts to engage with interested parties and solicit comment from the public as its work has progressed. While the present proposal benefits from those efforts in some areas, it unfortunately remains ill fitting and overly burdensome in others.

The promise of a fintech charter is that it will allow innovative, nimble companies that use technology to provide competitive products and expand access to underserved groups. These firms, by virtue of being non-depository, may also create less risk to taxpayers and customers compared to traditional banks and present different considerations regarding customer protections and safety and soundness.

While the OCC’s current proposal shows some improvement over its previous statements, it remains overly focused on the survival of the entity instead of the protection of customers. It also explicitly and implicitly imposes requirements and conditions on SPNBs that many will find impossible to meet—without a sufficient countervailing benefit. Finally, while the proposal provides more specificity than previous statements, it is still too vague.

To address these issues I recommend that the OCC:

• Reorient charter requirements away from insisting that SPNBs demonstrate survivability and toward ensuring that SPNBs can fail in an orderly manner that protects their customers.
• Clarify the requirements for SPNBs to obtain and maintain a charter consistent with the rights and responsibilities of national banks under relevant law.

I discuss each of the recommendations in turn. In addition, I have attached a previous letter I authored with Hester Peirce and J. W. Verret, which I wish to include for reference. 

The OCC Should Focus Its Requirements on Ensuring Firms Can Protect Customers in the Event of Failure, Rather Than Preventing Firms from Failing

The OCC is responsible for regulating nationally chartered banks in a way that protects customers, ensures the safety and soundness of the national banking system, and “promotes a vibrant and diverse banking system that benefits consumers, communities, businesses, and the U.S. economy.” This means that the OCC is responsible for creating a regulatory environment where the interests of the customer, rather than of any particular financial institution or business model, are paramount. It also means that the OCC should be mindful of the risks customers face from a lack of access to financial products and services, not just the risks attendant to their provision.

Non-depository fintech firms present an opportunity to expand access to financial services, lowering customers’ risk. They also present different, and likely lower, risks to the banking system as a whole because they do not take demand deposits and do not receive federally backed deposit insurance. In light of this the OCC should not base SPNB regulation on existing depository regulation. The mere fact that depository institutions are regulated in a certain way or face certain requirements is irrelevant if the risks that those regulations seek to address are not present or can be addressed via less burdensome regulation in the context of non-depository SPNBs. The OCC should not seek to make a “level playing field” by mandating unnecessary requirements.

The OCC should instead create regulatory fairness by regulating firms according to the risks they create. This means that the OCC should regulate fintech firms based on what is required to provide appropriate protection for customers and encourage access and innovation in light of the concerns presented by the fintech firms’ unique business model.

In light of this, the OCC’s proposal for SPNBs is overly burdensome. Despite the different risk profiles presented by fintechs, the OCC’s proposal subjects them to many of the same requirements traditional depositories face, despite the fact that they are unnecessary to protect customers. These requirements include submitting a detailed business plan and obtaining a non-objection letter if the SPNB wishes to deviate from the business plan. SPNBs also may be required to develop alternative minimum business strategies that would detail their plans to react to a host of different business conditions. These requirements exist to assure the OCC that each SPNB will not fail, but firm survival is not necessary for customer or systemic protection.

As J. W. Verret and I previously described in greater detail in the context of the OCC’s proposed rule on receiverships for uninsured national banks, the OCC should focus on making certain that non-depository SPNBs have the ability to fail in a way that protects customers. This would require the SPNB to be able to wrap up operations in an orderly manner and transfer any ongoing obligations (such as loan servicing) to a backup provider with adequate time to provide customers with sufficient notice and information to allow the customers to protect their interests. If the SPNB were able to complete all of its outstanding tasks or ensure those tasks were properly transferred to a new entity that would complete them, then the customer, and by extension the banking system, would be protected. In fact, a well-executed failure could allow SPNBs to avoid receivership entirely and be resolved via bankruptcy because all of the customer (as opposed to investor or corporate creditor) interests will have been addressed.

While the current proposal does mention the importance of an orderly wind-down, it falls short in giving appropriate weight to the ability to fail with grace. The focus on requirements intended to demonstrate that SPNBs will not fail is not only unnecessary but may also be counterproductive. 

For example, the requirement that an SPNB get a non-objection letter for any material deviation from its business plan could make it more difficult for the SPNB to survive adverse business conditions. Many firms, especially those that are seeking to provide the most innovative solutions, will find the need to change their business plans quickly to survive. If an SPNB is forced to request permission from the OCC, and if that permission is not provided quickly, the firm will be forced to choose between risking regulatory sanction or the death of the firm. To even have a chance of being adequately responsive to the needs of SPNBs, the OCC will have to devote considerable resources to processing non-objection letters. It is doubtful that the OCC will be able to make such a sustained commitment given the OCC’s other obligations and limited resources. As such, the non-objection letter requirement is likely to make it more, not less, likely that SPNBs will fail.

Whatever the value of the OCC requiring depository institutions to convince the OCC they will not fail, non-depository SPNBs present a materially different issue. The OCC should not just adapt existing requirements where they are not warranted. Instead, the OCC should focus on the critical element of protecting customers in the fintech context: the ability of SPNBs to fail in an orderly manner that protects customers.

The OCC Should Clarify the Requirements SPNBs Will Have to Meet to Obtain and Maintain a Charter Consistent with the Rights and Responsibilities of National Banks under Relevant Law

The OCC’s current proposal remains vague about certain charter requirements. These requirements could, depending on how the OCC interprets and applies them, exceed what is required and infringe on the powers of SPNBs. The OCC should clarify its expectations to provide certainty to SPNB applicants and ensure that the OCC does not unduly restrict SPNBs.

For example, the current proposal requires SPNBs to develop a financial inclusion plan (FIP) that is acceptable to the OCC as a condition of obtaining a charter. The proposal is vague as to what an FIP would require, and it contemplates the requirements varying based on the SPNB’s business model and product offerings. The proposal also requires SPNBs to obtain ongoing public input on their FIPs. The OCC grounds the FIP requirement in the OCC’s obligation to ensure that national banks provide “fair access to financial services and fair treatment of customers.” These requirements may actually be more onerous than what is required by the Community Reinvestment Act (CRA).

While the OCC may possess the authority to encourage SPNBs to pursue financial inclusion, it should avoid imposing requirements that mimic, or exceed, the requirements of the CRA, which does not apply to non-depository institutions. For example, the requirement that each SPNB solicit, consider, and respond to public comment on its FIP, which the OCC will consider as part of its examination of the SPNB, is akin to the public comment the OCC solicits under the CRA.

When it drafted the CRA, Congress could have included non-depository institutions, but elected not to. Whatever the merits of expanding the CRA to cover non-depository institutions may be, it is a question Congress—not the OCC—should address. Imposing similar, or more onerous, requirements to SPNBs without clear statutory authorization risks frustrating Congress’s legislative purpose. Additionally, the further the OCC gets from the clear requirements of the underlying statute, the more risk that the implementation will vary significantly depending on OCC leadership, denying SPNBs regulatory certainty.

Likewise, the OCC proposal states that companies offering “predatory” products and services would not be eligible for a charter. While unfair, deceptive, and other illegal behavior should be aggressively suppressed, failure to clearly and properly define what constitutes predatory behavior risks chilling innovation and the expansion of services to the groups that need them most.

For example, many SPNBs seek to provide services to traditionally underserved groups that may present a relatively high credit risk, which means a relatively high interest rate must be charged to compensate for the risk. SPNBs also seek to provide services using innovative techniques. Firms using new methods may set their prices assuming the new method is only moderately successful. In cases where the new method is more successful than anticipated, the firm may enjoy greater profits than initially anticipated, at least in the short term. However, those profits are likely to be driven down by competition.

Given that “targeting” underserved groups and costs that “exceed the true risk and cost of making a loan” have been previously identified by the OCC as points of concern for bank examiners, the OCC should provide more explicit guidance on what it considers to be predatory behavior. In doing so, the OCC should consider that under the National Bank Act, a national bank is entitled to operate pursuant to the laws governing interest in its home state. As such, merely charging a relatively high interest rate should not be considered predatory or bar a firm from becoming an SPNB. Likewise, being profitable is not illegal. Preventing SPNBs from offering credit at relatively high rates may prevent SPNBs from serving the underserved. Similarly, treating profitability in and of itself as a source of concern could discourage firms from entering risky markets. Such an outcome would frustrate one of the most important potential benefits of the OCC’s SPNB charter.

Conclusion

The OCC’s efforts to provide a national bank charter that works for innovative non-depository fintech firms show promise. As currently proposed, however, the charter risks being unduly burdensome and unnecessarily vague. The OCC should amend its proposal to focus on providing SPNBs with clear regulation that provides for appropriate customer protection without imposing unnecessary or inappropriate burdens, restrictions, or requirements.