Earlier this month, Aaron Klein from the Brookings Institution, and Brian Knight from the Mercatus Center, penned an op-ed in which they argued that the OCC should be willing to allow a certain amount of failure amongst fintech firms who receive a special purpose national bank charter. Their logic is that failure is an ethos of Silicon Valley, as well as a “necessary part of a healthy economy,” and that by granting fintech charters to many firms, some will inevitably fail, while others will end up successfully delivering improved financial services to consumers. They argue:
If the OCC sets a zero failure rate goal, and achieves it, something went wrong. If none of the firms chartered by the OCC fail, then either the OCC simply chose firms that were so entrenched that failure was not an option, or the OCC created a chartering regime that was so cumbersome and difficult that only firms that had already made it would apply. Either outcome is undesirable.
While I am supportive of the OCC accepting some failure amongst chartered fintechs – provided consumers are adequately protected – to expect that the Comptroller will do so is simply wishful thinking. The proposed fintech charter, which was released as a concept paper in December, makes it clear that fintechs must go through the same chartering process as traditional banks. This process is rigorous, and is designed precisely to ensure an OCC chartered bank does not fail – or at least has a minimal likelihood of failure.
Further adding to the OCC’s reluctance to embrace failure, is the fact that they would likely be responsible for cleaning up the mess if a fintech were to fail. As a precursor to a fintech charter, the OCC recently finalized its framework for resolving uninsured national banks. This framework has never been tested, and the OCC has no experience in unwinding failed financial institutions. If a chartered fintech were to fail, the Comptroller would be exposed to a lot more heated political accountability than any bankruptcy trustee managing the failure of a tech startup would experience.
Proposed Fintech Charter
Many of the details of the OCC’s proposed fintech charter have yet to be filled in. However, the proposal makes it clear that any entity applying for the charter will be required to demonstrate a high probability of survival.
For starters, the applicant would be required to submit a detailed business plan that covers three years and demonstrates that the “proposed bank has a reasonable chance for success, will operate in a safe and sound manner, and will have adequate capital to support its risk profile.” The plan must also indicate how the fintech will maintain adequate capital levels at all times, as well as identify alternative business strategies to address worst-case scenarios.
Such a detailed business plan requirement is not indicative of a regulator willing to accept failure. Tech startups are often worried about having enough cash on hand to meet month-end payroll, let alone how they’re going to raise capital two years from now if their business hits a rough patch. The OCC also leaves open the possibility that fintechs will be required to have resolution plans, which would specify how the firm would sell itself, or wind down, in the event of failure. Asking a tech startup to submit a resolution plan is like asking a 4th grader to draw up a will – they wouldn’t know what to do and the final product would be meaningless.
Fintech charter applicants will also be required to have a comprehensive compliance risk management system in place that includes “appropriate systems and programs to identify, assess, manage and monitor the compliance process.” Most new fintech companies will not have the resources, both human and financial, to implement such a compliance regime. Those that do will likely have been around longer and already demonstrated some level of success. In other words, these companies will be less likely to fail.
What Will be the Capital Requirement?
The desirability of a fintech charter to potential applicants will largely depend on where the OCC comes out on capital requirements for these institutions. Some public commenters have expressed a desire to see significant capital requirements imposed on chartered fintechs due to the novelty of their business models and the riskiness this entails. Other commenters have argued that capital requirements should not exceed regulatory minimums because fintech companies typically don’t accept deposits, and thus have relatively smaller balance sheets compared to traditional banks.
The OCC seems to recognize there is not a one-size-fits-all approach to capital regulation. As the fintech charter proposal states: “the OCC would consider adapting capital requirements applicable to a fintech applicant for a special purpose national bank charter as necessary to adequately reflect its risks.” However, if the OCC ends up caving to pressure from community banking groups and imposes significant capital requirements on chartered fintechs, it would lessen demand for the charter and lead to only the most well-established fintech companies applying.
Unwinding a Failed Fintech
Another factor inhibiting the OCC from embracing failure is the fact that the Office will be the one responsible for unwinding a failed nationally chartered fintech. The National Bank Act grants the OCC the authority to resolve national banks that are not insured by the FDIC, and last December the agency released their framework for the receivership of uninsured national banks. Currently, the OCC supervises 52 uninsured nationally chartered banks, but all of these are trust banks that are principally engaged in fiduciary activities that contain little risk and closely resemble financial institutions with which the OCC has been long familiar. The fact that the OCC has been supervising these institutions for so many years without a framework in place for resolving them is a testament to the inherent stability in their business model.
The real purpose of the OCC’s receivership framework is to pave the way for a fintech charter. The framework is similar in many respects to the FDIC’s receivership provisions, with one critical difference being that the claims process under the OCC’s framework provides claimants the option to submit their claim for judicial review, in addition to, or as an alternative to, filing a claim with the OCC.[i] The FDIC’s receivership framework generally only allows claims to be submitted to the receivership estate.
Many fintech companies have unique business models and funding structures that would make resolving them more complicated than your typical failed community bank. Take for instance the case of online small business lender On Deck Capital, whose shares dropped 15% last week after the company reported a fourth-quarter loss that was bigger than expected. If On Deck were a nationally chartered bank that failed, how would the OCC find buyers for the bespoke loans that sit on the firm’s balance sheet, and how would they deal with the sophisticated hedge fund investors who have purchased many of the firm’s other loans?
Unlike the FDIC, the OCC has no experience in resolving a failed financial institution. Adding to the complexity is the fact that, unlike the FDIC’s deposit insurance fund, there is currently no funding mechanism in place should the liquidation of a failed uninsured bank’s assets be insufficient to cover the receiver’s administrative expenses. Combined, these factors indicate that the OCC is ill-equipped, and ill-prepared, to address the failure of an uninsured bank.
Risk Aversion is Here to Stay
In an interview with American Banker last fall, the OCC’s general counsel, Amy Friend, stated: “We are risk-averse by nature. That’s what we’re trained to do.” This risk aversion is reflected in the OCC’s proposed fintech charter, which makes it clear that any fintech seeking a national bank charter will have to meet a high bar. A conservative approach to chartering fintech companies will likely slow the pace of financial services innovation in the U.S. But to expect anything other than conservatism from our banking regulators is to ignore reality.
[i] The National Bank Act grants the OCC the authority to appoint the receiver of a failed uninsured national bank. The receiver does not have to be the OCC, but in reality it would likely be the OCC