The Office of the Comptroller of the Currency announced on July 31 that it will begin accepting applications for special purpose national bank charters from nondepository financial technology companies (fintechs) that are engaged in the business of banking. In its press release, the OCC asserts that “[c]ompanies that provide banking services in innovative ways deserve the opportunity to pursue that business on a national scale as a federally chartered, regulated bank.”

The concept of granting special purpose national bank charters to fintechs was first proposed by the OCC in December 2016 and has become known as the “OCC Fintech Charter.” In its press release, however, the OCC emphasizes that it not seeking to create a new type of national bank charter, which is something only Congress can do. Rather, the OCC states that fintech national banks “will be supervised like similarly situated national banks,” including with respect to “capital, liquidity, and financial inclusion commitments.”

Fintechs have always had the ability to seek to become a depository national bank. However, accepting deposits has ramifications that render this option unattractive to most potential applicants. First, and foremost, significant corporate parents of any depository institution, including any investor with 25 percent or greater ownership or control, are subject to the Bank Holding Company Act (BHCA). The BHCA places restrictions on a covered person’s permissible business activities, imposes enterprisewide capital requirements, and triggers burdensome ongoing reporting obligations. These requirements are incompatible with the business models of most firms, including investment companies that are likely to invest in financial industry startups.

In addition, because of the potential for risk of loss to the Federal Deposit Insurance Fund, the FDIC must approve any charter applications for a depository bank. In evaluating a given depository charter application from a fintech, the FDIC could either impose conditions that are incompatible with the fintech’s business model or deny the application presenting undue risk. The fact that the OCC will not require a fintech national bank applicant to accept deposits represents a key aspect of this new development.

A fintech applicant for a special purpose charter will need to commit to a three-year business plan that it will be unable to vary from without obtaining prior, formal approval from the OCC. The applicant will also need to demonstrate knowledge and experience among its senior management and board members regarding operating in a bank environment. In addition, enterprise risk and compliance management systems will need to be comparable, in terms of both breadth and robustness, to those of other banks. Finally, as a de novo national bank, the fintech will be required to maintain capital for the first three years of its operation at levels that significantly exceed that required for an established institution. For these reasons, only those fintechs with deep financial pockets and well-established business plans are likely to find that becoming a national bank presents a feasible option.

Those fintech lenders that conclude that a national bank charter does not offer a viable option may wish to pursue a “bank model” lending relationship with a regulated bank, which offers the advantage of interest rate exportation subject to rigorous, but narrowly tailored, legal and regulatory requirements. In this regard, although there are depository bank alternatives to obtaining a nondepository, special purpose national charter that would not trigger the application of the BHCA (e.g., a Utah industrial bank charter), those options would necessitate obtaining FDIC approval and satisfying substantially similar requirements to those of the OCC with respect to capital, funding, risk and compliance management systems, a three-year business plan, etc.

One impediment to fintechs’ seeking an OCC charter may be the potential uncertainty caused by lawsuits filed by parties opposed to the concept of an OCC Fintech Charter. After the OCC first published its proposal to charter fintechs as special purpose national banks in December 2016, two suits were filed against the OCC to prevent it from acting on that proposal. In April 2017, the Conference of State Bank Supervisors filed a lawsuit in D.C. district court seeking to enjoin the OCC from issuing special purpose charters to fintechs on the basis that the OCC lacks the legal authority to grant such charters beyond certain types of institutions listed in the BHCA (i.e., limited purpose trust institutions and credit card banks). In addition, in May 2017, the superintendent of the New York Department of Financial Services filed suit in Manhattan district court, alleging both that the OCC lacked the authority to grant such charters and that its proposal was a “reckless folly” that would allow fintechs to circumvent state consumer protection laws. Both of these cases were later dismissed without prejudice due to a lack of ripeness because the OCC had not begun to accept special purpose charter applications from fintechs.

To learn more about the process for becoming a special purpose national bank, listen to Pepper Hamilton’s webinar on this topic.

Pepper Points

• Fintechs with deep financial resources and stable business plans are likely to act quickly on the opportunity to become a special purpose national bank. A national charter offers significant advantages, including strong federal preemption, direct access to Federal Reserve payment systems, eligibility for membership in the payment card associations, the ability to engage in legally recognized “activities incidental to the business of banking,” and enhanced business reputation.

• Nonbank fintech lenders will continue to enjoy certain competitive advantages over their bank competitors, including over newly minted national bank fintechs. The financial costs of doing business as a nonbank are much less than those of a regulated bank, and a nonbank is able adapt its products and services quickly in response to changing customer needs without being hindered by an inflexible business plan.

• The OCC’s decision to charter fintechs as national banks will likely prompt additional fintech lenders to consider the possibility of entering into a “bank model” lending relationship, whereby a regulated bank originates loans to consumers that are promptly invested in, and subsequently serviced by, the nonbank. These relationships allow the nonbank to leverage the bank’s ability to export its home state’s favorable interest rate and are less costly and burdensome than becoming a bank. The major downside to these relationships is the ongoing legal uncertainty posed by “true lender” lawsuits, which this latest OCC action does nothing to alleviate.