Unbounded Upstarts


Regulating the new FinTech kids on the financial services block

By Karen Epper Hoffman

The fast-paced rise of specialty financial technology companies has garnered headlines, consumer attention and venture capital, heaping an altogether new competitive pressure on banks to raise their game. As the market growth of these so-called FinTech firms increases, many are questioning who is keeping them in line.
“These companies are never examined or subjected to the kind of review a bank would receive,” says James Kendrick, ICBA’s vice president for accounting and capital policy. “They are not being examined for safety and soundness, and are not even subject to same kind of compliance exams that community banks are subject to.”

Last year, FinTech lenders originated nearly $29 billion in consumer loans alone, a nearly sixfold increase from less than $5 billion just two years earlier. That doesn’t count FinTech loans to small businesses or to college-bound students.

By creating new online platforms and putting pressure to innovate on big banks and community banks alike, the rise of new FinTech players has been swift and disruptive. It also has raised concerns among government policymakers and the mainstream financial industry that these nonbank firms, because they don’t undergo the same prudential and consumer compliance oversight as traditional retail banks, could cause serious problems for consumers, upend the regulatory balance in the marketplace, and potentially even jeopardize the health of the overall economy and financial system.

For example, ICBA has voiced concerns about the still-unknown risks embedded in the loan portfolios amassed by less-regulated online FinTech lending specialty platforms. Little is assuredly known about many of the novel, untested underwriting practices of these nonbank market players, Kendrick explains. The suspicion and worry are that regulatory supervision would hinder if not prevent mainstream financial institutions from engaging in the same lending practices, he says.

Regulatory playing field
Chris Cole, ICBA’s executive vice president and senior regulatory counsel, points out that FinTech firms aren’t subjected to the same fair lending, Equal Credit Opportunity Act, and Community Reinvestment Act requirements as well as general examinations as community banks. However, several congressional leaders and banking agencies are beginning to take note of liberties that some FinTech firms may be taking in disclosing their fees and other important terms.

Certainly, because these impersonal, Wall Street-funded lenders operate only online, their business models lack the accountability of community banks that engage in relationship rather than transactional banking, Kendrick adds. Another major, unresolved concern: Who will be harmed—or left to pay the bill left behind—if and when billions of dollars of these loans go bad?

Cole points out that a significant number of FinTech firms, because they cannot accept core deposits, also face the challenge of building funding reserves to support their financial activities. This limitation makes these companies—many of which rely on selling their loans to investors—operate with potentially volatile and unstable funding, he explains. “Whether they are getting the money they need or not depends almost entirely on the market for loans.”
Case in point: When Lending Club’s CEO Renaud Laplanche resigned in May 2016 following an investigation that showed the top executive sold unqualified loans to investors, many buyers stopped purchasing loans from any the FinTech lenders, Cole points out. “They were having a true funding crisis,” he says.

Policymakers, including top federal banking regulators, have recognized these various risks and challenges posed by burgeoning FinTech firms. Federal regulators are closely evaluating whether or how much these disparate firms should be more thoroughly regulated. The Consumer Financial Protection Bureau announced it is closely reviewing marketplace lenders that deal with consumers. Comptroller of the Currency Thomas J. Curry has publicly raised concerns about how well or whether these nonbank firms comply with various financial laws and regulations. While acknowledging the technological innovation FinTech firms can deliver, Curry also expressed concern about the lack of proven stability among the same companies.

A FinTech charter
Whether to require FinTech firms to obtain full financial charters or specialized financial charters is one currently debated idea, and one that the Office of the Comptroller of the Currency also has proposed. The proposed limited bank charter—as initially discussed at a June symposium on banking industry innovation by the OCC and attended by ICBA representatives—would allow these FinTech companies to lend in all 50 states, but not to take deposits (similar to trust companies), Cole says. Curry said at the symposium, and has stated since then, that he believes the OCC has the statutory authority to propose and put through this charter without the approval of Congress.

However, Cole adds that ICBA and community banking leaders still have reservations about whether a FinTech charter would be sufficiently rigorous to fully level the regulatory playing field. While the limited charter would benefit FinTech firms, which would no longer have to separately register in each state in which they choose to lend, such nonbank firms still would not be subjected to the same safety and soundness exams as banks, Cole points out.

“A community bank must be examined every year, or every 18 months if it is well rated and has less than $1 billion in assets,” he says, adding that the advantage or disadvantage for community banks and consumers of a limited FinTech charter “remains to be seen.”

Understanding this, ICBA staff have met with Curry and other OCC officials to allay such “fears and concerns” about an inadequately regulated FinTech charter. Pointing out that “the devil is in the details,” Cole says regulators could roll out preliminary proposals for a limited bank charter by the end of the year, even though the charter had yet to be formally proposed as Independent Banker went to press.

In a September speech, Curry acknowledged the issue of maintaining a level regulatory playing field. “If we at the OCC do decide to grant limited-purpose charters in this area,” he said, “the institutions that receive the charters will be held to the same strict standards of safety, soundness, and fairness that other federally chartered institutions must meet.

Karen Epper Hoffman is a financial writer in Washington state.