Bank Wars IV: A new (old) hope for Fintech?

The CSBS is fighting the OCC’s efforts to offer a non-depository bank charter for fintechs, but why? Would the world where the CSBS…

The CSBS is fighting the OCC’s efforts to offer a non-depository bank charter for fintechs, but why? Would the world where the CSBS prevails be better than one where they lose?

Welcome to the continuing saga of the battle between the Conference of State Bank Supervisors (CSBS) and the Office of the Comptroller of the Currency (OCC) over the OCC’s efforts to offer a national bank charter to non-depository fintech firms. In previous installments of Bank Wars, we have discussed the CSBS’s statutory legal arguments, its allegations that the OCC’s procedure was defective, and the CSBS’s arguments based on concerns about federalism.

Left largely untouched in previous posts, however, is an analysis as to the underlying justifications for the CSBS’s suit. Sure, they may have a legal argument; do they think the world will really be a better place if they win? If so, why? Winning the policy argument is important, both because it may influence the court at the margin, and because a victory in court that is seen as doing more harm than good risks political backlash and legislative intervention.

Ok, so why does the CSBS think the OCC’s actions aren’t just wrong as a matter of law but actually bad? Well, the CSBS’s arguments can be broken down into roughly three buckets, though there is plenty of overlap and the lines are murky. The CSBS claims that the OCC’s proposed charter will be bad for (1) consumer protection, (2) systemic safety, and (3) competition and innovation. The CSBS’s complaint makes these arguments directly, and by reference to three letters dated November 14th, 2017, January 13th, 2017, and April 13th, 2017 (exhibits A, D, and G respectively) the CSBS sent to the OCC as part of the OCC’s soliciting comment on its rule regarding receiverships for uninsured national banks and on the fintech charter.

Let’s take a quick look at some of the CSBS’s arguments, and some possible rejoinders.

Consumer Protection

The CSBS argues that the OCC’s charter will preempt important state laws aimed at protecting consumers. These laws include licensing, supervision, and usury laws. The CSBS argues that the OCC’s preemption of state law in the traditional banking space has harmed consumers by preempting laws aimed at preventing predatory lending practices, and that this mistake should not be repeated for fintech firms. The CSBS’s view is that state lawmakers and regulators are closest to the action and are best positioned to monitor non-depository financial firms and protect consumers from potential abuse.

Of course, there are counterarguments. First, it should be noted that the CSBS’s narrative of the harms of preemption is not universally accepted. For example, some scholars argue that much of the harmful activity leading up to the mortgage crisis occurred in state regulated entities. To the extent that state lawmakers and regulators are similarly fallible as their federal counterparts, the policy justification for keeping regulation at the state level is weakened.

Second, it is unclear whether deposit taking is actually important from a consumer protection perspective. National- — and, in many cases, state-, chartered banks preempt other states laws all the time, and the CSBS is not calling for preemption in that context to be undone. What is it about non-depository firms that makes preemption more dangerous?

Third, while some state laws may be preempted, banks are still subject to many other state consumer protection laws. These include laws banning discrimination and unfair and deceptive trade practices, which are core to consumer protection. Further, the powers the states would be losing would generally be taken over by the OCC or CFPB, not disappear, so whether the loss of state power necessarily leads to weakened consumer protection is unclear.

Finally, the OCC can argue that the current system is in fact harmful to consumers by denying them the benefits of choice, innovation, and competition. There is evidence that state regulations applying to fintech firms are limiting options and restricting credit. The OCC could argue that proper consumer protection protects not only against the risks created by a financial product or service, but also from the risks that a lack of access to products and services creates, and that a national fintech charter furthers both of these aims.

Systemic risk

The CSBS argues that the OCC’s fintech charter also poses risks to the overall financial and banking regulation system. Among the concerns voiced by the CSBS is that Congress has passed numerous laws since the National Bank Act that apply only to depository institutions. These laws would presumably not apply to non-depository fintech charter banks, creating uncertainty about how they are to be regulated. The CSBS is dubious of the OCC’s statements that it will impose similar requirements, when necessary, as part of the fintech bank’s operating agreement.

The CSBS is concerned about laws where the new fintech firms both would and would not be considered a bank. The CSBS argues that recipients of the fintech charter would be exempt from SEC enforcement under many U.S. securities laws, and that the OCC also lacks the necessary authority to oversee them.

The CSBS also asserts that the OCC fintech charter would threaten the balance of the dual banking system by stripping states of their longstanding ability to regulate non-depository financial institutions. While, as discussed above, this may have consumer protection implications, it may have more general structural effects on the broader economy or banking system. The CSBS’s position is that the dual banking system works best when it is “balanced”. If the OCC expands the practical definition of banking, states may be at a competitive disadvantage, weakening the dual-banking system.

Finally, the CSBS argues that the lack of deposit-taking may make granting access to financial infrastructure, like the payments system, more risky. For example, in its January 13th letter, the CSBS argues that deposit-taking is important to the payments system because having deposits on hand is “essential to the willingness of economic actors to accept payment in mediums other than cash is the confidence that, when requested, cash will be received in a timely manner.”

As with the CSBS’s consumer protection arguments, there are counterarguments. First, it is possible that the CSBS’s analysis of the laws is wrong and the fintech charter banks will or will not count as banks in the opposite way CSBS fears. For example, the 1933 Securities Act exempts securities issued by “banks and savings associations the deposits of which are insured in accordance with the Federal Deposit Insurance Act” (15 USC 78I(i)). This would seem to exclude fintech banks from the exemption and place their securities offerings back under the SEC’s jurisdiction. Who is right about the statutory analysis? We will need to wait and see, but it is possible that the CSBS is overstating the number of laws that won’t apply.

Of course, some laws won’t apply to the new fintech banks, but then the question becomes, so what? If the laws exist to address risks created by taking deposits, then the fact they don’t apply to non-depository institutions shouldn’t create more risk. If the laws that would apply to traditional banks but not fintechs address risks not related to deposit-taking, but other laws or the OCC’s inherent authority can adequately address those issues, total risk may not actually increase.

Finally, it is unclear if the infrastructure concerns are valid. For example, while having deposits is possibly important to address in a payments system where clearing and settlement takes days, in a real time or near real time system, there may not be the same risks. The OCC will need to show that it has a plan to address these risks, but the mere fact that deposits are considered important in some (different) cases doesn’t mean that is always the case.

Competition and innovation

Finally, the CSBS argues that the OCC’s charter would be bad for competition and innovation. The CSBS alleges that the lack of specific standards and case-by-case nature of regulation in the fintech charter risks creating an unfair system where some fintech firms may be favored over others, an argument my colleagues and I have also made. The CSBS also argues that applying many banking laws to depository institutions that wouldn’t apply to fintech banks creates an unfair environment for banks. The CSBS views these possibilities as distortions to the competitive landscape that will hurt consumers and firms competing with OCC fintech charter holders.

The CSBS also argues, most fully in its January letter, that state based regulation encourages innovation while the OCC charter would hurt innovation. According to the CSBS, state regulation of non-bank lenders and money transmitters tends to be activities-based. Conversely, banks tend to be regulated on an institutional basis (similar institutions subject to similar rules) and the OCC’s fintech firms would be subject to case-by-case regulation. The CSBS argues that activities-based regulation is more transparent and even-handed, while the OCC’s case-by-case regulation of fintechs would be opaque and difficult to anticipate or navigate. According to the CSBS, innovation is best served by transparent and evenhanded rules.

In the complaint, the CSBS points to several innovations that came out of the state bank system, including ATMs and interest-bearing checking as further evidence of how innovation friendly the state system is. In an April letter, the CSBS also points to the Nationwide Multistate Licensing System (NMLS) as an example of innovation friendly state policies. The NMLS system also features prominently in CSBS’s “Vision 2020” initiative to make it easier for fintechs to operate in multiple states. These arguments are likely as much defensive as offensive, since the OCC will probably argue that the current state-based system is holding back innovation and competition (which is correct) and the CSBS wants to convince the court that stopping the OCC would not be denying the public the benefits of innovation.

In response, the OCC may argue that the CSBS’s arguments about competitive fairness are inapt. For one, the OCC could argue that the CSBS’s argument that because fintech banks would not be subject to the same laws as depository banks is inconsistent with the CSBS’s argument about the importance of activities-based regulation. If the laws in question relate to taking deposits, and fintech banks are not engaged in that activity, the logic of activity-based regulation would dictate that those laws should not apply. The purpose of regulation is to address certain risks, such as consumer protection or systemic safety, not to ensure that every competitor is equally burdened by regulation, Harrison Bergeron style, in the name of “fairness.” If a business model develops that poses different risks than its incumbent competition, it should be regulated differently.

The OCC may also point out that the regulatory status quo is also unfair and inconsistent with activities-based regulations. Banks can lend and transfer money, the same activities the OCC’s fintech charter seeks to address, under different and advantageous rules compared to their non-bank competition. Unless the CSBS can point to a compelling reason why taking deposits changes the nature of the activity, it is hard to justify the advantages incumbent banks enjoy.

The strongest argument the CSBS makes is that the OCC’s process and case-by-case regulation is opaque and unfair to the fintech firms themselves. However, there are critiques of those arguments. The best response would be for the OCC to provide concrete standards and a transparent process for application, something that my colleagues and I have recommended several times. This would not only moot the CSBS’s argument, but would also improve OCC’s the charter considerably. The second, less satisfying, response is that this sort of opaque discretion is not unique to the fintech charter. Rather, it is found all over state and federal financial regulation.

It is unclear how important any of these policy issues will be in a court of law, but in the court of public opinion (and policy), it is often as important to convince people that your vision of the world is better. Whether the CSBS or OCC comes out on top remains to be seen, but we shouldn’t have to wait long for the OCC’s return salvo in this ongoing bank war.