Debut of the OCC’s FinTech Charter + Supervisory Standards

by | Aug 5, 2018 | Blog | 0 comments

Greetings,

The US economy added 157k jobs in July and the unemployment rate dropped to 3.9%. Wage growth came in strong at 2.7%, potentially fueling inflation down the road and keeping the Fed on its stated rate hike path. The Fed kept rates on hold and noted that economic activity had been “rising at a strong rate,” and unemployment “has stayed low”. The Fed also repeated its guidance for “further gradual increases”, increasing expectations for a September rate hike.

The US Treasury released a report on Fintech – the last in a series of recommended policies stemming from the Trump Administration’s Executive Order on Core Principles for Regulating the Financial System. (Previous reports included Banks and Credit Unions, Capital Markets, Asset Management and Insurance.)

Hours after the release of the UST report, the OCC released a statement indicating that they would begin accepting applications from FinTech companies. The news has generated sharp reactions across the spectrum. Notably, the recommendation for the charter is bipartisan as the charter builds on the recommendation of the OCC under the Thomas Curry from the Obama administration.

There are many questions to sort through and PeerIQ will be hosting a webinar to address these on this Wednesday, 8/8, at 1 p.m. EDT. Click here to register and to add the invitation to your calendar.


Webinar: OCC’s New FinTech Charter – What Does it Mean for Lenders and Investors?

 

In this newsletter, we summarize the Treasury’s recently released study on FinTech. We then dig into the OCC’s new proposed FinTech charter.


Summary of Treasury’s FinTech Report

The Treasury released a report on “Non-bank financials, Fintech and Innovation”. The main recommendations of the report are:

  • Work with federal and state regulators to establish a “regulatory sandbox” to invite innovations from new and existing market participants
  • Encourage regulators across the country to harmonize rules to create a clear and consistent environment for innovators and existing financial institutions
  • Update rules to accommodate technological advances such as facilitating service partnerships between banks and nonbank firms and further digitize the mortgage experience
  • Facilitate a faster retail (same-day settlement) payments system
  • Congress to codify “valid-when-made” doctrine and the role of the bank as “true lender” of the loans it makes
  • The CFPB to rescind the Payday rule as the rule would further restrict access to credit
  • Provide regulatory clarity for the use of data and algorithms in underwriting
  • The IRS should enable lenders to underwrite using tax reporting data

Also, the US Treasury encourages the OCC to further develop its a Special Purpose National Banking (SPNB) Charter introduced in December 2016 (summarized here in our prior newsletter).


OCC Asserts its Authority and is Open to Accepting SPNB Charters

Immediately following the report, Joseph Otting, Comptroller of the Currency, announced that the OCC would start accepting applications from “fintech companies that are engaged in the business of banking but do not take deposits.” The OCC, whose authority has been challenged by NYS Department of Financial Services, cited the National Bank Act as the source of its powers to grant charters. (Early applicants for the charter should be prepared for the possibility of litigation from State AGs.)

The OCC implicitly made the argument that they are the appropriate regulator for FinTechs to ensure an even playing field and “consistency in the application of laws and regulations across the country and ensure that consumers are treated fairly.”

An SPNB can engage in a limited range of banking or fiduciary activities like credit card operations, taking deposits, paying checks, lending money, community development, or cash management activities. The policy is a significant development as companies with the Fintech charter would be able to perform banking activities like lending and payment processing nationally. Fintech companies can avoid myriad state and local regulations, experiment to provide new financial products, and compete and serve as national banks.


Who are the Likely Winners and Losers?

The long-term winner of the charter is the US consumer who will benefit from greater competition, innovation, and access to credit. Payments companies that seek to compete with Visa/Mastercard also stand to benefit. Lenders that qualify for the charter may also have a competitive advantage. Payments arms of firms like Google, Apple, Amazon and PayPal would fit the profile, as well as large non-bank lenders that can demonstrate sustainable profitability de-risked their business models. Fintechs that have liquidity, funding, or going-concern risks will struggle to obtain charters.

The “safety and soundness” standards are at the same level as for other national banks, and our view is that technology firms that can satisfy their liquidity needs from operations or sale of marketable securities (under various market conditions), and have credible access to the capital markets would be likely beneficiaries.

Technology firms may also choose to avoid the charter to maintain a culture of growth and innovation. Partner funding banks such as Web Bank and Cross River Bank will continue to play an important role.

 

I am a Lender – How do I Qualify for The FinTech Charter?

Below we summarize three buckets capturing the standards for the FinTech Charter: Management and Governance, Capital & Liquidity, Risk Management. We also highlight specific areas where PeerIQ’s analytics can help.

Management and Governance Requirements

Supervisory Standard

 Description PeerIQ View

Robust, well-developed business plan

 A detailed 3-year business plan with economic forecasting and risk assessments. Key areas:

 

·        Market Definition / Customer Base

·        Economic conditions

·        Competitive Landscape

·        Risk Assessment (including related to regulatory BSA/AML, etc.)

·        Experience of management and board

·        Initial and Future capital contributions

·        “Plans for serving the community”

 ·  FinTechs will need to ensure that they have a well-documented business plan that can survive stressed market environments

 
Governance Structure ·        Management teams must have expertise, financial acumen, and risk management framework

·        ‘Hands-on’ Board (e.g., guide risk management framework, provide credible challenge, exercise independent judgement)

·        Structure should be commensurate with risk and complexity of products

 ·        Expect less VCs on boards and board tilted to former regulators and bank execs

·        Already in motion at several platforms (e.g., SoFi, Lending Club, Avant)

 

Risk Management Requirements

Supervisory Standard

 Description PeerIQ View

Partner with PeerIQ

Risk Management and Compliance ·        Top-down, enterprise-wide culture of compliance

·        Systems (e.g. policies and procedures, practices, training, internal controls, and audit)

·        Compliance programs to implement BSA, AML, OFAC, and other related obligations

 ·        Growth vs. Compliance culture trade-off PeerIQ’s class-leading risk management platform can help measure and monitor risks, and stay in compliance with regulations
Financial Inclusion ·        Must demonstrate a commitment to financial inclusion that supports fair access and fair treatment

·        Explanation of how products would provide access to under-served consumers and small business

 ·        The Treasury report emphasizes financial inclusion from fintech lending and lenders must be able to demonstrate it effectively Benchmark your under-served borrowers to those in the broader market using PeerIQ’s TransUnion dataset
Formal Plan for Failure ·        Articulate specific financial or risk triggers to address best-case or worst-case scenarios

·        Comprehensive framework for evaluating effects of severe stress

·        Triggers alerting the entity to the risk of potential stress, and notification procedures

·        Credible options to restore financial strength

·        ‘May require’ a clear exit strategy

 ·        “Living Wills” have become the norm post-crisis for financial institutions.

·        This is a potentially onerous regulatory requirement.

 PeerIQ’s stress-testing tools help develop worst-case loss estimates under various scenarios

PeerIQ’s Risk Management and Benchmarking Tools

Capital and Liquidity Requirements 

Supervisory Standard

 Description PeerIQ View

Partner with PeerIQ

Capital ·        Qualitative factors (e.g. quality of management, operating procedures and controls, asset quality, risk diversification, etc.)

·        On and off-balance sheet composition

·        Credit risk

·        Concentration Risk

·        Market Risk

·        Capital should be commensurate with risk and complexity of products

 ·        Capital requirements not specified

·        Off-balance sheet financing would include securitization programs

 PeerIQ’s Credit Facility Management Suite helps optimize capital required
Liquidity ·        Access to funds, and cost of funding

·        Projected funding sources, needs, and costs

·        Net cashflow and liquid asset positions

·        Projected borrowing capacity

·        Highly liquid and collateral positions (including marketability of such assets)

·        Various interest rates scenarios, time horizons, and market condition stress tests

 ·        Likely to be the most challenging area

·        Securitization and other distribution mechanisms required for improving marketability of assets

·        Data & analytics required for liability management, stress testing, and improving transparency on collateral pools

 PeerIQ’s stress-testing tools help develop worst-case loss estimates under various scenarios, and set aside the appropriate amount of capital

PeerIQ’s Credit Facility Management and Stress Testing Tools

FinTechs that can demonstrate “safety and soundness” and exhibit robust 3rd party risk management analytics have a competitive advantage. Reach out to PeerIQ to learn more!

 

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