States and the Federal Reserve are both calling dibs on burgeoning financial technology (fintech) organizations following a July Treasury Department report calling for the regulation of fintech companies.
Not all fintech companies conduct banking services, but those that do have the option of obtaining state or national bank charters.
As the fintech sector continues to grow quickly, some advocates for state banking — like the Arizona State Attorney General and the Conference of State Bank Supervisors — are telling the Office of the Comptroller of the Currency (OCC), which charters national banks, to keep its hands out of the pie, throwing oil on the fiery debate over whether the feds or the states are better at regulating the financial industry.
State bank charters typically cost less than national charters, which may be ideal for fintech startups without much capital. Wisconsin Banker, for example, estimated in 2016 that a nationally chartered bank in Wisconsin could save $50,000 to $60,000 annually by switching to a state charter.
For any startup, keeping costs down is key, which is why some states are gunning for startup fintech banks to charter with them. Keeping costs down can also help facilitate innovation. On the flip side, if a fintech organization charters with a state, that means it can’t operate in all 50 states without chartering in each one. Thus, a state-chartered fintech bank would potentially have to maneuver more rules and regulation than a nationally-chartered bank.
Lawrence White, professor of economics at New York University’s Leonard N. Stern School of Business, thinks the argument that state charters encourage banks to innovate more and national charters “stifle” innovation is a “red herring” in the fintech debate.
“It’s not about stifling innovation, it’s about having to deal with one regulator rather than 50 regulators, that’s what this is really all about,” White told InsideSources in an interview. “Partly this is pure power and jurisdiction, but also I think the states genuinely believe that ‘We the states do a better job of regulating financial entities that have a lot of consumer facing aspects, we do a better job of protecting our consumers.’ The feds have a tradition of neglecting consumers and being more partial to the businesses and banks that they regulate. So the states are saying, ‘We can do a better job.'”
There’s a powerful incentive for states to pursue fintech companies: as the sector grows rapidly, states risk losing a new wave in charter revenue to the federal government.
But because e-commerce and the internet have nationalized commerce and banking, fintech companies may see national charters as more attractive than state charters.
To attract fintech companies, encourage innovation, and nab some of that charter revenue, some states (like Arizona and New Jersey) have launched their own fintech incubators.
Besides the obvious money-making aspect, there’s also the question of who is better at protecting consumers within the financial industry, which White believes is the heart of the fintech debate.
According to White, the issue of consumer protection has been a sticking point for state and federal regulators for a long time, and the fight over fintech is just the latest manifestation of it.
“For a while the states seemed to be happy with the Consumer Financial Protection Bureau (CFPB) was doing, but under the current administration, the states are fearing that the CFPB is going to be a much diminished entity, and so they’re saying, ‘You have got to rely on us, the states [for consumer protection],'” White said. “That’s basically their story.”
Because national charters preempt state regulations, White said, national banks may not be held accountable to the same kinds of consumer protection laws that state banks are, like usury limits.
“Usury limits are a state-level thing, not a federal thing, so that’s one reason why a bank would want a national charter not a state-level one, to avoid usury limits,” White said. “I think the feds would say usury limits don’t take into account the riskiness from a lender’s perspective, and borrowers (like fintech startups) would be cut off from credit they otherwise would want to obtain and need.”
In December 2016, the OCC released a paper outlining why it believes it is in the public interest to grant national bank charters to fintech companies. In the OCC’s view, encouraging fintech companies to apply for national charters would “help promote consistency in the application of law and regulation across the country and ensure that consumers are treated fairly” as the sector evolves.
According to that paper, if a fintech company were granted a national charter, “the institution would be held to the same rigorous standards of safety and soundness, fair access, and fair treatment of customers that apply to all national banks and federal savings associations.”
But as White pointed out, that’s not good enough for some state bank advocates, especially given how the feds were unable to reign in banks before the 2008 financial crisis.
“Recall that the 2008 financial crisis was only a mere decade ago, a time when ‘innovative’ financial engineering and a hunger for high returns led many to lose their homes, their jobs, and their life savings,” wrote Chris Odinet, a law professor at the University of Oklahoma, in a column for The Hill. “Bailouts left the taxpayer holding the bag. It’s against this backdrop that we ought to view this [federal] nonbank charter with some skepticism.”
The OCC collected public comments on its proposal to grant national charters to fintech companies, and addressed them in a May 2017 paper, affirming that fintech companies — like other national banks — would be held to rigorous consumer protection standards and leverage and risk-based capital requirements, same as other national banks.
The entire paper quells fears that fintech banks would be given some kind of special treatment or held to more lax standards. Instead, the OCC repeats over and over again that any fintech company seeking a national charter will be held to the same standards as regular national banks.
In a way, that’s exactly what some state bank advocates fear: that fintech startups with more capital will forego state charters for national ones under bank-friendly regulators and not have to bother with state lines and extra state regulations that are, according to some, better at protecting consumers and allowing the industry to grow and innovate.
“There’s no good answer — it partly depends on what you think the magnitudes are, how important you think state-level protection for consumers is, rather than giving these companies more space to do what they do [with a national charter],” White said.
Fintech is still in the early stages of innovation and development, so it’s unclear whether more will go for national or state charters. Still, Odinet wrote, it’s important to approach the sector cautiously to avoid another crash.
“So as we move into a world where Wall Street and Silicon Valley become increasingly intertwined, it’s important to balance our hopes for how technology can make life better with our need to maintain a conservative approach to how we address financial regulation,” Odinet wrote. “If fintech really is a brave new world, it requires us to walk carefully and deliberately on this tight rope. No one wants to see us innovate our way into another crisis.”