As financial technology companies increase in the industry, grow in size, and expand the scopes of their businesses the question really isn’t “will they be regulated.” They will. The question is by whom.
FinTechs have expanded in scope from pure operational processing with liability to the customer or intended extension of credit to the “card issuer” to lending and deposit taking.
As history has evolved, customers have come to expect the “safety” that is the result of regulations at the banks on all their financial dealings, such as:
- Depositor’s insurance
- Truth in lending
- Anti-money laundering
- Privacy laws
Have you ever purchased something on line and suddenly begin receiving sales emails from hundreds of companies you have had no contact with, no interest in, etc.? There’s no privacy.
Additionally, bank regulations designed to support the Community Reinvestment Act ensure credit is made available to local communities that might be otherwise underserved.
FinTechs will fight some of the regulation that can tend to be over-burdensome, just ask the banks. It lowers profits and creates large infrastructures for compliance which leads to inefficiencies across the board. On the other hand, federal action on regulation could significantly streamline what might otherwise become an even worse situation for the companies, regulation, and licensing by the individual states.
Since FinTechs typically are geographic neutral, they operate across state lines and even across country lines. Although the states would like their share of the revenues, when dealing with the internet the location of the seller, buyer, and provider of services becomes somewhat of a moot point. This can be seen from the current issues the Internal Revenue Service is trying to sort out related to bitcoins.
State regulation of some banks works, typically when the banks are focused geographically within a state. As banks expand outside of the local geographies, more and more issues arise. To support the individual requirements for pricing of the individual states where these companies do business would be inefficient, cumbersome, and expensive for the FinTechs, to say nothing about applying in 50 different states plus any other countries that might be covered.
The OCC already has the authority to issue special purpose charters for entities engaging in limited banking activities, such as a Trust Company, and could select which banking rules would logically apply to these limited purpose charters. In fact, the OCC is now working to determine what regulations would be applied and has released a white paper discussing their plans to proceed with special purpose charters for either lending money, paying checks, or receiving deposits.
To the extent that Banks are currently customers of FinTech companies, the banks are already requiring they conform to the Bank Secrecy Act and Anti-Money laundering regulations. This is necessary for the banks to remain compliant under their current regulation. In addition to these requirements, consideration is being given to address the Community Reinvestment Act and requiring higher capital requirements than other banks because of “off balance sheet” business activities. This would also require FinTechs to develop formal plans for failure as other banks have developed.
So, who will win the fight to be the primary regulators for FinTechs? We believe it will be the OCC although, like other banks, there may be a dual system allowing charters at the state level as well. It’s worth mentioning that the release of the white paper in December of 2016 was immediately followed by a law suit challenging the OCC as the regulator over the state of location or incorporation. So, this is likely to be a challenge to states’ rights. However, our opinion is that the federal government will win out on this one.