Financial services firms are always looking for strategic steps to strengthen their prospects and expand their offerings. The most obvious one is to become a national bank. Joining the ranks of national banks has a number of advantages for a fintech company, but there are also serious challenges to consider.
The benefits in bank conversion are clear. Becoming a national bank reduces the number of regulators from 52 (50 states, the Consumer Financial Protection Bureau, and the Federal Trade Commission) to one or two (the Office of the Comptroller of the Currency and the Federal Reserve Board, although the CFPB might be back if you get big). Many of the rules are simplified for banks — in many instances only one law will apply.
You also might be able to obtain funding by accepting deposits that, in the long term, may be lower cost and more stable than alternatives. More importantly, you can add those glowing terms “National Bank” to your name, with all of the trustworthiness that conveys to customers. Investors and creditors will have more confidence in you because of the careful oversight you will receive from the OCC, so your costs of capital and contracting should go down, not just your costs of compliance.
But there are also considerable challenges. The OCC (and the FDIC, if you seek to start a bank as a de novo) might not be willing to allow you to operate as a national bank. There are the ordinary hurdles of persuading the regulators that you have sufficient capital, savvy, and ethical management, as well as a sensible business plan. And you need to persuade them that you will support the community in which you will operate. But in addition to those hurdles, faced by everyone who wants to operate as a national bank, you need to persuade them that you ought to be considered part of the club defined by the magic words: “business of banking.”
Those words have always been somewhat elastic — the Federal Reserve Board has found a host of activities are permissible as “banking,” and numerous activities are listed in the OCC’s August 2011 “Powers of National Banks and Federal Savings Associations.” But the bank regulators’ mission of ensuring a safe and sound banking system has created an inclination on the part of many in the agencies to only allow entities that are engaged in “traditional” banking activities to obtain the charter. This inclination has been exacerbated by the elevation of risk management as the primary metric for evaluating the worthiness of business plans, resulting in a distrust of innovation because it cannot be proven not to lead to failure.
The bank regulators may say they believe the disclaimer that past performance is not necessarily indicative of future results, but in the absence of other evidence, they rely heavily on that guide. The recent hearing held by the House Committee on Oversight and Government Reform highlighted the FDIC’s recent conservatism in contrast to the minimal impact of de novo failures on the largely recovered Deposit Insurance Fund.
Martin Gruenberg, the chairman of the FDIC, testified that “almost two-thirds of all institutions reported higher earnings for the year than they did in 2014” and “only eight institutions failed last year — the lowest number since 2007. By the end of the first quarter of 2016, the number of problem institutions declined to 165, the lowest level since mid-2008.” We can hope that FDIC’s fears are now starting to return to normal. As the American Banking Association said, fear of a few failures can prevent large successes.
The regulators may agree that the activity you propose as the foundation of your business plan is a banking activity, but worries about limited risk diversification may cause them to reject your proposal as not being broad enough to be a “bank.” This fear of failure because the company is not widely diversified is reflected in the dissent to the Federal Reserve Board’s recent approval of an application for a bank focused on prepaid cards, in the FDIC’s guidance on limited purpose banks, and in the OCC’s treatment of narrow focus banks.
That such resistance can be overcome is evident. There are banks that are focused exclusively on providing trust services; there are banks that are focused exclusively on providing credit card loans; and there is the Federal Reserve’s approval of a charter focused on prepaid cards. Perhaps this is only one more hurdle that can be overcome by a sophisticated presentation.
There is one final question, but it may be the biggest one: Will your investors want you to become a bank?
Many corporate investors will not want to control a bank because they do not want to be regulated as a bank holding company — if only because they do not want to divest their nonfinancial activities. A wealthy individual can still control a bank and a steel company, but a corporate entity cannot. Even wealthy individuals may not want to go through the detailed and intrusive vetting required to be allowed to control a bank. Any “controlling” stockholder (with control defined broadly) will need to endure such scrutiny, as will the members of the board and the senior executive officers. If this first conversation with the owners goes well, the journey can begin.
John Beaty, a Washington-based partner in the financial services practice at Venable LLP, has for decades helped financial businesses develop and implement bank regulatory solutions. Email him at [email protected].