New Fintech Rules Level the Regulatory Playing Field

Recent guidance from the Basel Committee on Banking Supervision setting global standards for the regulation of financial technology (“fintech”) companies is helping to level the regulatory playing field between fintech companies and credit unions as well as encourage fintechs to partner with credit unions and other depository institutions.

Fintech companies are now increasingly looking to partner with credit unions and banks because of the Basel Committee’s new fintech rules titled “Sound Practices on the Implications of Fintech Developments for Banks and Bank Supervisors” that were published earlier this year.  Big technology companies such as Google and Apple are also now less likely to expand their financial services offerings as a result of this Basel Committee standard.

These new international rules, which World Council of Credit Unions’ comments strongly supported, clarify that fintech companies should generally be subject to the same rules that apply to credit unions and other depository institutions, including comprehensive prudential, consumer protection, data security and anti-money laundering/countering the financing of terrorism (AML/CFT) regulations.

As also urged by WOCCU, the Committee’s final standard includes a recommendation that depository institution prudential regulators analyze the applicability of their existing regulations to fintech companies and close any loopholes. Prudential supervisors closing loopholes will help ensure that fintech companies cannot easily circumvent the expensive compliance burdens that credit unions face today. In the United States, this means that fintech companies seeking to offer deposit-like products will likely need to become banks, purchase banks, or partner with credit unions and other depository institutions.

Early results indicate that most fintechs would prefer to partner with credit unions and banks rather than become banks or bank holding companies. The European bank BBVA, for example, has invested heavily in fintech companies as a “strategic commitment” to expanding its financial technology offerings, and partnering with BBVA has allowed BBVA’s fintech partners to offer new services and grow their businesses.

Regulatory burden appears to be the main reason why fintech companies would rather partner with credit unions and banks than become banks or bank holding companies themselves. The Office of the Comptroller of the Currency, the United States Treasury bureau responsible for regulating national banks, may offer a “fintech charter” that would likely allow fintech companies to qualify as a type of national bank operating under the National Bank Act, however, the National Bank Act has had relatively few amendments since its passage during the Civil War in 1864. According to American Banker, Comptroller Joseph Otting said in May that many fintech companies that had been interested in becoming banks two years ago have balked at applying for bank charters once they learned more details about the capital requirements, liquidity requirements, business activity restrictions and other regulatory burdens associated with being a depository institution.

It may not be surprising that a law written primarily in the 1860s has not proved attractive to tech companies. The National Bank Act would likely impose significant regulatory capital and liquidity restrictions on fintech companies, including Basel III risk-based capital requirements.  The National Bank Act would also limit fintechs to engaging primarily in “business of banking” activities that are based on how banks operated in the 1860s, such as accepting deposits, making loans, negotiating and issuing drafts and notes, and exercising powers incidental to banks’ traditional business activities such as offering payments services. The NCUA also follows the same general approach for analyzing federal credit union incidental powers under the Federal Credit Union Act.

Having a bank as a subsidiary is also not attractive to most fintechs because companies that own banks are typically regulated as bank holding companies by the Federal Reserve Board. Like credit unions and banks, bank holding companies must typically limit their business activities to financial services and not engage in non-financial commercial activities. The policy origins of the rule limiting banks, credit unions and bank holding companies to engaging primarily in financial services dates back to the 18th Century when a bank that was directly engaged in the fur trade refused to do business with competing fur traders. Although most technology companies today are not engaged in fur trading, a technology company like Google might not be allowed to engage in non-financial commercial activities such as search and advertising if it became a bank holding company.

This means that even large technology companies may find it difficult to provide deposit-like products going forward without partnering with credit unions and banks. Although FDIC-insured industrial loan companies, which are also known as industrial banks, are a niche form of depository institution charter offered by a few states that can be owned by non-financial companies without Bank Holding Company Act application, the Basel Committee’s fintech guidance may help close this loophole. In 2017, fintech companies SoFi and Square applied for industrial loan company charters, but political opposition to these charter applications has mounted and SoFi has already withdrawn its application. Walmart’s unsuccessful effort to obtain an industrial loan company charter in the 2000s was stymied by similar political opposition.

Credit unions are subject to very high compliance burdens but the Basel Committee’s recent fintech guidance urged by WOCCU is helping to level the playing field between credit unions and fintechs. Faced with the prospect of credit union-like regulatory burdens, many fintech companies are now taking to heart the advice “if you can’t beat ’em, join ’em” and are actively looking to partner with credit unions and banks instead of competing with them.

Michael S. Edwards is Vice President and General Counsel for WOCCU. He can be reached at 202-508-6755 or medwards@woccu.org.