Fred Fu refuses to get money from online lenders, and thinks others can quickly find themselves loaded with debt from too many loans from financial technology companies if they aren’t careful.
“I don’t trust myself,” the 25-year-old recent Columbia University statistics graduate admitted. “It’s like gambling actually.” Some trading loses after a two-month stint on Robinhood also left Fu with a bad taste.
But not everyone is like Fu; online lending from the “fintech” sector is booming — prompting a legal duel between state and federal banking regulators on whose rules the budding industry must follow.
In two cases, one in Manhattan Federal Court and another in Washington D.C. Federal Court, state banking regulators are asking judges to block the Office of the Comptroller of the Currency (OCC) from issuing “special purpose national bank” charters that would enable the fintechs to lend money and pay checks, though not accept deposits.
Vulnerable consumers will get hurt by the end-run around their supervision, state regulators contend. The OCC — the federal agency that oversees banking regulations — insists it’s got every right to set standards for an evolving market that originated 36% of all the personal loans in 2017, with a number going to people who don’t often use traditional banks.
States and federal agencies square off
Is this a turf war? A fight for customers’ best interest? Growing pains for a new banking world soaked in consumer data? Observers say the closely-watched cases are a mix of all three.
“The payment industry, fintechs and banks are going to have to work out their role in the emerging ecosystem,” said Professor Bill Maurer, director of the Institute for Money, Technology and Financial Inclusion at the University of California, Irvine.
To lend or send money — for things like mortgage loans, debt collection and money transmission — non-depositary financial companies now need state licenses.
Those licenses come with ground rules on issues like consumer disclosures and limits to lending rates and finance charges, the coalition of state banking regulators note. The OCC would let fintechs sidestep that, they claim.
According to them, the last time the OCC overrode state rules was the mid-1990s, when it said state anti-predatory lending laws didn’t apply to national banks, federal thrifts and their mortgage-issuing subsidiaries. That helped lay the groundwork for subprime mortgage abuses in the years to come, contributing to the Great Recession, the state regulators charged.
Margaret Liu, deputy general counsel of the Conference of State Bank Supervisors (CSBS), told MarketWatch the OCC might pledge that predatory lending or consumer exploitation will not happen under its watch. “But there’s not a lot of transparency to the actual details of the fintech charter. The OCC is kind of saying ‘trust us.’”
Most customer complaints pour into state regulators, putting them in a position to quickly spot and address consumer problems. “It’s an important role that can’t get erased by regulatory fiat,” she said.
The CSBS, which filed the Washington D.C. federal case, oversees 75% of the country’s banks and over 20,000 non-depositary financial-service providers. The New York State Department of Financial Services filed the Manhattan federal case, saying the OCC’s “reckless folly should be stopped.”
An OCC spokesman declined to comment, but in court papers the agency insists it will expect as much of fintechs as it does for the banks it grants charters. Besides, there isn’t anything in the rules to suggest state consumer protection laws would get second billing, the OCC said.
The OCC started accepting charter applications in July, but no one’s applied yet, the agency said in court papers.
There are now 6,000 fintech companies globally, according to estimates by the Center for Strategic and International Studies. Ahead of the OCC’s decision, online lenders like SoFi and Lending Club spoke in favor of the special charters.
Stephen Harkey, the chief marketing officer of ViVi — a company planning the American launch of a flat-fee digital wallet later this month after building markets in Brazil and Mexico — sees a nervous banking establishment. “I absolutely think banks are afraid fintechs will hurt them financially,” he said. “We’d much rather be governed under one set of rules than 50 set of rules.”
Harkey said the quicker federal charters became “completely acceptable,” the quicker companies could pass the savings from compliance expenses to users. “The cost savings will be dramatic,” Harkey said.
Tough rules for fintechs were necessary, Harkey acknowledged. But it wasn’t like the status quo was entirely fair. Check-cashing stores kept far too much and banks weren’t above fees either, he noted. “Banks love charging you $35 for over-drafting your account.”
Thomas Curry led the OCC when it started eyeing special fintech charters several years ago. Before that, he worked as Massachusetts’ commissioner of banks, so he knows not all regulators are created equal. He was aggressive on consumer protections, but “some states don’t care at all. It’s really not a part of their mission or not a priority.” Charters would set a baseline, Curry said.
Some fintech companies have already gotten mixed up with regulators. For example, the Securities Investor Protection Corp. said Robinhood hadn’t consulted it in the rollout of the company’s s cash management program. The Federal Trade Commission is suing Lending Club for allegedly not being clear on its fees, though the company is fighting the claims it calls “legally and factually unwarranted.” (Robinhood declined to comment.)
Rule changes, societal shifts
The charter saga started in 2015, when Curry said the feds had to lean into innovation, a lot of which was “developing outside of the regulated banking industry.”
Part of his hope was harnessing that creativity to help people and small businesses in under-banked communities. That’s a void fintechs say they can fill.
One quarter of American households in 2017 either didn’t have checking and savings accounts, or didn’t do all their banking with an insured institution, according to the Federal Deposit Insurance Corporation. Specifically, 6.5% of all households were unbanked and another 18.7% were underbanked, it said.
Mistrust and misinformation are issues, Pastor Carlos Ortiz told MarketWatch. Ortiz leads the Cristo Vive Miami congregation and is the director of Spanish-speaking churches for the National Hispanic Christian Leadership Conference. The conference agreed to offer ViVi to parishioners and Ortiz is working as a paid consultant in the rollout.
Check-cashing store charges were “just outrageous, they are horrendous” and Ortiz heard from many who complained often about the rates and getting robbed when walking out.
But Ortiz said many folks still wouldn’t deal with banks because they were spooked by memories of bank runs and closures in Latin American countries. As for undocumented residents, Ortiz said they were under the misimpression they needed immigration papers to start an account. “They feel afraid banks might tell the government.”
Don’t Miss: Powell says rural poor need help with education, credit access
Services like Vivi worked as a stepping stone to more traditional banking services, Ortiz said. Without these online offerings, “definitely this will present a problem to the community.”
How to avoid digital ‘red-lining’
The court cases revolve around whether the OCC overstepped its powers.
The state regulators interpret statutory wording on the “Business of Banking,” which is over 150 years old, to say any nationally-chartered bank needs to do three things: receive deposits, pay checks and lend money.
Doing at least one of those “core banking functions” will suffice, the OCC said, so its special charters are legitimate, even if foregoing deposits.
For Maurer, the legal arguments are beside the point, because many fintechs partner with FDIC-insured banks to accept deposits. “The bigger fear is what they can do with all the data,” he said.
For example, if the use of alternate data, like someone’s social-media profile, their search and payment history, goes unregulated it could result “digital red-lining,” he said. That’s effectively another word for discrimination.
The states already sued the OCC once before over the charter plans. But the first suits were filed before the OCC confirmed it would issue special charters, so judges tossed the cases in late 2017 and early 2018, saying it was premature to act.
In the current cases, OCC lawyers say the regulators don’t have standing to sue. No companies have the special charters yet, so the regulators can’t claim they’ve been harmed yet, the OCC says.
The regulators say this is not some theoretical exercise, pointing to news articles where the OCC’s top official, comptroller Joseph Otting, said plenty of unidentified companies are interested. They want the OCC to identify which companies are eyeing the charter.
The OCC said giving up names was uncalled for and would “intimidate anyone seeking to open a discussion with the OCC. And this may in fact be the primary purpose behind CSBS’s request.”
Get a daily roundup of the top reads in personal finance delivered to your inbox. Subscribe to MarketWatch's free Personal Finance Daily newsletter. Sign up here.