LEGAL
Insights & Trends
Faced with a multitude of legal and regulatory issues, including those arising from innovations in technology, as well as talk of a government scale-back of the regulatory burden on the financial industry, banks and their counsel must be aware of recent trends and developments to mitigate new risks effectively.
The banking industry constantly faces a multitude of legal and regulatory issues. In particular, the increasing role and importance of technology in the banking industry has brought several technology-based concerns to the forefront, including cybersecurity issues and the risks introduced by new financial technology (fintech) companies entering the financial services market in partnership or competition with traditional banks. Additionally, with a Republican President and Congress in place, there has been a push to scale back, and in some cases fully rescind, banking laws and regulations enacted under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act).
The issues raised by the call for loosening existing regulations to spur economic growth, as well as the need for lawmakers and the financial regulatory agencies to respond to new risks, particularly those posed by technology, are likely to dominate the focus of banking attorneys’ attention for the foreseeable future. Against this background, this article examines emerging trends and key legal issues in the banking industry, including
For more information on the legal and regulatory framework governing U.S. banking activity, see Practice Note, US Banking Law: Overview (subscription required).
The fintech sector has experienced explosive growth over the past few years. According to a report published by Citigroup, investment in private fintech companies has grown from $1.8 billion in 2010 to $19 billion in 2015 (Citi GPS: Global Perspectives & Solutions, Digital Disruption: How FinTech is Forcing Banking to a Tipping Point, March 2016).
Fintech companies seek opportunities by disaggregating components of traditional banking services and offering more targeted financial products and services to businesses and consumers. Consumer banking is viewed by fintech companies as particularly ripe for these opportunities. Channel diversification is expected to continue to be a key driver in the banking industry, with fintech companies playing a major role in designing financial products and services that aim to enhance customer engagement through mobile and Web-based platforms.
Fintech companies are proving to be especially adept at developing narrowly defined, but highly effective, financial services offerings that traditional banks have neglected. For example, fintech companies provide:
Besides competing directly with traditional banks, fintech companies are also working together with them. Fintech companies’ strengths in product design and development can complement the distribution and infrastructure strengths of traditional banks.
The developments in the fintech sector are presenting significant legal, compliance, and practical challenges for fintech companies and traditional banks. For example:
State and federal financial regulatory agencies are also wrestling with how fintech companies entering the traditional banking industry should be regulated and supervised. While there has been a recent increase in state and federal regulatory scrutiny of fintech companies, much of the current regulation is driven by financial regulators determining how preexisting laws, regulations, and supervisory programs apply in the fintech context.
State financial regulators are responsible for licensing and supervising many fintech companies, including enforcing compliance with state laws, regulations, and supervisory programs. For example, fintech companies offering:
Many fintech companies are also subject to certain federal regulations, particularly those relating to:
Additionally, fintech companies in vendor relationships with banks may already trigger Bank Service Company Act requirements, which allow the financial regulatory agencies to directly examine these companies.
The most significant, recent federal regulatory development is the December 2016 proposal by the Office of the Comptroller of the Currency (OCC) to allow fintech companies to apply for a special-purpose national bank charter. In addition to setting out the general framework as to how the special-purpose charter would work, the OCC also asked a number of questions about what it termed “responsible innovation,” with the public comment period ending in January 2017.
Chartering as a fintech bank would provide fintech companies with several advantages. The most valuable advantage is that an OCC-chartered fintech bank would benefit from the same federal law preemption of state laws as other national banks. For example, specific state laws requiring a fintech bank to be licensed in order to engage in certain types of businesses or activities would be preempted. State examination and visitorial authority would also be limited.
Certain laws would not be preempted, including state laws:
For more information on the limitations of state law and regulatory authority with respect to federally chartered banks, see Practice Note, Federal Preemption Issues in Banking (subscription required).
However, chartering as a fintech bank would subject a fintech company to extensive federal regulation, including financial regulatory agency supervision, reporting, and examination requirements. For example, fintech banks would be subject to:
Additionally, if a fintech bank accepts deposits:
For more information on the restrictions on bank holding companies and their non-bank subsidiaries under the Bank Holding Company Act, see Practice Note, Bank Holding Companies: Business Activities and Regulation (subscription required).
Fintech banks are subject to application and chartering requirements similar to those that apply to full-service national banks. The application for the special purpose national bank charter must address the proposed fintech bank’s:
State financial regulators, including the New York State Department of Financial Services (NYSDFS) and the Conference of State Bank Supervisors, have reacted unfavorably to the OCC’s proposal. They believe that the proposal represents federal encroachment on an area that the states historically have regulated, and in which they have developed longstanding expertise. State financial regulators argue that they are in the best position to protect consumers and ensure an appropriately tailored regulatory framework for fintech companies.
Lawmakers have also expressed concern about the OCC’s proposal. In a March 2017 letter signed by Representative Jeb Hensarling, the House Financial Services Committee Chairman, along with 33 other House Republicans, the OCC was urged not to rush to allow for the creation of a special purpose national bank charter without providing details regarding the charter or an opportunity for comment (Letter from Jeb Hensarling, U.S. House of Representatives Financial Services Committee Chairman, to Thomas J. Curry, Comptroller of the Currency (March 10, 2017)).
In March 2017, the OCC released a licensing manual supplement providing more information on how the OCC will apply the existing national bank licensing standards and requirements to fintech companies applying for special purpose national bank charters (OCC, Comptroller’s Licensing Manual Draft Supplement, Evaluating Charter Applications from Financial Technology Companies, March 2017).
Although it does not offer specific details, the manual provides a roadmap for applicants on a range of issues, including how approved applicants would be regulated and supervised. For example, the manual indicates that fintech banks would be subject to:
Fintech banks may also be subject to liquidity requirements and be required to provide detailed recovery and exit plans.
Although fintech banks would not be subject to the Community Reinvestment Act, they will have to formulate a detailed financial inclusion plan as part of the chartering process, including proposed goals, approaches, activities, and milestones for serving the relevant market and community.
Capital requirements will also be determined on a case-by-case basis. Fintech banks will have the same minimum capital requirements as traditional banks, but the OCC may in certain cases establish special minimum capital requirements, based on specific risk factors (for example, limited on-balance-sheet assets or nontraditional strategies).
Continue reading the full article (subscription required) for coverage of cybersecurity regulations, deregulation, vendor management, and more.
William Stern is a partner in Goodwin’s Financial Industry, Banking, Consumer Financial Services, and FinTech practices. Mr. Stern works on a variety of transactional and regulatory matters for Goodwin’s financial services clients. Jeremy Estabrooks writes and speak on U.S. financial services law and regulatory issues. Prior to joining Practical Law, he worked at two large international law firms and American Express.
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