Fitch: Fintech Bank Charters a Regulatory Balancing Act

NEW YORK--(BUSINESS WIRE)-- The potential for financial technology (fintech) firms to obtain federal bank charters could have significant impacts on the operating strategies and regulatory environments for some players in this emerging sector, says Fitch Ratings. The exploratory move is in line with a broader desire by regulators globally to formulate a regulatory stance that ensures appropriate oversight and monitoring of fintech companies without stifling innovation.

A comment published last week by the Office of the Comptroller of the Currency (OCC), if ultimately approved, would allow for special purpose bank charters for fintech companies. Becoming a special purpose bank would mean greater regulation and attendant capital requirements, albeit less than those imposed upon a bank that takes insured deposits.

Increased reporting and compliance burdens, as well as capital costs, could weigh on profitability, all else being equal. The requirements of a charter could also affect the agility and lower-cost business strategies of some fintech firms that have leveraged their less regulated status into comparative advantages over banks.

Fitch does not expect all fintech companies to be interested in applying for a federal bank charter. Many view themselves purely as technology-driven intermediaries and would prefer to not incur balance sheet risk if possible. The requisite higher capital and other costs that would come with a charter could also act as a disincentive. Equity investors have also historically assigned higher valuation multiples to technology companies than to balance sheet lenders that generally employ greater leverage and are more capital intensive, which could dissuade some fintech companies from this approach.

A bank charter could still provide benefits for certain fintech companies, such as marketplace lenders. For example, they would no longer have to partner with a bank to facilitate business activities such as making loans, reducing their reliance on third parties. A federal banking charter could also reduce uncertainty over state usury rate caps that have become a more prominent issue recently following a federal court decision in June (Madden versus Midland Funding), which stated that agreed upon interest may not be enforceable in certain circumstances.

A special purpose bank charter would likely not allow for insured deposit-taking, which would require FDIC approval and regulation, but in Fitch's opinion it could be an initial, gradual step in that direction. Insured deposit funding would be a much more significant shift for fintech companies' credit profiles, as reliance on wholesale funding is a primary constraint for many business models.

In particular, marketplace lenders that target the very high end of the credit quality spectrum would likely find access to lower cost and more stable insured deposit funding more attractive as this segment is more price competitive and produces narrower margins. However, these benefits would come with significantly greater regulation and compliance requirements if approved, potentially offsetting the funding benefits gained.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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Source: Fitch Ratings

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