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Fintech: Strategic advantages and initial costs for entry into banking

News, strategies, and resources for bank chartering

Financial technology (fintech) companies have had specific advantages relative to "regular" banks, including a start-up culture, a lack of legacy technology infrastructure, and a regulatory environment that has allowed them more time to focus on product development and customer experience. While those long-term advantages have paid dividends for the fintech financial services industry, there are still numerous advantages to having a bank charter. This page contains news, strategies, and resources to help our clients as they consider entering the banking industry.

Pathway opens for non-financial and fintech companies to obtain de novo industrial bank charters

On March 17th, 2020, the Federal Deposit Insurance Corporation (FDIC) released a notice of proposed rulemaking (NPR) seeking comment on a proposed rule that would require certain conditions and commitments for approval or non-objection to certain filings involving an industrial bank or industrial loan corporation (ILC ) provided the parent company is not subject to consolidated oversight by the Federal Reserve Board (FRB). The developments open the door for additional non-financial companies and fintech companies to enter regulated financial services and provide a clearer path to not being subject to the FRB’s oversight. "This proposal would ensure that parent companies serve as a source of strength for their industrial bank subsidiaries," said FDIC Chairman Jelena McWilliams.

On March 18th, 2020, the FDIC approved separate applications by payment company Square Inc and student loan servicer Nelnet Inc to become de novo industrial banks, the first time the agency has granted such licenses in over a decade. FDIC Chairman McWilliams stated the following on the approvals: "Nelnet [and Square] satisfied each of the statutory factors required for approval, subject to certain conditions. One of the conditions would require the proposed bank[s] to maintain levels of capital that are significantly higher than typical FDIC-insured banks."

Learn more about the pathway by reading our full report and detailed analysis.

What does it take to meet regulators’ expectations to become a bank

In last year’s “So you want to be a bank,” we described the specific strategic considerations and options financial technology companies should consider in deciding whether or not to “join them” rather than “beat them” and what the actual journey for entry into the banking system might entail. Now, we take a dive deeper on what it takes to move from a desire to acquire a banking license to meeting the explicit and implicit price of admission for entry and getting the “all clear” from regulators.

Why and how to become a bank

To date, success for fintech companies has been accomplished through bank partnerships, nonbank funding models, and a group of licenses at the state level. Fintech firms forged important partnerships and relationships with traditional banks to deliver innovative solutions. But many are still ultimately reliant on traditional banks for many aspects of money movement.

While operating outside of the banking industry has had its advantages, there are numerous advantages to having a bank charter, including:

  • Access to stable, lower-cost Federal Deposit Insurance Corporation (FDIC)-insured deposits
  • Direct payment system access
  • Ability to operate across state boundaries under a single regulatory framework through national pre-emption which enhances regulatory certainty
  • The imprimatur of approval from licensing authorities
  • Emergency borrowing from the Federal Reserve Bank (FRB) discount window

Depending on the individual fintech company’s product mix and future strategy, these banking industry advantages may be critical to obtaining sustainable profitability and generating scale in the next phase of their evolution.

Some of the strategic choices that fintech firms face today include:
  • Operate and fund independently of the banking system
  • Utilize a bank partnership model for access to the payments system and credit product funding and/or offering of joint banking or financial products
  • Formally enter the banking system with a charter
  • Prepare for sale to another entity in the fintech and banking industry
Where to now?

First and foremost should be an evaluation across the core elements of your business plan and growth strategy. While entry into the banking system may appear daunting at first, its many long-term strategic advantages may, for some entrants, outweigh the initial costs.

Methods of entry

Entry into the banking system can be accomplished by organizing as a new, so-called de novo bank or through the acquisition of an existing bank. For simplicity, our analysis will consider a fintech company’s acquisition of an existing bank as a de novo charter formation since the bank regulatory agencies will effectively evaluate the acquisition through that regulatory lens.

At present, there are several charter types for entering the banking system that a fintech company should consider, each having its own distinct advantages and potential drawbacks. These include:

  • National bank charter (full service and special purpose 'FinTech charter')
  • State charter (Federal Reserve member/State and Federal Reserve non-member and FDIC/State state nonmember)
  • Industrial Loan Corporation (ILC charter)
  • Thrift or savings and loan charter (federal and state)
  • Trust charter

Each chartering authority, whether federal or state has its own application requirements and processes. The federal banking agencies and the Conference of State Bank Supervisors (CSBS) have established a uniform application template for consistency and ability to meet multiple application needs with a single filing.

The content of a charter application and its corollary business plan can be summarized as follows:

  • Describes organizers
  • Describes the overall governance structure
  • Provides for sufficient capital in relation to the proposed business plan
  • Demonstrates how the entity can reasonably be expected to achieve and maintain profitability
  • Describes how the entity will be operated in a safe and sound manner
  • Demonstrates how its business poses an acceptable risk to the FDIC’s Deposit Insurance Fund, if applicable
  • Demonstrates that its corporate powers are consistent with applicable federal and state banking laws and regulations

Regulators expect applicants to consider meeting with the relevant federal and state authorities prior to a formal application to provide an overview of their interest and plan in owning and operating a banking organization. In some instances, especially where the proposed business plan is novel or the company is seeking a fintech charter, providing a draft application prior to formal submission can assist with a more efficient and effective path to preliminary and then final approval.

Important considerations for the business plan components include, but are not necessarily limited to:
  • Risk assessments
  • Records, systems, and controls, including risk oversight, compliance risk management, and anti-money laundering program
  • Financial management, including financial and capital projections
  • Monitoring adherence to the business plan and revising the plan if needed
  • Alternative business strategy, including contingency plans and recovery/exit strategies
  • Community Reinvestment Act strategy or financial inclusion plan for fintech charters

The regulatory requirements and expectations for access to FDIC-insured deposits and the banking system include robust financial, governance, risk management, and compliance capabilities that mitigate risks to the federal safety net and potential harm to consumers. As part of the bank entry evaluation and preparation, firms should consider conducting a gap analysis against current and future capabilities, evaluating how their current financial resources, risk, and governance approach may fall short of the more formal requirements embedded in bank regulations and guidance.

Focus, in particular, should be on the level of capital and liquidity required to weather cyclical and adverse conditions given the fintech company’s proposed business strategy and risk profile. A specific capability expectation is for roles and responsibilities across what is commonly referred to as the “three lines of defense” (business line, independent risk management, and internal audit) to be adequately defined and supported by qualified staff and infrastructure.

Further, a well-designed governance framework—including the board of directors and committees of senior management, risk, and assurance functions—that provides reasonable checks and balances over the firm’s risk-taking and operations is required. For firms contemplating a FinTech Charter, there is an additional requirement for recovery and resolution planning as well.

All of these capabilities will be tested by examiners potentially prior to approval and through post-approval exams, to verify that the company’s operations are fully aligned with supervisory expectations.

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