Fintech Disruption: Balancing Financial Services Innovation and Regulation

By Alex Kraik*

The financial services sector, specifically banking, has been mostly impervious to new competition. This is due to regulatory bulwarks that create barriers to entry and the industry’s unique business model.[1]  However, over the past decade, the staid financial world has attracted new industry participants.  These interlopers are beginning to pose a serious threat for market share.  The financial world is currently uniquely vulnerable due to the financial crisis’ erosion of trust in the banking sector, shifting demographics, and the ubiquity of mobile devices.  Financial technology (“fintech”) companies threaten to diminish bank profits by 10-40% by 2025 in their traditional business markets: consumer finance, mortgages, lending, retail payments, and wealth management. [2]  While fintech companies will likely never be able to fully compete with brick and mortar institutions, they have the potential to erode the industry’s profitability, influence growth, and force buy-out decisions.[3]

Having survived the heady days of the dot-com boom in the late 1990s,[4] established financial institutions (“FIs”) are now seeing a new round of challengers buoyed by technological advancements.  This time, new enterprises are creating technologies and innovations that compete with, supplement, and even bolster traditional FIs and intermediaries.[5]  The fledgling fintech challengers consist of both technological start-ups and traditional financial companies. They embrace a wide range of fields, such as financial literacy, retail banking, personal investments, and crypto-currencies.[6]  Fintech companies now total approximately 12,000 entities, a marked increase from the small pool numbering 800 in April 2015.[7]  Venture capital investment in these entities has resultantly soared, totaling over $40 billion in the past 5 years with almost $13 billion in 2016 alone.[8]

The rise of fintech has not gone unnoticed by federal regulatory authorities. The Office of the Comptroller of Currency (“OCC”) charters, regulates, and supervises all national banks and ensures they comply with federal laws and regulations.[9]  The OCC also has the power to approve or deny applications for new bank charters and promulgate new rules and regulations governing investments and lending.[10]  On December 2, 2016, Comptroller Thomas J. Curry announced that the OCC would consider applications from fintech companies to become special purpose national banks.[11]

The National Bank Act grants the OCC its authority.[12]  The agency interprets this power as permitting it to grant charters to special purpose banks.[13]  These unique banks must either engage in fiduciary activities or provide at least one of the core banking services—receiving deposits, clearing checks, or lending money—to be granted a charter.[14]  Special purpose banks are also able to apply for charters, as there is no legal limitation on the type of special purpose for which a charter can be issued.[15]  Typical special purpose banks include trust banks and credit card banks.[16]  Against this broad regulatory canvas, discourse around fintech regulation has increased in lock step with the level of the threat posed by the emerging competition.

Under the current laws, a national bank charter permits an FI to conduct business nationwide while subjecting that bank to regulatory standards and federal oversight.[17]  A special purpose bank that is granted a charter is subject to these same federal laws.[18]  Prospectively, the OCC proposes to assess the distinct activities that fintech companies wish to engage in on a case-by-case basis.[19]  In addition to the OCC’s regulations and oversight, a fintech company granted a special purpose charter would also need to coordinate with other regulators: the Federal Reserve, Federal Deposit Insurance Corporation, and Consumer Financial Protection Bureau.[20]

The OCC aims to regulate chartered fintech companies like national banks.  The same safety, solvency, and customer protections would apply.  However, the OCC proposes to tailor these standards to account for a fintech company’s size, complexity, and risk level.[21]  In its white paper on the subject, the OCC identified baseline expectations for any fintech company seeking a charter.  These include: a developed business plan, proper governance structure, a minimum level of capitalization, a minimum level of liquidity, and a robust compliance system.[22]  Additionally, the OCC will require fair financial customer engagement and a developed insolvency plan.[23]  Notably, the OCC is considering enforcing higher capital requirements for these firms because of the nature of their business activities and fears that accounting balance sheets may not be able to properly capture their financial health.[24]

The OCC states three primary reasons for imposing a regulatory framework onto fintech companies: (i) to ensure that these enterprises operate in a safe, stable manner to effectively serve consumers, (ii) to promote consistent regulation across the country and in the financial sector, and (iii) to make the federal banking system stronger.[25]

Mindful of operating expenses and transactional costs, fintechs are advocating for a charter that will obviate the need to register and comply with laws in multiple states.[26]  They prefer compliance with one federal standard.[27]  Not surprisingly, the OCC’s announcement in December 2016 immediately drew the ire of the New York Department of Financial Services.[28]  It, along with other state regulators, warns that a federal charter is dangerous and unnecessary.[29]  Together with established FIs, state regulators assert that federal charters would give fintech companies an unfair advantage over banks by allowing fintechs to benefit from the preemption of state regulatory standards, while possibly avoiding the same supervision as their more complex bank counterparts.[30]

Another line of criticism stems from the fear of setting a precedent.  If fintech companies are eligible for charters, other financial firms, especially mortgage lenders and payday-lending shops, might also see this as their opening to receive charters.[31]  Because fintech is a broad descriptor, this precedent might permit any firm using financially related technology or offerings to argue that they qualify for a charter.[32]

Criticism of the OCC’s notion of turning fintech companies into special purpose national banks is protectionist and shortsighted.  Since market efficiencies are available, they should be grafted onto the financial sector.  Technology is everywhere; it fills industry gaps and shortcomings.  Advancements are forcing enterprises to not only adapt and innovate to maintain profitability and client service standards but also to survive.  So long as regulatory watchdogs remain alert, one is hard pressed to see why the industry progress is disagreeable for consumers.  Indeed, the adoption of a regulatory apparatus allows the OCC to adjust its oversight to the needs and challenges of fintechs and to assist in shaping the future of the FI sector.

Fintech chartering is not yet a given; many hurdles remain.  Even if this debate continues, technological innovation and financial creativity will not cease.  Therefore, the real risk is the nation falling behind in financial services and remaining captive to outdated business models.  The choice for regulators would appear to be one of either leading or catching up after being dragged into an increasingly competitive fray.


The views and opinions expressed in this blog are those of the authors only and do not reflect the official policy or position of the Michigan Journal of Environmental and Administrative Law or the University of Michigan.

*Alexander Kraik is a Junior Editor for MJEAL.  He can be reached at akraik@umich.edu

[1] Miklos Dietz et al., Cutting Through the Noise Around Financial Technology, McKinsey & Company (Feb. 2016), http://www.mckinsey.com/industries/financial-services/our-insights/cutting-through-the-noise-around-financial-technology.

[2] Id.

[3] Patricia Hart, Banks are Right to be Afraid of the FinTech Boom, Time (Dec. 12, 2016, 12:15 PM), http://time.com/3949469/financial-technology-boom/.

[4] Dietz et al., supra note 1.

[5] Id.

[6] Matthew Blake et al., Five Things You Need to Know About Fintech, World Economic Forum (Apr. 20, 2016), https://www.weforum.org/agenda/2016/04/5-things-you-need-to-know-about-fintech/.

[7] Dietz et al., supra note 1.

[8] João-Pierre Ruth, Fintech VC Dipped 13 Percent in 2016, Mirroring Rest of Tech., Xconomy (Feb. 15, 2017) http://www.xconomy.com/new-york/2017/02/15/fintech-vc-backing-dipped-13-percent-in-2016-mirroring-rest-of-tech/; CBInsights, The Global Fintech Report Full Year 2016: Report Highlights, https://www.cbinsights.com/research-fintech-2016-report (last visited Feb. 26, 2017).

[9] Off. of the Comptroller of Currency, About the OCC,  https://www.occ.treas.gov/about/what-we-do/mission/index-about.html (last visited Feb. 26, 2017).

[10] Id.

[11] Press Release, Off. of the Comptroller of Currency, OCC to Consider Fintech Charter Applications, Seeks Comment (Dec. 2, 2016).

[12] 12 C.F.R. § 5.20(e)(1); 12 U.S.C. §§ 1-16.

[13] Id. at 12 C.F.R. § 5.20(l).

[14] Id.

[15] Off. of the Comptroller of Currency, Exploring Special Purpose Nat’l Bank Charters for Fintech Companies 3 (2016).

[16] Id.

[17] Off. of the Comptroller of Currency, supra note 15, at 4.

[18] Id. at 4; See Off. of the Comptroller of Currency, Interpretations and Actions, https:www.occ.gov/topics/licensing/interpretations-and-actions/index-interpretations-and-actions.html (last visited Feb. 25, 2017).

[19] Off. of the Comptroller of Currency, supra note 15, at 4.

[20] Id. at 7-8.

[21] Id. at 8.

[22] Id. at 8-11.

[23] Id. at 12-13.

[24] Lalita Clozel, OCC Grants New Charter to Fintech Firms – with Strings Attached, American Banker (Dec. 2, 2016, 9:17 AM), https://www.americanbanker.com/news/occ-grants-new-charter-to-fintech-firms-with-strings-attached.

[25] Off. of the Comptroller of Currency, supra note 15, at 2.

[26] Clozel, supra note 24.

[27] Id.

[28] Sullivan & Cromwell LLP, Off. of the Comptroller of Currency Proposal to Charter Special Purpose Nat’l Banks for FinTech Companies: OCC Outlines Supervisory Expectations and Seeks Public Comment (Dec. 4, 2016), https://sullcrom.com/office-of-the-comptroller-of-the-currency-proposal-to-charter-special-purpose-national-banks-for-fintech-companies.

[29] Id.

[30] Id.

[31] Lalita Clozel, Will the OCC’s New Charter Go Beyond Fintech Firms?, American Banker (Jan. 3, 2017, 1:08 PM), https://www.americanbanker.com/news/will-occs-new-charter-go-beyond-fintech-firms.

[32] Id.

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