As the battle over the Office of the Comptroller of the Currency (OCC)’s proposed financial technology (“fintech”) charter continues, investors in fintech companies should consider what it would mean for their business strategies if fintech companies actually did become banks. From an investor’s perspective, is there upside or downside to a fintech company becoming a bank?
First, there are advantages to status as a bank. In particular, it could liberate fintech companies from certain onerous state-by-state requirements, such as licensing requirements and interest rate limits. Especially for fintech companies whose businesses center on money transmission or consumer lending—activities that are particularly affected by these state laws—this could be a huge advantage.
But status as a bank is not a panacea. Anticipate the possibility of more regulatory scrutiny, not less, even if that scrutiny comes from only one or two banking regulators rather than the varied array of state regulators that can oversee nonbank fintech companies. National banks are chartered and examined by one federal agency, the OCC; state-chartered banks are examined by their chartering state and, typically, either the Federal Reserve or the FDIC. While status as a bank may thus reduce the number of regulators directly supervising the fintech company, that does not mean that it will reduce the aggregate amount of supervision. Banks are highly regulated entities that are limited in the activities in which they can engage and are subject to ongoing supervision and examination. (And a new bank is always subject to increased regulatory oversight for the first few years of its existence—its “de novo period.” A bank that forges new ground, such as one of the first holders of the OCC fintech charter or a bank with an unusual business plan, will likely attract even greater attention.)
Investors in fintech companies should also be aware that ownership of a bank is not the same as ownership of other companies. Ownership of a bank can trigger status as a bank holding company (BHC), which is a regulated entity supervised and examined by the Federal Reserve and subject to numerous laws, regulations, and policies specific to BHCs. Among other provisions to note, BHCs are restricted in the types of investments they can make—there are significant limits on their ability to invest in activities that do not relate to banking or finance. This could hinder investors that want the freedom to make diverse investments in a variety of companies.
Therefore, a key question an investor should ask is whether it could become a BHC via its ownership stake in a fintech bank.
To answer that question, two key definitions are important to understand: generally speaking, a BHC is a company that has “control” over at least one “bank.”
“Bank” is defined in a number of ways in different contexts, but for purposes of determining BHC status, it generally excludes entities that do not take deposits. Thus, it appears that a bank chartered under the OCC’s new fintech charter—which is for entities that do not take deposits—would not be a “bank” for these purposes. This means that ownership of a national fintech bank likely would not trigger BHC status.
But if a fintech company were to pursue a more traditional type of bank charter (whether national or state) involving the taking of deposits, that bank would likely qualify as a “bank” for purposes of the definition of BHC. If so, control of that bank would trigger BHC status.
So what is “control”? Determining whether a company has “control” of a bank can require a complicated multi-step analysis, including review by the Fed.
By default, “control” is considered to exist in certain specified conditions, such as “ownership, control, or power to vote 25% or more of the outstanding shares of any class of voting securities of the bank, directly or indirectly or acting through one or more other persons,” or “control in any manner over the election of a majority of the directors, trustees, or general partners (or individuals exercising similar functions) of the bank.” Another way it can exist is through “the power to exercise, directly or indirectly, a controlling influence over the management or policies of the bank”; the Fed has explicit authority to determine whether such power exists, “after notice and opportunity for a hearing.”
The Fed has provided guidance to help determine whether “control” may exist in the context of minority equity investments, notably the 2008 Policy Statement on Equity Investments in Banks and Bank Holding Companies, which helps investors understand how they can hold equity interests in banks without becoming BHCs. For instance, some investors have entered into “passivity commitments” with the Fed, in which the investors agree to refrain from certain actions, such as holding more than one seat on the bank’s board of directors, to minimize influence over the company. This may not be desirable for an investor that prefers a more active management role, but it may be an option for others.
Any investor in a fintech company chartered under the new OCC fintech charter should therefore familiarize itself with the regulatory framework applicable to banks and BHCs, determine whether its investment might trigger status as a BHC, understand the options available to address that possibility, and make investment decisions accordingly. Any fintech company weighing the possibility of obtaining an OCC fintech charter should first determine whether the company would be considered a “bank” and whether any investors in the company might become BHCs. If an investor in the company would become a BHC, the company should consult with its investor to make sure the investor is aware of this potential change and the implications of becoming a BHC.