Banking on the “Business of Banking”: How the 2nd Circuit’s Ruling in Lacewell v. OCC Could Change the Future of Fintech Regulation

Kilpatrick Townsend | Mike Breslin and Bennett Gillogly | Nov 11, 2020

dual banking systems - Banking on the “Business of Banking”: How the 2nd Circuit’s Ruling in Lacewell v. OCC Could Change the Future of Fintech Regulation

Despite often operating on a nationwide scale, fintech companies rarely meet the stringent requirements for obtaining a national banking charter. Under the current regulatory landscape, these companies must therefore secure individual state licenses and conform to a patchwork of inconsistent state-specific regulations. The process is not only expensive and cumbersome for the companies, it also creates a risk of gaps in consumer protections. Beyond compliance with the individual state regimes, many fintech companies must also comply with additional layers of federal regulation and oversight.

Two divergent proposals have emerged to improve the fintech regulatory landscape. First, the Conference of State Bank Supervisors (“CSBS”) announced in 2017 that it would harmonize state regulations by creating a 50-state licensing and supervisory system. As of June 2019, 23 states had committed to this multistate agreement. Second, the Office of the Comptroller of the Currency (“OCC”) announced in July 2018 that it would begin accepting applications for federal special purpose national banking (“SPNB”) charters submitted by nondepository fintechs.

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Proponents of the multi-state solution, including the CSBS, have since filed lawsuits against the OCC, alleging the OCC is exceeding its authority to issue SPNB charters. While the CSBS’s lawsuit was ultimately dismissed for lack of standing, the United States District Court for the Southern District of New York (“SDNY”) recently denied the OCC’s motion to dismiss a suit by the New York State Department of Financial Services (“NYDFS”) and signaled its belief that the OCC would exceed its authority if it issues a SPNB charter to a non-depository fintech. The OCC has appealed that decision to the Second Circuit, and the outcome of that appeal – Lacewell v. Office of the Comptroller of Currency – will likely determine what it means to be in the “business of banking” and direct the immediate future of fintech regulation.

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The Dual Banking System 

The changing definitions and regulations for a “bank” have long been at the core of American financial policy. When declaring that the Second National Bank could not be taxed or controlled by the states, the Supreme Court in McCulloch v. Maryland created the doctrine of “federal preemption.” During the Civil War, Congress passed the National Bank Act of 1864 both to introduce a national currency and establish the OCC to administer federal bank charters to companies in “the business of banking.” The Federal Reserve Act of 1913 created a decentralized central bank and required federally chartered banks to obtain membership and insurance. Developments like these institutionalized a dual banking system of divergent regulatory regimes for national and state banks.

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The “business of banking” was traditionally understood as receiving deposits, paying checks, and lending money. The rise of fintech companies offering tangentially related services has forced regulators to expand their conceptions of banking. A consistent trend across all industries, but especially fintech, is that innovation outpaces regulation. Fintech innovation, though, is unique in that its increasing complexity creates very real financial and legal risks for businesses and consumers. For instance, the meteoric rise in internet accessibility and sophistication of mobile applications promises banking ubiquity, but raises questions about how geography-based regulations and disclosure requirements should be applied. And while machine learning and artificial intelligence can deliver faster and more accurate decisionmaking, absent appropriate regulation they could also behave in unintended ways to cause market instability or discriminatory outcomes. As fintech creates more holistic consumer products leveraged on increasingly sophisticated systems, the regulatory regime must adapt to avoid the dual banking system’s incapacity to protect consumers without impeding innovation.

During the early stages of the fintech industry, state chartering was necessarily the default regulatory regime, but it is nonetheless one that provides many benefits. Without federal restrictions on capital raising, fintech companies can invest and expand faster than traditional banks. Competition among the states to attract fintech businesses facilitates business-friendly regulatory schemes that encourage innovation. On the other hand, this is also what created the patchwork of inconsistent compliance regulations and disclosure requirements. Fintech organizations must not only meet these state requirements, but also comply with many federal oversight agencies and legislation. And additional flow-down regulations arise for companies that rely on relationships with banks for access to the payments system. Even if the CSBS succeeds in its efforts to harmonize state regulations, these federal requirements will still apply.

See: 

FinTech Charter Hits Speed Bump

OCC sets stage for FinTech firms to charter as national banks

U.S. bank regulator allows fintech firms to seek federal charter

The OCC’s proposal to offer SPNB charters to nondepository fintech companies reflects an expanding view of what constitutes the “business of banking.” The key benefit to becoming federally chartered is the accompanying federal preemption. To be sure, stripping fintech companies of the strictest state requirements will allow them to provide new products while being held to the same fair access and consumer protection standards as national banks. Even so, federal regulations are often less fluid and could limit a fintech company’s opportunities for further innovation. There are a number of other reasons fintech companies might not want to obtain a national charter, as doing so would subject them to federal capital and liquidity requirements, as well as regulatory exams.

Lacewell v. OCC

Only months after the OCC announced in July 2018 that it would begin accepting SPNB charter applications from nondepository fintechs, Maria Vullo, in her capacity as Superintendent of the NYDFS, sued for declaratory and injunctive relief. The NYDFS complaint alleged that the OCC’s actions would destabilize financial markets and put consumers at risk of exploitation from federally-chartered entities “improperly” insulated from New York law.1 Such risks, according to the complaint, include weakening controls on predatory lending practices, creating an unfair competitive advantage for well-capitalized firms, and growing fintechs to become “too big to fail.”2 The complaint also pointed to instances since the 1970’s in which federal courts have checked the OCC’s previous attempts to expand its definition of the “business of banking.”3 The NYDFS suit ultimately requests that the court declare the SPNB charter provision unlawful if applied to non-depository institutions.

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