KT Fintech Blog

The KT Fintech Blog provides insights into how the emergence of fintech is fundamentally changing virtually every aspect of the financial services landscape and how traditional businesses navigate this rapidly evolving industry.

Category: Marketplace Loan

Posted on Friday, October 20 2017 at 9:00 am by
Acting Comptroller Discusses Innovation and Financial Technology

Written By Eamonn Moran

Acting Comptroller of the Currency Keith A. Noreika recently discussed innovation and financial technology during a speech at Georgetown University Law Center’s Institute of International Economic Law’s Fintech Week. His remarks highlighted his optimism for innovation enhancing products and services for consumers and provided an update on activities related to the Office of the Comptroller of the Currency’s Office of Innovation, including the latest on the agency’s thinking regarding a charter for fintech companies that offer banking products and services.

According to Noreika, “we are at the beginning of a period in this country that is more open to rethinking our approach to regulation, so that we can promote economic opportunity while ensuring the financial system operates in a safe and sound manner and protects consumers from abuse.” He perceives bankers, industry members, regulators, and legislators to “appear ready and willing to have discussions today that would have been impossible six months or a year ago.” He views this change in tone as “very encouraging,” which “suggests that we are finally able to have a constructive, bipartisan conversation about how to approach our regulatory framework.” He stressed that in any steps we take, “we must carefully weigh the cumulative effects of our actions. That includes the impacts on markets, consumers, and banks, and on other companies, such as fintechs, that are innovating the way financial products and services are delivered based on the evolving needs of consumers, businesses, and communities nationwide.”

Noreika noted that his optimism is also based in part on how he views change, including the transformations occurring in the financial services marketplace today, as a part of the “natural evolution” of the banking industry toward “increasing convenience, speed, and control.” Pointing to some of the transformations in the banking sector, such as mobile banking, he stressed the importance of being “careful to avoid defining banking too narrowly or in a stagnant way that prevents the system from taking advantage of responsible advances in technology and commerce.”

In describing the work of the OCC’s Office of Innovation, Noreika noted that the office’s “primary purpose is to make certain that institutions with federal charters have a regulatory framework that is receptive to responsible innovation and the supervision needed to support it,” and that the office “serves as a clearinghouse for innovation-related matters and a central point of contact for OCC staff, banks, nonbank companies, and other industry stakeholders.” He noted that the OCC also is in the early phases of developing a framework for OCC participation in bank-run pilots that allow banks to develop and test products in a controlled environment. In his view, pilots “can accomplish the same goals as what others call ‘sandboxes,” and allow [the agency] to gain insight into a product and to become comfortable with a proposed product’s controls and risks early in the process.”

Building upon remarks he made in July, Noreika reiterated his views that companies that offer banking products and services “should be regulated in the same way that banks are and subject to the same type of ongoing supervision and examinations that banks face.” Consistent with his predecessor, Noreika also is of the mindset that companies that offer banking products and services should be allowed to apply for national bank charters in order to pursue their businesses on a national scale if they choose, so long as they meet the criteria and standards for doing so. He again emphasized that national charters should be just one choice for companies interested in banking, and should exist alongside other options that include becoming a state bank or state industrial loan company (ILC), or operating as a state-licensed financial service provider. Noreika highlighted how certain states, like Georgia, already offer limited purpose charters that even allow commercial companies to be the parent company of the state institution (merchant acquirer limited purpose banks). Furthermore, fintech companies could also pursue partnerships or business combinations with existing banks, or even consider purchasing a bank.

“If, and it is still an if, a fintech company has ambitions to engage in business on a national scale and meets the criteria for doing so, it should be free to seek a national bank charter,” Noreika stated. That includes pursuing a charter under the OCC’s authority to charter special purpose national banks or the OCC’s long-existing authority to charter full-service national banks and federal saving associations, as well as other long-established limited-purpose banks, such as trust banks, bankers’ banks, and other so-called CEBA credit card banks. According to Noreika, “[m]any fintech and online lending business models fit well into these categories of national bank charters, and there has been some interest in fintechs becoming full-service banks, trust banks, and credit card banks. Chartering innovative de novo institutions through these existing authorities enhances the federal banking system, increases choice, promotes economic opportunity, and can improve services to consumers, businesses, and communities.” He cautioned, however, that a national bank charter “is a special thing, and the OCC will not undermine its value by granting charters to companies that are not ready to meet [the agency’s] admittedly high expectations.”

Noreika also took the opportunity to correct some misperceptions that he has seen and heard about – especially the concerns about fintech charters leading toward the inappropriate mixing of banking and commerce. He pointed to the many examples where commercial companies are already allowed to own banks at the state and federal levels, including national credit card banks, state merchant processing banks, state-chartered ILCs. “The law allows commercial companies today to own these types of banks for good reason – they support legitimate business goals and deliver valued products and services to their customers,” he observed. He recognized that the Bank Holding Company Act defines what it means to be a bank for the purposes of that law, but if a particular chartered bank does not satisfy that definition, its parent company would not become a bank holding company solely by virtue of owning the bank. Accordingly, nonbank holding companies, commercial entities, or other banks could own such banks under the law. He did want to be crystal clear about one thing, however: “[t]he chartered entity, regulated by the OCC, would be a bank, engaged in at least one of the core activities of banking – taking deposits, paying checks, or making loans.”

Posted on Wednesday, October 11 2017 at 9:00 am by
CFPB Makes Accommodations for Certain Fintech Products in Final Small Dollar Lending Rule

Written by Eamonn Moran

On October 5, the Consumer Financial Protection Bureau (CFPB or Bureau) released its long-anticipated final rule on small-dollar lending, which covers payday, vehicle title, and certain high-cost installment loans. Along with providing consumer protections governing the underwriting of covered short-term and longer-term balloon-payment loans – including payday and vehicle title loans – the rule also contains disclosure and payment withdrawal attempt requirements for covered short-term loans, covered longer-term balloon-payment loans, and certain high-cost covered longer-term loans. In one of the most significant differences from the proposal, the Bureau is not, at this time, finalizing the ability-to-repay determination requirements proposed for certain high-cost installment loans, but it is finalizing those requirements as to covered short-term and longer-term balloon-payment loans.

We note that the rule excludes from coverage some new fintech innovations, such as certain no-cost advances and programs to advance earned wages when offered by employers or their business partners.

Based on prior discussions with various stakeholders, the Bureau solicited and received comments on the proposed rule in connection with the definition of lender under proposed 12 C.F.R. § 1041.2(a)(11) about some newly formed companies that are seeking to develop programs that provide innovative access to consumers’ wages in ways that do not seem to pose the kinds of risks and harms presented by covered loans. The CFPB acknowledges that some, but not all, of these companies are fintech businesses. In addition, their business models differ – some are developing new products as an outgrowth of businesses focusing mainly on payroll processing, for example, while others are not associated with consumers’ employers but rather are focused primarily on formulating new means of advising consumers about how to improve their cash management approach. In particular, the Bureau observes that a number of these innovative financial products are seeking to assist consumers in finding ways to draw on the accrued cash value of wages they have earned but not yet been paid. “Some of these products are doing so without imposing any fees or finance charges, other than a charge for participating in the program that is designed to cover processing costs. Others are developing different models that may involve fees or advances on wages not yet earned,” the Bureau states.

The Bureau notes that some efforts to give consumers access to accrued wages may not be “credit” at all, while other initiatives are structured in more complicated ways that are more likely to constitute “credit” under the definition set forth in § 1041.2(a)(11) and Regulation Z. For instance, when an employer allows an employee to draw accrued wages ahead of a scheduled payday and then later reduces the employee’s paycheck by the amount drawn, there is a plausible argument that the transaction does not involve “credit” because the employee may not be incurring a debt at all. This is especially likely where the employer does not reserve any recourse upon the payment made to the employee other than the corresponding reduction in the employee’s paycheck. On the other hand, if an employer cannot simply reduce the amount of an employee’s paycheck because payroll processing has already begun, there may be a need for a mechanism for the consumer to repay the funds after they are deposited in the consumer’s account.

The Bureau has decided in 12 C.F.R. § 1041.3(d)(7) to exclude such wage advance programs – to the extent they constitute credit – from coverage under the rule if they meet certain additional conditions. The Bureau notes that the payment of accrued wages on a periodic basis, such as bi-weekly or monthly, “appears to be largely driven by efficiency concerns with payroll processing and employers’ cash management.” In addition, the Bureau believes that the kinds of risks and harms that underlie many of the new requirements in the rule “may not be present where these types of innovative financial products are subject to appropriate safeguards.” The Bureau has concluded that “new and innovative financial products that meet these conditions will tend not to produce the kinds of risks and harms that the Bureau’s final rule is seeking to address with respect to covered loans.”

This accommodation may be an attempt to foster and support innovation in the industry that poses little to no consumer risk. The Bureau states that it has “consistently expressed interest in encouraging more experimentation in this space,” but also cautions that “nothing prevents [it] from reconsidering these assumptions in a future rulemaking if there is evidence that such products are harming consumers.” The Bureau made changes in the rule in response to comments it received. In particular, the Bureau’s changes appear to be supportive of certain promising innovations, including innovative income-smoothing and financial management products and services. It is reasonable to expect the regulators to make additional accommodations for fintech-related products and services in the future, assuming that there are appropriate safeguards and consumer protections put in place.

For a more detailed summary of the rule along with additional takeaways, please click here.

Posted on Monday, September 18 2017 at 9:00 am by
Senate Banking Committee Holds Fintech Hearing

Written by Eamonn Moran

The Senate Committee on Banking, Housing, and Urban Affairs held a hearing entitled “Examining the Fintech Landscape” on September 12, 2017. The witnesses were: Lawrance Evans, Director, Financial Markets, U.S. Government Accountability Office (GAO); Eric Turner, Research Analyst, S&P Global Market Intelligence; and Frank Pasquale, Professor of Law, University of Maryland Francis King Carey School of Law.

The hearing focused on the opportunities fintech may bring, the various ways fintech is interacting with and impacting the financial system, how these new technologies can help Americans who are currently underserved by the traditional banking system, and the current regulatory supervision of the fintech industry. Given the recent data breaches, particular issues such as data security, data collection, and the proper regulatory treatment to ensure that consumers and the financial system are safeguarded were emphasized.

Mr. Evans’ testimony was based on the GAO’s April 2017 report that provides a high-level look at four commonly referenced fintech sub-sectors – marketplace lending, mobile payments, digital wealth management and distributive measured technology. He noted that the GAO is currently undertaking work that will support congressional efforts to strike the appropriate balance in ensuring an effective regulatory framework while not creating barriers to entry for innovative firms with “socially beneficial products.”

Mr. Turner’s testimony focused on the five key areas that his firm has identified as fintech’s impact on consumers in the financial industry today. These include digital lending, mobile payments, digital investment management, insurance technology and distributed ledger technology, which includes Blockchain.  According to Mr. Turner, “the industry is still young and challenges remain.  Regulation has been unevenly applied to the sector and in many ways the introduction of a clear regulatory framework could help boost innovation.”

Mr. Pasquale focused his testimony on the consumer protection issues associated with fintech, and express reservations about deregulation and legislative or regulatory efforts to federally preempt state laws now applying to fintech. He also stressed that improving financial cyber security should be “an essential goal of fintech policy.” According to Mr. Pasquale, “we should be very worried about the ability of technology alone to solve much larger social problems of financial inclusion, opportunity and non-discriminatory credit provision.”

The witnesses were asked to address what are some of the most significant fintech risks that Congress should evaluate. Mr. Turner opined that “the biggest risk right now is a fractured regulatory system.” He observed that fintech companies “have looked for regulation wherever they can and right now it seems that they’re just trying to fit themselves into a system that wasn’t made for them.” Mr. Pasquale highlighted cybersecurity and the “opaque algorithms being used to access credit” and the “many different types of data sources” that could play a role in credit decision-making. In light of recent data breaches, there was widespread agreement that consumers should know exactly how their data is being used.

The witnesses seemed generally supportive of a “regulatory sandbox” approach that has been implemented in the United Kingdom which allows firms to operate on a limited basis to test different ideas while under regulatory supervision, but without needing to comply with the full regulatory enforcement regime.

The witnesses agreed that the best opportunity posed by fintech is enhanced and sustained financial inclusion, with the potential downside of certain “bad actor” companies gaming the system as a means to market high-cost loans to individuals. Going forward, Mr. Turner emphasized the need for fintech companies to have a framework that allows them to decide whether to be a deposit-taking institution and be like a real bank, or have some sort of defined regulatory structure specific to fintech companies. He also stressed the need for Congress and regulators to think long and hard about the scope of any definitions they formulate (such as what a digital lender is and what a peer-to-peer payment company is), as a means to help ensure a proper regulatory framework and level playing field across the lending industry.

Senator Brian Schatz (D-HI) noted that it would be helpful to have a dedicated innovation office within the federal government that is thinking comprehensively about the many different issues and questions that pertain to fintech. As he observed, “[t]his could be a one-stop shop in the government for fintech businesses to figure out which regulations apply to them and a mechanism for coordinating among the regulators. It will be a wild West without some attempt to coordinate.  You already have regulators with varying degrees of aggressiveness in this space and enthusiasm for this space. But we need someone who is thinking around a few corners, rather than just sort of narrow questions of compliance for particular companies.” Senator Mark Warner (D-VA) and the witnesses agreed that this is something that should strongly be considered, especially given the problem of interagency cooperation.

Given the strong bipartisan interest in fintech issues, we anticipate additional congressional hearings in the months to come.