Moving the Goalposts: U.K. and U.S. Trends in Fintech Bank Licensing
The dominant fintech narrative for the Canadian banking industry shifted in 2016 from a new entrant versus incumbent storyline to one of collaboration, as major Canadian banks continued to partner with new technology entrants. The intent of these partnerships varies but they generally aim to expand the incumbent bank’s customer service offerings, improve its customer/user experience (or UX) or accelerate its learning curve in a specific technology.
In the meantime, other jurisdictions, notably the U.K. and the U.S., have made it (or are proposing to make it) easier to obtain a banking licence, likely leading to more direct competition in the retail banking space between new technology entrants and incumbents. Below, we look at what banking regulators are doing in the U.K. and the U.S. to move the goalposts for fintech banking entrants and conclude with some thoughts on how this might impact the competitive landscape.
UNITED KINGDOM: REGULATIONS USHER IN NEW ERA OF DIGITAL BANKS
In 2013, the U.K. Prudential Regulation Authority (PRA), which is in charge of granting deposit-taking bank licences, lowered entry barriers for certain types of new entrants, which included reducing initial minimum capital and liquidity requirements, and streamlining ongoing reporting requirements, among other changes. In particular, the minimum amount of initial capital required by new applicant banks was reduced from £5-million to £1-million. Aditionally, certain new entrant banks have been granted “mobilization,” an authorized banking licence with restrictions. These banks can accept aggregate deposits up to £50,000 for an initial period until additional capital has been raised. Further amendments were introduced in January 2016 when the PRA and the Financial Conduct Authority, launched a New Bank Start-up Unit to assist applicants with the authorization process.
These policy changes have resulted in a significant increase in deposit-taking licence applications and grants. In 2016, four new “digital” banks were granted U.K. banking licences including Atom Bank, which offers savings accounts that are accessed exclusively through a smartphone. Several more have applied for licences — such as Zopa, an online peer-to-peer lender — and according to published reports, up to 20 banks are presently in talks with the Bank of England and the PRA about receiving a licence. The PRA’s 2013 amendment was not enacted for fintech companies exclusively, but to generally “enable increased competition in the banking industry, to the benefit of customers.” Nevertheless, U.K. fintech entrants have clearly taken advantage of the rule changes to launch operations that directly compete for banking customers.
UNITED STATES: NEW FINTECH CHARTER
In the U.S., the Office of the Comptroller of the Currency (OCC), the federal regulator with the authority to grant national banking charters, announced on December 2, 2016 that it would, with a view to responsible innovation, grant special purpose banking licences to certain fintech companies.
Eligibility for a special purpose licence is limited to applicants who engage in fiduciary activities or core banking functions, including receiving deposits, paying cheques, or lending money. Given that fintech companies provide a wide-array of products and services, the OCC has said that it will consider on a case-by-case basis whether a particular fintech firm is engaging in permissible activity. The licences would allow fintech challengers to operate nationally without having to fulfill the requirement of obtaining licences from each state in which they intend to operate. However, the new entrants would still need to comply with certain state laws, such as anti-discrimination, fair lending, and debt collection.
Specific requirements that fintech companies would need to meet in order to be granted a licence, other than the limited eligibility requirements noted above, have yet to be determined and the OCC is currently in the process of soliciting input from the public. The OCC has said that fintech companies — and all special purpose national banks — will be required to meet high governance, risk management, and supervisory standards, just as all national banks must.
With that said, the OCC has maintained that the new regime will tailor these standards, allowing the regulator to be flexible and take into account the different sizes, risk profiles, and business models of fintech firms. In particular, OCC has said it may alter the capital requirements for fintech firms. Because much of fintech business activity is off balance sheet, the minimum level of capital that a fintech must maintain may be higher.
Although it is clear that the Canadian federal government will consider fintech issues as part of its overall 2016 legislative review of its financial services legislation, it remains to be seen what will change. It seems certain that the existing rules, crafted at a time before iPhones existed, will be updated to allow for clearer paths to investment in fintech or collaboration with them by banks. It is unclear, however, whether the federal government will revisit and amend the Canadian bank licensing process to accommodate new fintech entrants.
Currently, an applicant can expect the banking licence process to takewell over a year and cost millions of dollars in internal and external resources. If the federal government was to introduce a less onerous path for licensing fintech-oriented participants as a form of bank, it would inevitably need to, at the same time, revise and update technology-oriented business powers and permissible investment regimes for all banks to provide a modern and level playing field.
Ultimately, would regulatory changes facilitating the licensing of new entrants have a material impact on the competitive banking landscape and pace of innovation? We have two main thoughts. First, the high cost and challenge of acquiring new customers will not change and this will likely remain the main hurdle for independent, consumer-facing fintech-oriented challengers. So, although reduced capital and liquidity requirements may lower barriers to entry, as is the case in the U.K., new fintech entrants will still need deep pocketed backers to fund customer acquisition or, alternatively, will need to identify some kind of game-changing value proposition or distribution model.
Second, once past the licensing gates, as the fintech challengers grow in size, they would ultimately still be subject to the exact same regulatory requirements as the incumbents. These compliance requirements are costly and operationally burdensome and new fintech entrants typically view their ability to avoid the existing regulatory framework as a key competitive advantage in terms of staying nimble and maintaining a low-cost service offering.
Any regulations introduced would need to, as the OCC noted in December, foster healthy competition by easing the regulatory burden on companies responding to the market demands of a rapidly evolving customer base, while also ensuring they operate in a safe and supervised manner. The OCC emphasized its commitment to “responsible innovation” and this seems to be a worthy goal. Fintech challengers also crave regulatory certainty and may choose to focus on those countries with a clearer path to licensing, with reasonable accommodations for start-ups with new technology and business models.
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