OCC FinTech Charter

[SLCPaladin]

Don't get me wrong... I am willing to hear out both sides.  I just want to make sure some benefit accrues to the consumer from all of this, otherwise, I am (and so will regulators be) disinclined to act on the matter.  The "special" benefit to consumers needs a really good case.

My feeling is that as long as FinTech companies allow retail investors access to the investment platform, it certainly does represent a special benefit. As soon as this retail segment is closed off, then I think the special benefit becomes less apparent. As a retail investor, investing in notes of this type is something I want continued access to, only I'd like more offerings from a larger variety of FinTech companies (I'm not yet an accredited investor, but getting close). This asset class has been helpful to me in a period of low interest rates.

[rawraw]

I disagree that Fintech materially changed the rates on consumer loans. Maybe that's wrong, but their rates seem similar to what banks were already offering. The change Fintech brought was the availability, since unsecured lending is not extremely attractive to a bank. 

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[nonattender]

No, I think you follow pretty well...  The question is really, aside from the buzzwords, what's "special" about doing banking functions over the internet - versus at a branch?  Ok, they're "limited" to 1/3 the function - alright, tie 3 "limiteds" together and, voila, a 'bank' - except without the same compliance rigor (unless there's something else 'special' that I'm missing in this equation).  What's special?

The first iteration of this charter will likely be subpar, but I give credit to the OCC for trying to "level the playing field" for fintechs.

What are the disadvantages from which they suffer, aside from higher cost of capital and, if not bank partnered, state by state reg? Seeing the first get addressed in a few instances, indirectly, by some banks doing more "risk retention" (ie, lessening capital costs).

Access to become a franchise in our public-private financial system* is currently very costly and laborious process, and as such a high barrier for entry.

Sure, but those walls were built for very good reasons.  What's "special" case for tearing 'em down?  I guess we are about to find out - though I'm not sure that simply "disaggregation" of services (when the gameplan seems to be to reg arb / daisy-chain aggregates back together, making them, effectively, "banks" again - but without the - pick your poison - "compliance rigor"/"barriers to entry") = "smart".

That being said, a charter won't be for everyone.  Decision will come down to what type of risk adjusted returns are your equity investors looking for.  Those comfortable with the returns playing at the fringe should not opt for the charter.  Therefore, I envision this charter really benefiting already established large scale tech companies such as Google, Amazon, Paypal, Facebook, etc.

Those guys don't seem to have much trouble accessing banking rails/systems, under current reg paradigm - but they have to partner, usually, for a lot of things, with a "well regulated militia" of chartered/compliant institutions.  They - or their VC arms - seem to be in a little bit of a bank-buying spree, lately - and banks are in a bit of a tech-buying spree lately, too - does that require new regulation or already happening?  I think the latter.  But I do see where it'd be nice to have Goog pay Izzy to lobby OCC, rather than foot that bill!

* The Finance Franchise https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2820176 see Section VI for analysis of fintech

Oof.  Academic writing alert.  Rhetorical snoozeville and attempts at reframing --- footnoted all the way through with "news" articles.

Don't do that to me, Joe --- there's a finite amt of that stuff that one can read in one's lifetime without just going completely crazy.

[SLCPaladin]

Don't do that to me, Joe --- there's a finite amt of that stuff that one can read in one's lifetime without just going completely crazy.

That's some real wisdom there Nonattender. I once heard a man--can't recall who--being interviewed on NPR who was getting on in years. He said this: "The older I get, the more inclined I am to take the approach to only do something if it is (1) really important or (2) really fun." I've adopted that as my personal motto. Life's too short to read uninspiring stuff.

[JoeF]

What are the disadvantages from which they suffer, aside from higher cost of capital and, if not bank partnered, state by state reg? Seeing the first get addressed in a few instances, indirectly, by some banks doing more "risk retention" (ie, lessening capital costs).

Not just cost of funds, but stability of funding and liquidity, especially in times of need.

Sure, but those walls were built for very good reasons.  What's "special" case for tearing 'em down?  I guess we are about to find out - though I'm not sure that simply "disaggregation" of services (when the gameplan seems to be to reg arb / daisy-chain aggregates back together, making them, effectively, "banks" again - but without the - pick your poison - "compliance rigor"/"barriers to entry") = "smart".

The walls were built to separate "banking" activities from other commerce.  Fintech companies provide "banking" services, thereby inherently suffer from the same risks chartered banks face.  If they are not part of the banking system, they become customers of chartered banks, because all money, except for physical cash, sits in banks.  Pretty much every financial crisis starts outside the banking system, when large customers fail, and kicks of a chain reaction that puts banks at risk.  So it appears the OCC is being proactive in trying to bring them in the circle so systemic risks can be monitoring.  I do, however, question the effectiveness of the current supervisory system even for banks, but that's another debate.   

Those guys don't seem to have much trouble accessing banking rails/systems, under current reg paradigm - but they have to partner, usually, for a lot of things, with a "well regulated militia" of chartered/compliant institutions.  They - or their VC arms - seem to be in a little bit of a bank-buying spree, lately - and banks are in a bit of a tech-buying spree lately, too - does that require new regulation or already happening?  I think the latter.  But I do see where it'd be nice to have Goog pay Izzy to lobby OCC, rather than foot that bill!

No trouble accessing, but I gather that access is coming at a cost that the "disruptors" feel they can cut.  Silicon Valley loves to preach the "your margin is my opportunity" mantra. 

Oof.  Academic writing alert.  Rhetorical snoozeville and attempts at reframing --- footnoted all the way through with "news" articles.

Don't do that to me, Joe --- there's a finite amt of that stuff that one can read in one's lifetime without just going completely crazy.

Different strokes.  I thought the paper was great because it is the most straight-forward description of the way finance actually works in our monetary system.  Most academic teaching on finance and banking is so disjointed from reality and has been driving economic policy for the last 40 years.  This paper cuts through the BS and delivers an accurate description of how the financial system works in reality.  TBF, there are more than just news articles referenced.  Where there are news articles, is to provide additional background information on topics one might not be familiar with, like bitcoin, p2p lending, etc.

[JoeF]

Don't do that to me, Joe --- there's a finite amt of that stuff that one can read in one's lifetime without just going completely crazy.

That's some real wisdom there Nonattender. I once heard a man--can't recall who--being interviewed on NPR who was getting on in years. He said this: "The older I get, the more inclined I am to take the approach to only do something if it is (1) really important or (2) really fun." I've adopted that as my personal motto. Life's too short to read uninspiring stuff.

Good quote, but what is really important or really fun is subjective.  I presented the link to provide context to my response.  Don't think you can truly discuss "what should/could be" (Fintech charter) if you don't understand "what is" (operational reality of current financial system".  To me that meets criteria #1,  really important.  But I follow this blog to understand the ecosystem of these business models and the banking system in general, not as a retail investor in anyone of the platforms, so to each his own, I guess.

[nonattender]

Don't do that to me, Joe --- there's a finite amt of that stuff that one can read in one's lifetime without just going completely crazy.

That's some real wisdom there Nonattender. I once heard a man--can't recall who--being interviewed on NPR who was getting on in years. He said this: "The older I get, the more inclined I am to take the approach to only do something if it is (1) really important or (2) really fun." I've adopted that as my personal motto. Life's too short to read uninspiring stuff.

Good quote, but what is really important or really fun is subjective.  I presented the link to provide context to my response.  Don't think you can truly discuss "what should/could be" (Fintech charter) if you don't understand "what is" (operational reality of current financial system".  To me that meets criteria #1,  really important.  But I follow this blog to understand the ecosystem of these business models and the banking system in general, not as a retail investor in anyone of the platforms, so to each his own, I guess.

Rhetoric translation:  "If you disagree with me, you don't understand the banking/financial system or the business models involved.  Also, you're probably just a small-time retail investor in p2p/mpl notes - and I follow the industry and truly understand, objectively."

Ok, Joe - we'll see how that goes.

[SLCPaladin]

Good quote, but what is really important or really fun is subjective.  I presented the link to provide context to my response.  Don't think you can truly discuss "what should/could be" (Fintech charter) if you don't understand "what is" (operational reality of current financial system".  To me that meets criteria #1,  really important.  But I follow this blog to understand the ecosystem of these business models and the banking system in general, not as a retail investor in anyone of the platforms, so to each his own, I guess.

I agree, importance and fun are subjective, but maybe only to a point. There are things that large swaths of individuals agree are universally important, and then there are things that are only important to a handful of enthusiasts. Everything can be interesting, and therefore stoke the curiosity of someone. I actually didn't read the paper, but I would if I had unlimited time. I appreciate the distilled comments and the application of it that you think it provides your argument. I'm invested in FinTech platforms because this is an important asset class for me, so obviously the evolution of how the industry is important to me. I am agnostic as to whether a OCC charter will be beneficial or not, but I enjoy hearing arguments for and against.

[nonattender]

I'm invested in FinTech platforms because this is an important asset class for me, so obviously the evolution of how the industry is important to me. I am agnostic as to whether a OCC charter will be beneficial or not, but I enjoy hearing arguments for and against.

One of the things at stake here is that if the platforms (currently) offering retail access to the p2p asset class get themselves a window cost of capital, your retail access (which is more expensive - and more expensive to build to service and to service) may just go away. ;(

Lots of twists and turns to follow, here... anyway, we'll see...

[JoeF]

Don't do that to me, Joe --- there's a finite amt of that stuff that one can read in one's lifetime without just going completely crazy.

That's some real wisdom there Nonattender. I once heard a man--can't recall who--being interviewed on NPR who was getting on in years. He said this: "The older I get, the more inclined I am to take the approach to only do something if it is (1) really important or (2) really fun." I've adopted that as my personal motto. Life's too short to read uninspiring stuff.

Good quote, but what is really important or really fun is subjective.  I presented the link to provide context to my response.  Don't think you can truly discuss "what should/could be" (Fintech charter) if you don't understand "what is" (operational reality of current financial system".  To me that meets criteria #1,  really important.  But I follow this blog to understand the ecosystem of these business models and the banking system in general, not as a retail investor in anyone of the platforms, so to each his own, I guess.

Rhetoric translation:  "If you disagree with me, you don't understand the banking/financial system or the business models involved.  Also, you're probably just a small-time retail investor in p2p/mpl notes - and I follow the industry and truly understand, objectively."

Ok, Joe - we'll see how that goes.

Apples and Pineapples...some readers may only be interested in asset side, what's being originated and what is available to them as an investor.  They may not care about the liability side, because it doesn't matter to them, they are committed to allocating a portion to their savings to this asset, so long as the platforms will accept them.  If that's the case, then I was just confirming your point that there is no need to get into the weeds of safety and soundness of the financial system.

I was coming at it from a different point of view, which was not an attempt to be superior to anyone else's view.   

[JoeF]

I'm invested in FinTech platforms because this is an important asset class for me, so obviously the evolution of how the industry is important to me. I am agnostic as to whether a OCC charter will be beneficial or not, but I enjoy hearing arguments for and against.

One of the things at stake here is that if the platforms (currently) offering retail access to the p2p asset class get themselves a window cost of capital, your retail access (which is more expensive - and more expensive to build to service and to service) may just go away. ;(

Maybe not.  I truly believe a pure p2p lender with access to emergency liquidity at the Fed would be the safest bank around in terms of "risk to the financial system".  This whole OCC thing isn't about insured deposits, they aren't cheap, banks compete like crazy for them and have tons of overhead costs to attract and maintain them.  And then you got to insure them, which costs a hefty "tribute" to the FDIC.  And now because you're leveraging the credit of the people of the US, you've got to be supervised, you know, in case you end up blowing the whole place up. 

No, give me emergency access to borrow from the Fed for liquidity in times where money is tight, but I'll lend with 100% "equity".  Sure it's not true equity, but it is sticky/maturity matched (you invested in a 60 month loan, so your money is parked for 60 months).  Losses are absorbed by the investors, no risk to the DI fund, with the Fed as a backstop when things get tight, and I should have that backstop because I provide credit to Americans to move the economy forward (public purpose).  Sure, they'll be supervision tied to that access, but it will be focused on asset quality, which is cool, because that's how I compete to attract investors anyway.  That'll get me a nice ROE that banks only dream of, be a shame to pass that up.

[SLCPaladin]

Apples and Pineapples...some readers may only be interested in asset side, what's being originated and what is available to them as an investor.  They may not care about the liability side, because it doesn't matter to them, they are committed to allocating a portion to their savings to this asset, so long as the platforms will accept them.  If that's the case, then I was just confirming your point that there is no need to get into the weeds of safety and soundness of the financial system.

I was coming at it from a different point of view, which was not an attempt to be superior to anyone else's view.

As an investor, I care mostly about the soundness of the notes and the borrowers I am lending to. That said, I still am invested in the platform stability because, hey, "platform risk." I think everyone was nervous when the Renault LaPlanche info hit the fan and how that would impact the platform. I was among those who were clamoring for LC to draw up a Bankruptcy Remove Vehicle (like the one Prosper has), because we want to protect ourselves against "platform risk." If an OCC charter performs some functions similar to FDIC insurance insomuch as it calms the jitters and makes things run more smoothly when there is liquidity crisis, then I'm all for that. But if it means retail capital gets squeezed off the platform, then obviously that is not something I would welcome. I suppose the devil is in the details and how the exactly it gets executed and drawn up.

[rawraw]

Not sure where Joef is coming from. Insured deposits are most certainly cheap. And a Fintech charter isn't likely to be funded by a branch network.  FDIC insurance fees are minimal and for well rated institutes, they can pay nothing.  And there is no requirement for a bank to be highly levered or blow up.

How will you get ROE banks dream of without leverage? Leverage is what makes many of these products attractive.

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[JoeF]

Not sure where Joef is coming from. Insured deposits are most certainly cheap. And a Fintech charter isn't likely to be funded by a branch network.  FDIC insurance fees are minimal and for well rated institutes, they can pay nothing.  And there is no requirement for a bank to be highly levered or blow up.

How will you get ROE banks dream of without leverage? Leverage is what makes many of these products attractive.

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Insured deposits are cheap, attracting them is not.  The current problem with small banks is that their cost of funds is too high. Currently the true marginal cost of funds for small banks is probably at least 2% over the fed funds rate.

The primary reason for the high cost of funds is the requirement for funding to be a percentage of the ‘retail deposits’. This causes all the banks to compete for these types of deposits. While, operationally, loans create deposits and there are always exactly enough deposits to fund all loans, there are some leakages. These leakages include cash in circulation, the fact that some banks, particularly large money center banks, have excess retail deposits, and a few other ‘operating factors.’ This causes small banks to bid up the price of retail deposits in the broker CD markets and raise the cost of funds for all of them, with any bank considered even remotely ‘weak’ paying even higher rates, even though its deposits are fully FDIC insured.

Additionally, small banks are driven to open expensive branches that can add over 1% to a bank’s true marginal cost of funds, to attempt to attract retail deposits. So by driving small banks to compete for a relatively difficult to access source of funding, the regulators have effectively raised their cost of funds.

If p2p platforms became chartered insured institutions, they would face the same challenge as small banks.

Regarding ROE, p2p lenders are leveraged more than any regulated institution could be.  100% of their loans are funded by debt.  That debt is perfectly duration matched and won't(can't) run (though it can stop investing in future loans, which is liquidity risk).  A bank needs equity to grow their loan book.   P2p lenders can grow their "balance sheets" all they want. They are not banks. So they're not subject to banking regulation, which, paradoxically, means that it can do a core function of banking much more efficiently than an actual bank can.  Hence the need, IMO, for a more modern regulatory framework and charter.

[rawraw]

Thanks for the detailed reply! 

Insured deposits are cheap, attracting them is not.  The current problem with small banks is that their cost of funds is too high. Currently the true marginal cost of funds for small banks is probably at least 2% over the fed funds rate.

The primary reason for the high cost of funds is the requirement for funding to be a percentage of the ‘retail deposits’. This causes all the banks to compete for these types of deposits. While, operationally, loans create deposits and there are always exactly enough deposits to fund all loans, there are some leakages. These leakages include cash in circulation, the fact that some banks, particularly large money center banks, have excess retail deposits, and a few other ‘operating factors.’ This causes small banks to bid up the price of retail deposits in the broker CD markets and raise the cost of funds for all of them, with any bank considered even remotely ‘weak’ paying even higher rates, even though its deposits are fully FDIC insured.

Additionally, small banks are driven to open expensive branches that can add over 1% to a bank’s true marginal cost of funds, to attempt to attract retail deposits. So by driving small banks to compete for a relatively difficult to access source of funding, the regulators have effectively raised their cost of funds.

I disagree almost 100%.  While your statements of fact are almost 100% true, I think you are misapplying them.  My disagreements in bullet form

1) There is no requirement that a bank must have retail deposits.  There is also no requirement that a bank must use a branch network to attract retail deposits.  You cannot take "typical" bank operating models and assume that's how all banks must operate.  Almost no industrial charters behave the way you suggest.  Almost no credit card banks behave the way you suggest.  And certainly there are plenty of banks that behave very differently from this.

2) I've seen no evidence of "bidding up" brokered or listing service deposits.  I just pulled up a brokered curve and see rates ~2% for 5 year funding.  I'm unsure what you think the brokered rate should actually be.

3)  What is the obsession on small banks?

4) I'd be curious if you could show me fintech lenders that has economic debt (not how accountants treat it like in LC's case, but actual debt) in excess of the leverage of a bank.  No one talks about mortgage originators having balance sheet leverage, so I am really unsure what your actually analyzing.  What balance sheet lender is out there operating with zero equity like you suggest?