Regulation

NJ Legislature Aims to Classify Merchant Cash Advance as a Loan in New Disclosure Bill

October 15, 2018
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Troy SingletonS2262 in New Jersey, a bill to require disclosures in small business lending, was amended this afternoon to define merchant cash advances as small business loans for the purposes of disclosure.

Banks and equipment leasing companies are exempt from the bill.

You can listen to the hearing here. Debate on S2262 begins at the 6 minute, 12 second mark.

The bill’s author (image at right) is Democratic Senator Troy Singleton who represents New Jersey’s 7th legislative district.

Testifying on Monday’s hearing against the bill were Kate Fisher of the Commercial Finance Coalition and PJ Hoffman of the Electronic Transactions Association.

New Jersey Moves to Regulate Small Business Loan Disclosures and Brokers

October 15, 2018
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New Jersey Capitol Building in TrentonA committee within the New Jersey State Senate convened today at 1:30pm to discuss S2262, a new small business loan disclosure bill. Similar to SB1235 in California, this bill would require all of the following on small business loan contracts less than $100,000:

  • The APR (This was removed during the committee hearing)
  • The annualized interest rate
  • The finance charge
  • The maximum credit limit available
  • The payment schedule
  • A list of all broker fees and a description of the broker’s relationship with the lender and any conflicts of interest the broker may have
  • These terms must be presented before a business accepts a loan

In addition, any change to the terms that would significantly affect the responsibilities or obligations of the small business concern under the loan must be noticed 45 days in advance.

During the hearing, the bill was amended to define merchant cash advances as small business loans. Kate Fisher of Hudson Cook, LLP who represented the Commercial Finance Coalition (CFC) during the hearing, strongly opposed that amendment. The CFC is a trade association representing small business lending and MCA companies.

Also testifying against it was PJ Hoffman of the Electronic Transactions Association. Other Trade groups are gearing up to oppose the bill as well, deBanked has learned.

The bill was voted through the committee and will continue to move forward.

Listen to the Committee Hearing here

Debate on the bill begins at the 6 minute, 12 second mark


Kate Fisher’s testimony has been transcribed below:

Senator Pou and committee members: Thank you for the opportunity to present testimony today regarding business loan disclosures.

My name is Kate Fisher and I am here today on behalf of the Commercial Finance Coalition, a group of responsible finance companies that provide capital to small and medium-sized businesses through innovative methods. I also am an attorney who helps providers of commercial financing comply with state and federal law.

The Commercial Finance Coalition supports efforts to make business financing more transparent.

The problem is the proposed amendment would define a merchant cash advance as a loan. A merchant cash advance is not a loan.

We all know how a loan works – the lender advances money and the borrower promises to pay it back.

A merchant cash advance is a factoring transaction, in which a business sells a percentage of its future receivables at a discount.

Take for example, a pizza shop. The pizza oven breaks and the owner needs cash to replace it.

In a loan, the pizza shop borrows the money and promises to pay the money back to the lender with interest.

In a merchant cash advance, the pizza shop sells its future receivables to a merchant cash advance company. In exchange for the money to buy that pizza oven, the merchant cash advance company will take 10% of each dollar the pizza shop makes.

If the pizza shop’s sales go down, it will pay less. If the pizza shop’s sales go up, it will pay more. And if the pizza shop is damaged by a hurricane and has to close for repairs, it will pay nothing until it can reopen its doors.

This uncertainty of repayment is why a merchant cash advance is not a loan – the pizza shop in our example, only pays if it sells pizza. Courts have overwhelmingly agreed that a merchant cash advance is not a loan. To quote a recent court decision:

“Receivables purchasing is an accepted form of business transaction, and is not a loan.”

Because a merchant cash advance is not a loan, and there is no fixed payment term, requiring an APR or annual interest rate disclosure would be misleading. For a small business looking for financing, these types of disclosures would only add confusion.

I’m very optimistic that New Jersey can lead the way in providing businesses with disclosures that are helpful – and not misleading.

Thank you.

California Now Requires Mandatory Disclosures on Commercial Finance

October 1, 2018
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California Governor Jerry Brown has signed SB 1235.

As of Jan 1, 2019, commercial finance companies in California will be required to disclose the following on their contracts:

(1) The total amount of funds provided.
(2) The total dollar cost of the financing.
(3) The term or estimated term.
(4) The method, frequency, and amount of payments.
(5) A description of prepayment policies.
(6) The total cost of the financing expressed as an annualized rate.

See the law’s full text here

To find out if this bill affects your company, contact an attorney.

Read all of our previous coverage of the law here.

Renaud Laplanche Barred From the Securities Industry

September 28, 2018
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Renaud Laplanche, 1 month before he resigned from LendingClub at the LendIt USA 2016 conference in San Francisco, California, USA on April 11, 2016. (photo by Gabe Palacio)
Renaud Laplanche, 1 month before he resigned from LendingClub at the LendIt USA 2016 conference in San Francisco, California, USA on April 11, 2016. (photo by Gabe Palacio)

The SEC announced today that it charged LendingClub Asset Management, formerly known as LendingClub Advisors LLC (LCA), and its former president and co-founder Renaud Laplanche, with fraud – for improperly using fund money to benefit LendingClub Corporation, LCA’s parent company. LCA, Laplanche and Carrie Dolan, LCA’s former CFO, also were charged with improperly adjusting fund returns.

LCA, Laplanche and Dolan have agreed to settle the SEC’s charges against them and will pay penalties of $4 million, $200,000, and $65,000, respectively. The SEC also barred Laplanche from the securities industry for three years. LCA, Laplanche, and Dolan agreed to the entry of the SEC’s order without admitting or denying the agency’s findings.

This follows Laplanche’s ouster from LendingClub in May 2016 amid revelations of falsified loan records and conflicts of interest under Laplanche’s leadership. He is now the CEO of Upgrade, a San Francisco-based online lender, and he has been hailed recently for his resilience for making such a quick comeback.

A representative from Upgrade provided deBanked with a statement from Laplanche:

“I am pleased to have worked out a settlement with the SEC to put to rest any issues related to compliance lapses that might have occurred under my watch at Lending Club. Consistent with SEC policy, I have agreed not to admit nor deny the specific narrative of the events contained in the settlement order.  I would like, however, to provide additional context:

1. To the extent there was an imbalance between 60-month and 36-month loans in one of the LCA funds as compared to its initial target, the specific 36/60-month balance was disclosed to investors every month.

2. Any manual adjustments used by the LCA team as part of the funds valuation methodology had a total net impact of 0.08% of the funds value over 5 years, and I strongly believe those adjustments were made by the LCA team in good faith.

In any event, I am glad that we can now put these issues behind us and focus on the important goals of making credit more affordable to consumers and delivering attractive returns to investors through disciplined underwriting and exciting product innovation.  With the benefit of my prior experience, I feel better equipped to establish a strong culture of compliance and effective internal controls under the supervision of capable professionals.”

LendingClub, the actual company, or LendingClub Corporation, was spared any charges from the SEC because of its cooperation with the agency. The SEC press release explains below:

“The SEC’s Enforcement Division determined not to recommend charges against LendingClub Corporation, which promptly self-reported its executives’ misconduct following a review initiated by its board of directors, thoroughly remediated, and provided extraordinary cooperation with the agency’s investigation.  LCA also reimbursed approximately $1 million to investors who were adversely impacted by the improperly adjusted monthly returns.”

Lending Club, which Laplanche brought public 2014, did not respond in time to questions before publication.

Congressman Cleaver’s Findings on Fintech Lending Mixed

August 30, 2018
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cleaver principlesCongressman Emanuel Cleaver, II from Missouri announced findings earlier this month from a year-long inquiry he initiated into fintech small business lending practices and minorities. His initial inquiry was to determine if merchant cash advance companies had mechanisms in place to avoid discriminatory lending practices.  

Cleaver concluded that some common practices in non-bank underwriting processes lend themselves to discrimination against minority business owners. One such practice is using a merchant’s personal credit score to determine a business’ credit worthiness, which the report maintains is unfair because “a personal credit score has little bearing on a business model or the owner’s business acumen, and using it unfairly punishes minority business owners who may not have had the same opportunities to build credit.” Another complaint is the common practice of having merchants sign forced arbitration clauses that forbid the borrower to take the lender to court.

The companies that he surveyed included OnDeck, Kabbage, Fora Financial, Lending Club, Biz2Credit and LendUp, even though Lendup only does consumer lending. And OnDeck, Kabbage and Lending Club don’t offer a cash advance product. Still, they make non-bank business loans.

The report also mentioned that algorithms used by some of these companies could inadvertently be discriminatory. That’s because they have the ability to incorporate the number of criminal records and bankruptcies in the merchant applicant’s zip code when making a funding decision. And these numbers tend to be higher in minority neighborhoods.

However, the report also highlighted some good practices, such as including a third party in the lending process to protect from engaging in unintentional discriminatory behavior.

“From the responses gathered,” the report reads, “it has become increasingly clear that a majority of the companies have taken some measure to prevent blatant discrimination. Nevertheless, additional protections are very much needed.”

“The initial findings are clear as day, Congressman Cleaver said in a statement about the report. “We need to further understand how lenders may be intentionally or unintentionally offering higher interest rates to minorities and underserved communities, and work to implement industry-wide best practices.”

The California Business Loan & MCA Disclosure Bill Has Passed

August 30, 2018
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The bill has passed. With the governor’s signature, all business loan contracts and merchant cash advance contracts in California will soon require a uniform set of formal disclosures including an annualized rate of the total cost. The precise formula for that rate will be determined by the state’s regulatory agency, the Department of Business Oversight.

Update: The bill’s death in committee was challenged by the bill’s author, Senator Steve Glazer, and ultimately allowed to come up for a vote after he complained to the senate majority leader that a committee’s decision is merely a recommendation, not a deciding factor on the bill itself. At 2:10 AM EST, it passed.

Update: The bill has died in the Senate Banking Committee. Daniel Weintraub, who serves as chief of staff to the bill’s author, tweeted after midnight eastern time that the bill was not moving forward.

Update: The bill passed the Assembly unopposed and is slated for a late night vote by the Senate Banking Committee.

Update 8/31/18: Today is the last day for the legislature to pass this bill. We will keep you updated

California’s bill to mandate certain disclosures on business loan and merchant cash advance contracts is looking a little bit worse. The Annualized Cost of Capital method (Explained here) that some folks in the industry were accepting of, has been scrapped in favor of whatever formula a state regulator decides to pick. That means if the Commissioner of Business Oversight decides on an APR disclosure, which many industry trade groups believed they had already successfully lobbied against, all loans and non-loans alike would have to report an APR, a mathematical impossibility for a product like merchant cash advance. At present, however, all that is known is that the Commissioner’s choice must be an annualized metric.

According to Bloomberg, the amended version of the bill needs to get approval in both the Assembly and the Senate by Friday before the legislative session ends.

Trade associations that have weighed in on this bill include the Electronic Transactions Association, Commercial Finance Coalition, Small Business Finance Association, and the Innovative Lending Platform Association.

You can view all of our previous coverage about the bill here.

1 Global Capital Charged With Fraud by SEC

August 29, 2018
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SEC Building
Securities & Exchange Commission building

The Securities & Exchange Commission unsealed a 10-count complaint against 1 Global Capital LLC (“1st Global Capital”), its owner Carl Ruderman, and related parties on Wednesday.

The South Florida firm “fraudulently raised more than $287 million from more than 3,400 investors to fund its business offering short-term financing to small and medium-size businesses,” the complaint begins.

Investors were offered low-risk, high-return investments that 1st Global would use to fund merchant cash advance deals. Ruderman, who owned the company through a trust, misappropriated $35 million of the funds, paying a lot of it to himself and companies he controlled that had nothing to do with MCA, the SEC alleges. Beyond that, millions more went towards other pet projects like a $50 million purchase of distressed credit card debt.

But the deception went deep, the complaint lays out. 1st Global touted a default rate of only 4% despite the fact that 15-18% of their deals over the last 2 years had resulted in collections lawsuits.

By October 2017, the statements investors received showing their monthly performance were faked with the value and performance significantly inflated. By June 2018, one line item on monthly statements (labeled “cash not deployed”) reported that investors collectively had $70 million in idle cash ready to be put into deals. Meanwhile, the company itself only had about $20 million in all of its bank accounts combined, money that was being used for everything including operating expenses, salaries, and commissions.

1st Global’s alleged auditor, Daszkal Bolton, LLP, says they never audited 1st Global’s statements and haven’t had anything to do with the company since 2016. Nonetheless, 1st Global placed Daszkal Bolton’s name on statements given to investors and stated on their website that investor balances were validated by an accounting firm quarterly.

The Seven-Minute Loan Shakes Up Washington And The 50 States

August 19, 2018
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This story appeared in deBanked’s Jul/Aug 2018 magazine issue. To receive copies in print, SUBSCRIBE FREE

moneyacrossthecountryIt takes seven minutes for Kabbage to approve a small-business loan. “The reason there’s so little lag time,” says Sam Taussig, head of global policy at the Atlanta-based financial technology firm, “is that it’s all automated. Our marginal cost for loans is very low,” he explains, “because everything involving the intake of information – your name and address, know-your-customer, anti-money-laundering and anti-terrorism checks, analyzing three years of income statements, cash-flow analysis – is one-hundred-percent automated. There are no people involved unless red flags go off.”

“THERE ARE NO PEOPLE INVOLVED UNLESS RED FLAGS GO OFF”


One salient testament to Kabbage’s automation: Fully $1 billion of the $5 billion in loans that it has made to 145,000 discrete borrowers since it opened its portals in 2011 were made between 6 p.m. and 6 a.m.

William Phelan
William Phelan, President and Co-founder, PayNet

Now compare that hair-trigger response time and 24-hour service for a small business loan of $1,000-$250,000 with what occurs at a typical bank. “Corporate credit underwriting requires 28 separate tasks to arrive at a decision,” William Phelan, president, and co‐founder of PayNet—a top provider of small-business credit data and analysis – testified recently to a Congressional subcommittee. “These 28 tasks involve (among other things): collecting information for the credit application, reviewing the financial information, data entry and calculations, industry analysis, evaluation of borrower capability, capacity (to repay), and valuation of collateral.”

A “time-series analysis,” the Skokie (Ill.)-based executive went on, found that it takes two-to-three weeks – and often as many as eight weeks—to complete the loan approval process. For this “single credit decision,” Phelan added, the services of three bank departments – relationship manager, credit analyst, and credit committee – are required.

The cost of such a labor-intensive operation? PayNet analysts reckoned that banks incur $4,000-$6,000 in underwriting expenses for each credit application. Phelan said, moreover, that credit underwriting typically includes a subsequent loan review, which consumes two days of effort and costs the bank an additional $1,000. “With these costs,” Phelan told lawmakers, “banks are unable to turn a profit unless the loan size exceeds $500,000.”

According to the National Bureau of Economic Research, the country’s very biggest banks — Bank of America, Citigroup, J.P. Morgan Chase, and Wells Fargo—have been the financial institutions most likely to shut down lending to small businesses. “While small business lending declined at all banks beginning in 2008,” NBER’s September, 2017 report announces, “the four largest banks” which the report dubs the ‘Top Four’—“cut back significantly relative to the rest of the banking sector.”

NBER reports further that by 2010—the “trough” of the financial crisis—the annual flow of loan originations from the Top Four stood at just 41% of its 2006 level, which compared with 66% of the pre-crisis level for all other banks. Moreover, small-business lending at the “Top Four” banks remained suppressed for several years afterward, “hovering” at roughly 50% of its pre crisis level through 2014. By contrast, such lending at the rest of the country’s banks eventually bounced back to nearly 80% of the pre-crisis level by 2014.

KENNETH SINGLETON
Kenneth Singleton, Professor, Graduate School of Business – Stanford University

That pullback—by all banks—continues, says Kenneth Singleton, an economics professor at Stanford University’s Graduate School of Business. Echoing Phelan’s testimony, Singleton told deBanked in an interview: “Given the high underwriting costs, banks just chose not to make loans under $250,000,” which are the bread-and-butter of small-business loans. In so doing, he adds, banks “have created a vacuum for fintechs.”

All of which helps explain why Kabbage and other fintechs making small business loans are maintaining a strong growth trajectory. As a Federal Reserve report issued in June notes, the five most prominent fintech lenders to small businesses—OnDeck, Kabbage, Credibly, Square Capital, and PayPal—are on track to grow by an estimated 21.5 percent annually through 2021.

Their outsized growth is just one piece—albeit a major one—of fintech’s larger tapestry. Depending on how you define “financial technology,” there are anywhere from 1,400 to 2,000 fintechs operating in the U.S., experts say. Fintech companies are now engaged in online payments, consumer lending, savings and investment vehicles, insurance, and myriad other forms of financial services.

Fintechs’ advocates—a loose confederacy that includes not only industry practitioners but also investors, analysts, academics, and sympathetic government officials—assert that the U.S. fintech industry is nonetheless being blunted from realizing its full potential. If fintechs were allowed to “do their thing,” (as they said in the sixties) this cohort argues, a supercharged industry would bring “financial inclusion” to “unbanked” and “underbanked” populations in the U.S. By “democratizing access to capital,” as Kabbage’s Taussig puts it, harnessing technology would also re-energize the country’s small businesses, which creates the majority of net new jobs in the U.S., according to the U.S. Small Business Administration.

“PEOPLE IN THE U.S. ARE STILL GOING TO BANK BRANCHES MORE THAN PEOPLE IN THE REST OF THE WORLD”


But standing in the way of both innovation and more robust economic growth, this cohort asserts, is a breathtakingly complex—and restrictive—regulatory system that dates back to the Civil War. “I do think we’re victims of our own success in that we’ve got a pretty good financial system and a pretty good regulatory structure where most people can make payments and the vast majority of people can get credit.” says Jo Ann Barefoot, chief executive at Barefoot Innovation Group in Washington, D.C. and a former senior fellow at Harvard’s Kennedy School. But because of that “there’s been more inertia and slower adoption of new technology,” she adds. “People in the U.S. are still going to bank branches more than people in the rest of the world.”

Jo Ann Barefoot
Jo Ann Barefoot, CEO, Barefoot Innovation Group

Barefoot adds: “There are five agencies directly overseeing financial services at the Federal level and another two dozen federal agencies” providing some measure of additional, if not duplicative oversight, over financial services. “But there’s no fintech licensing at the national level,” she says. And because each state also has a bank regulator, she notes, “if you’re a fintech innovator, you have to go state by state and spend millions of dollars and take years” to comply with a spool of red tape pertaining to nonbanks.

At the federal level, the current system— which includes the Federal Reserve, Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC)—developed over time in a piecemeal fashion, largely through legislative responses to economic panics, shocks and emergencies. “For historical reasons,” Barefoot remarks, “we have a lot of agencies” regulating financial services.

For exhibit A, look no further than the Consumer Financial Protection Bureau created amidst the shambles of the 2008-2009 financial crisis by the 2010 Dodd-Frank Act. Built ostensibly to preserve safety and soundness, the agencies have constructed a moat around the banking system.

Karen Shaw Petrou, managing partner at Federal Financial Analytics, a Washington, D.C. consultancy, is a banking policy expert who frequently provides testimony to Congress and regulatory agencies. She wrote recently that the country’s banking sector has been protected from the kind of technological disruption that has upended a whole bevy of industries.

“The only reason Amazon and its ilk may not do to banking, brokers and insurers what they did to retailers—and are about to do to grocers and pharmacies,” she observed recently in a blog—“is the regulatory structure of each of these businesses. If and how it changes are the most critical strategic factors now facing finance.”

cornelius hurley
Cornelius Hurley, Executive Director, Online Lending Policy Institute

Cornelius Hurley, a Boston University law professor and executive director of the Online Lending Policy Institute, is especially critical of the 50-state, dual banking system. State bank regulators oversee 75 percent of the country’s banks and are the primary regulators of nonbank financial technology companies. “The U.S. is falling behind other countries that are much less balkanized,” Hurley says. “Our federal system of government has served us well in many areas in our becoming a leading civil society. It’s given us NOW (Negotiable Order of Withdrawal) accounts, money-market accounts, automatic teller machines, and interstate banking. But now it’s outlived its usefulness and has become an impediment.”

Take Kabbage, which actually avoids a lot of regulatory rigmarole by virtue of its partnership with Celtic Bank, a Utah-chartered industrial bank. The association with a regulated state bank essentially provides Kabbage with a passport to conduct business across state lines. Nonetheless, Kabbage has multiple, incessant, and confusing dealings with its bank overseers in the 50 states.

“Where the states get involved,” says Taussig, “is on brokering, solicitation, disclosure and privacy. We run into varying degrees of state legislative issues that make it hard to do business. Right now we’re plagued by what’s been happening with national technology actors on cybersecurity breaches and breach disclosures. We are required to notify customers. But some states require that we do it in as few as 36 hours, and in others it’s a couple of months. We’ve lobbied for a national breach law of four days,” he adds, which would “make it easier for everyone operating across the country.”

“NOW WE HAVE WILDLY DIFFERENT INTERPRETATIONS OF BROKERING AND SOLICITATION…”


Then there’s the meaning of “What is a broker?’” says Taussig, who as a regulatory compliance expert at Kabbage sees his role as something of an emissary and educator to regulators and politicians, the news media, and the public. “The definitions haven’t been updated since the 1950s and now we have wildly different interpretations of brokering and solicitation,” he says. “The landscape has changed with e-commerce and each state has a different perspective of what’s kosher on the Internet.”

Kabbage Sam Taussig
Sam Taussig, Head of Global Policy, Kabbage

Washington State is a good example. It’s one of a handful of jurisdictions in which regulators confine nonbank fintechs to making consumer loans. In a kabuki dance, fintech companies apply for a consumer-lending license and then ask for a special dispensation to do small-business lending.

And let’s not forget New Mexico, Nevada and Vermont where a physical “brick-and-mortar” presence is required for a lender to do business. Digital companies, Taussig says, would have to seek a waiver from regulators in those states. “Many companies spend a lot of money on billable hours for local lawyers to comply with policies and procedures,” Taussig reports, “and it doesn’t serve to protect customers. It’s really just revenue extraction.”

All such restraints put fintechs at a disadvantage to traditional financial institutions, which by virtue of a bank charter, enjoy laws guaranteeing parity between state-chartered and federally chartered national banks. The banks are therefore able to traverse state lines seamlessly to take deposits, make loans, and engage in other lines of business. In addition, fintechs’ cost of funds is far higher than banks, which pay depositors a meager interest rate. And banks have access to the Fed discount window, while their depositors’ savings and checking accounts are insured up to $200,000.

The result is a higher cost of funds for fintechs, which principally depend on venture capital, private equity, securitization and debt financing as well as retained earnings. And that translates into steeper charges for small business borrowers. A fintech customer can easily pay an interest rate on a loan or line of credit that’s three to four times higher than, say, a bank loan backed by the U.S. Small Business Administration.

Kabbage, for example, reports that its average loan of roughly $10,000 typically carries an interest rate of 35%-36%. It’s credits are, of course, riskier than the banks’. The company does not report figures on loans denied, Taussig told deBanked, but Stanford’s Singleton says that the fintech industry’s denial rate is roughly 50 percent for small business loans. “Fintechs have higher costs of capital and they’re also facing moderate default rates,” notes Singleton. “They’re not enormous, but fintechs are dealing with a different segment. Small businesses have much more variability in cash flows, so lending could be riskier than larger, established companies.”

fintechEven so, venture capitalists continue to pour money into fintech start-ups. “I’ve gone to several conferences,” Singleton says, “and everywhere I turn I’m meeting people from a new fintech company. One of the striking things about this space,” he adds, “is that there are lot of aspiring start-ups attacking very specific, very narrow issues. Not all will survive, but someone will probably acquire them.”

Contrast that to the world of banking. Many banks are wholeheartedly embracing technology by collaborating with fintechs, acquiring start-ups with promising technology, or developing in-house solutions. Among the most impressive are super-regionals Fifth Third Bank ($142.2 billion), Regions Financial Corp. ($123.5 billion), and BBVA Compass ($69.6 billion), notes Miami-based bank consultant Charles Wendel. But many banks are content to cater to familiar customers and remain complacent. One result is that there’s been a steady diminution in the number of U.S. banks.

Over the past ten years, fully one-third of the country’s banks were swallowed whole in an acquisition, disappeared in a merger, failed, or otherwise closed their doors. There were 5,670 federally insured banks at the end of 2017, according to the Federal Deposit Insurance Corp., a 2,863-bank, 33.5% decrease from the 8,533 commercial banks operating in the U.S. in 2007.

It does appear that, to paraphrase an old expression, many banks “are going out of style.” In recent years there have been more banking industry deaths than births. Sixty-three banks have failed since 2013 through June while only 14 de novo banks have been launched. In Texas, which is known for having the most banks of any state in the country, only one newly minted bank debuted since 2009. (The Bank of Austin is the new kid on the Texas block, opening in a city known as a hotbed of technology with its “Silicon Hills.”)

IF YOU TELL REGULATORS THAT YOU WANT TO GROW BY 100% A YEAR, THEY’LL FREAK OUT


One reason there’s so little enthusiasm among venture capitalists and other financial backers for investing in de novo banks is that regulators are known to be austere. “If you’re a company in the U.S.,” says Matt Burton, a founder of data analytics firm Orchard Platform Markets (which was recently acquired by Kabbage), “and you tell regulators that you want to grow by 100 percent a year – which is the scale you must grow at to get venture-capital funding – regulators will freak out. Bank regulators are very, very strict. That’s why you never hear about new banks achieving any sort of scale.”

But while bank regulators “are moving sluggishly compared to the rest of the world” in adapting to the fintech revolution, says Singleton, there are numerous signs that the status quo may be in for a surprising jolt. The Treasury Department is about to issue (possibly by the time this story is published) a major report recommending an across-the-board overhaul in the regulatory stance toward all nonbank financials, including fintechs. According to a report in The American Banker, Craig Phillips, counselor to Treasury Secretary Steven Mnuchin, told a trade group that the report would address regulatory shortcomings and especially “regulatory asymmetries” between fintech firms and regulated financial institutions.

EDITOR’S NOTE: Since this story went to print, the OCC began accepting fintech charter applications following the Treasury’s report

Chris Cole, ICBA
Christopher Cole, Senior Regulatory Counsel, ICBA

Christopher Cole, senior regulatory counsel at the Independent Community Bankers Association—a Washington, D.C. trade association representing the country’s Main Street bankers—told deBanked that, among other things, the Treasury report would likely recommend “regulatory sandboxes.” (A regulatory sandbox allows businesses to experiment with innovative products, services, and business models in the marketplace, usually for a specified period of time.)

That’s an idea that fintech proponents have been drumming enthusiastically since it was pioneered in the U.K. a few years ago, and it’s something that the independent bankers’ lobby, whose member banks are among the most threatened by fintech small-business lenders, says it too can support. Treasury’s Phillips “has said in the past that he’d like to see a level playing field,” the ICBA’s Cole says. “So if (regulators) are going to allow a sandbox, any company could be involved, including a community bank. We agree with him, of course, because we’d like to take advantage of that.”

In March, 2018, Arizona became the first state to establish a regulatory sandbox when the governor signed a law directing that state’s attorney general (and not the state’s banking regulator) to oversee the program. The agency will begin taking applications in August with approval in 90 days, says Paul Watkins, civil litigation chief in the AG’s office. Watkins told deBanked that he’s been most surprised so far by “the degree of enthusiasm” from overseas companies. With the advent of the sandbox, he adds, “Landlocked Arizona has become a port state.”

OCC SealThe OCC, which is part of the Treasury Department, may also revive its plan to issue a national bank charter to fintechs, sources say (EDITOR’S NOTE: This had not yet been implemented before this story went to print. The OCC is now accepting such applications) – a hugely controversial proposal that was put on ice last year (and some thought left for dead) when former Commissioner Thomas J. Curry’s tenure ended last spring. At his departure, the fintech bank charter faced a lawsuit filed by both the New York State Banking Department and the Conference of State Bank Supervisors. (Since then, the lawsuit was tossed out by the courts on the ground that the case was not “ripe” – that is, it was too soon for plaintiffs to show injury).

Taussig, the regulatory expert at Kabbage, reports that the Comptroller of the Currency, Robert J. Otting, has promised “a thumbs-up or thumbs-down” decision by the end of July or early August on issuing fintechs a national bank charter. He counts himself as “hopeful” that OCC’s decision will see both of the regulator’s thumbs pointing north.

Margaret Liu
Margaret Liu, Deputy General Counsel, CSBS

The Conference of State Bank Supervisors, meanwhile, has extended an olive branch to the fintech community in the form of “Vision 2020.” CSBS touts the program as “an initiative to modernize state regulation of non-bank financial companies.” As part of Vision 2020, CSBS formed a 21-member “Fintech Industry Advisory Panel” with a recognizable roster of industry stalwarts: small business lenders Kabbage and OnDeck Capital are on board, as are consumer lenders like Funding Circle, LendUp and SoFi Lending Corp. The panel also boasts such heavyweights in payments as Amazon and Microsoft.

Working closely with the fintech industry is a “key component” of Vision 2020, Margaret Liu, deputy general counsel at CSBS, told deBanked in a recent telephone interview. CSBS and the fintech industry are “having a dialogue,” she says, “and we’re asking industry to work together (with us) and bring us a handful of top recommendations on what states can do to improve regulation of nonbanks in licensing, regulations, and examinations.

“We want to know,” she added, ‘What the main friction points are so that we can find a path forward. We want to hear their concerns and talk about pain points. We want them to know the states are not deaf and blind to their concerns.”