The Changing FinTech Landscape

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21 The Changing FinTech Landscape: A Snapshot of M&A Themes and Trends The U.S. operates under a "dual banking system" in which banks can charter under federal or state law. This means, among other things, that the powers and limitations of a particular charter may vary. For example, while national banks and federal savings associations may rely on federal preemption to avoid state usury limits and other laws that impermissibly conflict with their federally authorized powers, state- chartered banks cannot. LendingClub, Jiko, Varo, and similar transactions are unique because they involve FinTechs embracing the heightened regulatory and supervisory burdens associated with bank holding company status. As bank holding companies, they are subject to Federal Reserve supervision and to limits on nonbanking activities under the BHC Act. By contrast, some charters do not technically constitute "banks" for purposes of the BHC Act, such as certain trust companies, credit card banks, and industrial loan companies (industrial banks or ILCs) and, for this reason, are perceived as highly valuable by commercial firms engaging in activities that are impermissible under the BHC Act. Industrial banks, in particular, have attracted significant interest over the years by commercial firms, particularly retailers, and more recently, by FinTechs. As state- chartered depository institutions, they benefit from all the privileges of a commercial bank (e.g., deposit insurance access to the Federal Reserve's discount window and payments system), but because they are exempt from the definition of "bank" under the BHC Act, their corporate parents and affiliates are not subject to Federal Reserve supervision and regulation. Attempts by Walmart and Home Depot in the mid-2000s to charter or acquire industrial banks drew intense public and political scrutiny. Such scrutiny led to formal and informal moratoria on industrial bank charters and acquisitions. From 2006 through 2019, no application for deposit insurance involving a commercial firm was approved. In 2020, the FDIC approved deposit insurance applications from Square and Nelnet, both of which established de novo industrial banks in Utah. The successful applications by Square and Nelnet for ILC charters was regarded by many in the industry as an inflection point for FinTechs. To date, many FinTechs have relied on partnerships with chartered banks or ILCs to provide loan origination services. The FDIC's recent approvals may pave the way for more FinTechs to consider ILCs as part of their business strategy. In addition, the FDIC's adoption of a final rule in December 2020, setting forth requirements that commercial firms must satisfy when seeking to control or establish an ILC, suggests that the FDIC expects more firms to pursue ILC charters. Notably, FinTechs have not embraced the OCC's controversial "FinTech charter," a type of "special purpose national bank" charter for FinTechs that are engaged in the business of banking but do not accept deposits. The purported benefit of this charter centers on FinTechs being able to preempt various state-level licensing and consumer protection laws. However, state banking regulators, particularly the New York State Department of Financial Services (DFS), have challenged whether the OCC is authorized under the National Bank Act to grant such a charter. Lawsuits by states against the OCC have faced procedural roadblocks, faltering on constitutional standing and ripeness grounds because no firm has yet to receive, or even apply for, a FinTech charter. Most recently, in early June 2021, the U.S. Court of Appeals for the Second Circuit reversed a lower court judgment in the OCC's favor, determining that the DFS lacked standing and that its claims were unripe. Since these dismissals have been on procedural grounds, there remains significant uncertainty as to how the substantive legal question—whether the National Bank Act requires firms to accept deposits to be eligible for a charter from the OCC—will be resolved. That uncertainty will continue to cloud the prospect of the FinTech charter being a viable route in the near term.

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