6 takeaways from Treasury fintech report: National charter, breaches and more

July 31, 2018 10:05 AM

WASHINGTON — The Treasury Department released an extensive report Tuesday detailing how nonbanks, including fintech firms and data aggregators, should be regulated.

The report makes more than 80 recommendations to regulators and Congress largely encouraging financial innovation within a regulated space. Treasury went so far as to endorse a much-discussed national fintech charter developed by the Office of the Comptroller of the Currency, just hours before the OCC announced it would begin accepting charter applications.

It also took clear positions on other hot-button issues, such as recommending a national data security breach system and creating a “sandbox” where regulators would oversee new product testing.

“The biggest risk to the United States is really not supporting an innovative environment in our opinion because of the cost considerations of advanced technologies, the cost considerations of data and also the ability of operating without physical branches,” said a senior Treasury official who spoke to reporters on condition of anonymity. “And all those are elements we think are just inevitable so again, we’ve laid out a framework here that we think is sound for the factors.”

In a statement accompanying the report, Treasury Secretary Steven Mnuchin called innovation a "cornerstone of a healthy U.S. economy."

"We must keep pace with industry changes and encourage financial ingenuity to foster the nation’s vibrant financial services and technology sectors,” he said.

Here are some highlights from the 200-page-plus report:

Treasury endorses the creation of a fintech charter

Comptroller of the Currency Joseph Otting

Former OCC chief Joseph Otting's CRA proposal was finalized in 2020. However, acting Comptroller Michael Hsu rescinded that in favor of the joint proposal.

Andrew Harrer/Bloomberg

One of the biggest recommendations by Treasury was an endorsement of OCC plans to create a new federal bank charter for fintech firms. The bank regulatory agency appeared to be waiting for that official backing, since hours later the OCC announced that it was moving ahead with accepting charter applications.

For years, the agency was weighing the charter idea, before Comptroller Joseph Otting took the helm last year. But the concept ran into several obstacles, including legal challenges by state regulators, who argued the agency did not have the authority to charter and supervise fintech firms on a national scale. The OCC developed the plan under former Comptroller Thomas Curry.

“Treasury recommends that the OCC move forward with prudent and carefully considered applications for special purpose national bank charters,” the report said.

However, it added that fintech firms receiving such a charter “should not be permitted to accept FDIC-insured deposits, to reduce risks to taxpayers” and the Federal Reserve should decide whether those firms should have access to the payments system.

The Treasury also recognized that state regulators play a role in harmonizing licensing requirements across states, an initiative that some states have already launched earlier this year after many fintech firms said the state-by-state process is cumbersome and outdated.

“Treasury supports state regulators’ efforts to build a more unified licensing regime and supervisory process across the states,” the report said. “Such efforts might include adoption of a passporting regime for licensure.”

The Treasury also added that if state regulators “are unable to achieve meaningful harmonization across their licensing and supervisory regimes within three years, Congress should act to encourage greater uniformity in rules governing lending and money transmission to be adopted, supervised, and enforced by state regulators.”

Treasury calls on Congress to create a single data security standard

Data Breach text on metal with broken lock

zimmytws - Fotolia

A large part of the Treasury report focused on how financial data is used, aggregated and secured.

The report noted studies predicting that, by 2020, digitized data will grow more than fortyfold over the level produced in 2009. And only 13 states have data security standards for protecting consumers’ financial information.

Lawmakers have held many hearings on data security in recent years and there have been several proposals to create a more uniform data protection system, but Congress has yet to enact a comprehensive solution.

The Treasury made a series of recommendations in its report that explicitly tell Congress to “enact a federal data security and breach notification law” to protect consumers “in a timely manner.”

The U.S. should create fintech 'sandboxes' for innovation

Another key Treasury recommendation is creation of a so-called sandbox where firms can seek regulatory guidance on launching a new product or service in the market.

The United Kingdom is further ahead in developing a sandbox and other countries, including Singapore, have since launched similar initiatives. But U.S. regulators have struggled to create a uniform system because of the many various federal and state regulatory regimes and concerns about preempting state laws.

The Treasury is attempting to move the ball forward by saying Congress should act if regulators cannot create a single-point, uniform sandbox.

“Treasury will work with federal and state financial regulators to design such a solution in a timely manner,” the report said. “If financial regulators are unable to address these objectives, however, Treasury recommends that Congress consider legislation to provide for a single process consistent with the principles set forth above, including preemption of state laws if necessary.”

The CFPB should rescind its payday lending rule

Signage advertising short-term loans stands in front of stores in Birmingham, Alabama, U.S., on Tuesday, Feb. 10, 2015. In Alabama, the sixth-poorest state, with one of the highest concentrations of lenders, advocates are trying to curb payday and title loans, a confrontation that clergy cast as God versus greed. They have been stymied by an industry that metamorphoses to escape regulation, showers lawmakers with donations, packs hearings with lobbyists and has even fought a common database meant to enforce a $500 limit in loans. Photographer: Gary Tramontina/Bloomberg

Gary Tramontina/Bloomberg

The Treasury also encouraged the Consumer Financial Protection Bureau to rescind its payday lending rule, which was issued in November under former CFPB Director Richard Cordray. Since then, acting CFPB Director Mick Mulvaney has indicated he would reconsider the rule.

The Treasury agreed in its report, saying that states already have “broad authority” in this area and “additional federal regulation is unnecessary.”

The report praised the OCC’s May bulletin that encouraged lenders to make certain small-dollar, short-term loans and requested that the Federal Deposit Insurance Corp. follow suit in taking back some of its previous guidance restricting such loans.

“Treasury recommends that the FDIC reconsider its guidance on direct deposit advance services and issue new guidance similar to the OCC’s core lending principles for short-term, small-dollar installment lending,” the report said. “Additionally, Treasury recommends that federal and state financial regulators take steps to encourage sustainable and responsible short-term, small-dollar installment lending by banks.”

Treasury punts on blockchain

Blockchain schematic on glass panel with senior technology executive pointing with finger at one of the encrypted blocks

Steven Heap/steheap - stock.adobe.com

The report touched on many areas of fintech, but it refrained from taking a position on blockchain technologies and digital assets; it said those issues will be “explored separately in an interagency effort led by” a Financial Stability Oversight Council working group.

“The working group is a convening mechanism to promote coordination among regulators as these technologies evolve,” the report said.

Treasury urges Congress to address Madden decision

A statue of Albert Gallatin stands outside the entrance of the US Treasurey Building in Washington DC. on February 25, 2005. Photographer: Ken Cedeno/Bloomberg News

Ken Cedeno Bloomberg News/Bloomberg News

Treasury also took significant positions on legal issues related to the marketplace lending model.

The report appeared to question a well-publicized court ruling by the U.S. Court of Appeals for the Second Circuit, which held that debts sold across state lines can be subject to state usury laws. Industry advocates have been urging Congress to enact legislation to address the decision in Madden v. Midland Funding to clarify that loans are “valid when made.”

“Treasury recommends that Congress codify the ‘valid when made’ doctrine to preserve the functioning of U.S. credit markets and the longstanding ability of banks and other financial institutions, including marketplace lenders, to buy and sell validly made loans without the risk of coming into conflict with state interest-rate limits,” the report said.

The report also discussed court decisions dealing with partnerships between banks and nonbanks that had created “uncertainty” over who is the “true lender” in a deal.

“Some of these decisions have deemed the nonbank partner as the true lender, which subjects the nonbank partner to a range of state-based requirements including interest rate limits and licensing requirements,” the report said.

“The uncertainties created by these court cases create pressure to alter these partnership arrangements based upon nonmarket factors,” Treasury added later. “Some marketplace lenders, for example, have already restructured their economic relationships with partnering banks to better account for the risks presented by these court cases. A fragmented legal structure creates an inefficient regulatory framework and significant compliance challenges for the bank partnership model.”