Washington financial regulators will soon find out whether their efforts to encourage fintech companies and other institutions to launch new banks begin to bear fruit.

Regulators laid the groundwork over the past year to shake up the U.S. banking system to reflect advances in technology and the decline of brick-and-mortar community banks.

Many eyes are turned to an expected announcement from the Office of the Comptroller of the Currency in early January on the first applicant for a special purpose national bank charter that financial tech companies need to enter banking. Meanwhile, actions that are underway at states and other federal regulators will be just as critical to shaping the next evolution of U.S. banking.

Online-only Varo Bank is set to be a bellwether for the fintech industry’s maturation into the banking mainstream.

Varo said Sept. 4 it received provisional OCC approval to form a de novo bank, potentially becoming the first all-mobile national bank in the U.S. The company still needs to obtain FDIC insurance for its deposits.

Varo Approval

Varo’s approval signals the OCC appears to be comfortable with a fintech-type business plan, former Comptroller of the Currency Thomas Curry told Bloomberg Law.

But Varo could also be the first case that tests the Federal Reserve Board’s willingness to allow a fintech company to join its ranks. Deposit insurance is part of new banks’ price of admission into the Fed system, which offers low borrowing rates and access to its payments network.

“Varo is going to force them to make that determination,” assuming the company receives deposit insurance, said Curry, now partner at Nutter McClennen & Fish LLP in Boston. “The fact that it will be federally supervised by the OCC should give them some comfort,” he added.

The question of Fed entry is particularly important for OCC fintech charter applicants, which wouldn’t be deposit taking institutions.

The Fed has been reticent to state whether it would consider allowing a chartered but non-depository institution into its system.

Fintech payment companies eyeing a federal charter say they could benefit from accessing the Fed’s payments system. With the OCC projecting a first round of applicants in early 2019, the issue could come to a head later in the year.

But the institution isn’t likely to opine until it has a real case before it. “The Fed is not going to answer a hypothetical,” Curry said.

Feds and the States

The Fed might get to idle a bit longer before a nationally-chartered, non-depository fintech company knocks on its door.

Litigation over the “fintech charter” between the OCC, the Conference of State Bank Supervisors (CSBS) and New York’s Department of Financial Services is expected to proceed at the court’s pace next year. That case will test the OCC’s authority to preempt state regulators while offering a bank-like charter that excludes deposit-taking, one of the three core banking activities. Fintech charter applicants are likely to have to wait out the litigation for a number of months, particularly if either side seeks an appeal.

For every company that gets a charter, “there’s going to be a dozen that don’t get it and will have to do it the old fashioned way,” he said. That would likely occur though a bank partnership, state licensing, or both, Kim said.

New Banks

State regulators are hopeful recent signals from the FDIC might shift the rhetoric around fintech chartering in ways that wouldn’t override states’ roles.

FDIC Chairman Jelena McWilliams’ interest in making it easier for de novo applicants to apply for deposit insurance is expected to chart a new path for full service banks, including fintechs or more niche industrial loan companies (ILC).

Square Capital, the small business finance division of payments processor Square Inc., announced Dec. 19 it would reapply for FDIC insurance to become an industrial bank based in Utah. An ILC charter for Square could encourage other well-capitalized fintechs to pursue the state-chartered bank route.

“The states are the charter of choice for the majority of banks, and probably somewhere upwards of 90 to 95 percent of new banks choose the state charters,” Michael Stevens, CSBS executive vice president, told Bloomberg Law.

Applications from industrial loan companies and fintech companies that want to take deposits could pick up, he said. Only 11 new banks have launched since the end of 2009, McWilliams noted in her Dec. 6 de novo policy announcement.

With so few newly chartered institutions in the past decade, it’s hard to know what friction points could pop up in chartering and supervising new types of banks offering more innovative products, Stevens said. “Those are the things that we’ll just have to work through as cases emerge,” he said.

State regulators are optimistic about the FDIC’s path. “The current financial regulatory system has lots of avenues for companies to engage in the regulated system,” CSBS Deputy General Counsel Margaret Liu told Bloomberg Law.

“What it creates is a really diverse system, and a competitive one. We think what the OCC would try to do with the fintech charter would really unfairly upset the competitive balance in the marketplace,” Liu said.

State Streamlining

The future of the OCC’s fintech charter has added urgency to state efforts to streamline their supervisory and licensing practices for non-bank lenders and money transmitters.

The CSBS plans to announce the results of some of its efforts under its “Vision 2020” program early next year, Liu said.

A fintech industry advisory panel presented a series of specific recommendations on licensing and supervision issues to the CSBS board at the end of 2018. Implementing some of the group’s key recommendations “will be a big focus in 2019,” Liu said.

“It’s really about making the dual banking system work, and work even better,” Liu said.

Treasury’s Three Year Horizon

Hanging over the future of fintech chartering is a three-year deadline set by the Treasury Department in a July 2018 report. The report criticized the current “patchwork quilt” of state and federal regulation of non-bank lenders and money transmitters.

Treasury encouraged states to move forward with unifying their licensing and supervisory systems. But it said it would ask Congress to get involved if “meaningful harmonization” across states doesn’t occur by 2021.

Business groups are eager to see the OCC’s offer of a single federal regulator for fintechs succeed. “Our biggest concern is that these companies have to deal with 50 state money transmission laws and antiquated patchworks,” Kate Prochaska, vice president and regulatory counsel at the U.S. Chamber of Commerce, told Bloomberg Law.

“What we would like to see is preemption,” whether that be through the OCC, the FDIC, or another regulator, Prochaska said. “We don’t operate in state-based commerce anymore and we want to make sure that we do have one federal charter,” she said.

The efforts state and federal regulators take in 2019 may give a better indication of whether or not Treasury will try to push Congress on federal preemption for fintech companies in the next few years.