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A group of senior Republicans in Congress have urged federal regulators not to rush into "ill-fitting" regulations on financial service companies, following a "heavy-handed" investigation into bank-fintech partnerships.
In a joint letter to the heads of three federal regulators, Republican members of the House Financial Services Committee raised the possibility that undue scrutiny of bank-fintech partnerships could stifle innovation.
The letter, addressed to the heads of the Federal Reserve System, the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency, was signed by all 29 Republicans on the committee.
It comes in response to a request for information (RFI) from the three agencies, published in July, on the suitability, risk and compliance implications of bank-fintech partnerships.
“As the RFI highlights, there are many different types of bank-fintech partnerships with varying complexities,” the lawmakers wrote. “Regulators should understand the nature of each type of partnership to avoid stifling innovation.
“Regulation and supervision should be appropriately scaled to address the nature of the partnership, not a one-size-fits-all approach.”
The lawmakers also warned the three agencies against “overstepping” their statutory authority.
“Regulators should collaborate to identify any existing gaps in authority and work with Congress,” they said. “Instead of stifling innovation, regulators should allow responsible innovation to better serve our constituents and the financial system more broadly.”
Proposed rule on brokered deposits falls flat
One day before the RFI was published, the FDIC published a notice of proposed rulemaking on the safety and soundness of brokered deposits, which implements Section 29 of the Federal Deposit Insurance Act (FDIA).
If finalised as proposed, the rule could significantly affect partnerships where a fintech accepts deposits on behalf of an insured depository institution (IDI).
The rule would expand the definition of “deposit broker” to any third party that receives funds for depositing to one or more IDIs, and is involved in setting the rates, terms and fees for the deposit account.
Previously, third parties that accepted funds for depositing at only one IDI were exempted from Section 29 of the FDIA.
Similarly, under the current rules, third parties whose “primary purpose” is to accept funds for depositing to an IDI can apply to the FDIC directly for an exception.
However, the proposed rule would replace this with a new model where the IDI has to apply for an exception based on each specific deposit placement arrangement with each qualifying third party.
The FDIC believes the rule will “strengthen the important prudential protections” of the brokered deposit rule.
The 29 Republicans disagree, however, calling it “flawed” and arguing that it will “not protect consumers or the financial system”.
The Republicans’ position is supported by the Financial Technology Association (FTA), whose members include PayPal, Block, Stripe, Wise, Revolut and Banking Circle Group.
The FTA, which described the proposed rule as “complex”, said it will affect smaller community banks the most, without having any benefit on safety or soundness.
The association also said the FDIC should use the responses to the RFI to “reconsider” the proposed rule, which could have “unintended consequences and undermine access to innovative financial products”.
Key concerns for federal regulators
In the RFI, the three regulators acknowledged that bank-fintech partnerships have helped to improve access to financial services for consumers and to cut costs for businesses.
However, they also suggested that these partnerships can also lead to shortcomings in risk and compliance procedures and in consumer protection.
Broadly speaking, the RFI is focused on bank-fintech partnerships that facilitate deposit-taking activities, payment services and lending activities.
It uses the term “fintech” to refer to a wide range of firms, from small and medium-sized enterprises (SMEs) to big tech firms, as long as they act as “intermediate platforms” between banks and customers.
One of the regulators’ biggest concerns around bank-fintech partnerships is the lack of clarity on which entity is accountable for legal and compliance functions.
“Contractual accountability for different aspects of the end-user relationship may be allocated among the parties to a bank-fintech arrangement,” the RFI reads. “However, banks remain responsible for compliance with applicable law.
“Failure to conduct sufficient due diligence, ongoing monitoring and oversight of the bank-fintech arrangement may complicate the bank's ability to ensure such compliance and to identify risk.”
The three regulators are also concerned that the division of labour in these partnerships may be leading to poor outcomes in terms of customer complaints and resolutions. These factors may expose the bank to compliance, litigation and other risks.
For example, a fintech may maintain the end-user relationship, including by responding to inquiries and complaints and providing required consumer protection and other disclosures.
However, independent of contractual responsibilities, the end user may still qualify as a customer of the bank for certain regulatory purposes.
Similarly, the fintech's role in providing disclosures may increase the risk of inaccurate or misleading representations concerning, for example, the applicability, nature or scope of federal deposit insurance available to end users.
“Under certain bank-fintech arrangements, it may be difficult for the bank to perform oversight and control functions over the fintech company where the fintech company has substantial negotiating power relative to the bank, or where the bank relies on revenue or liquidity from the fintech company,” the RFI states.
“Difficulty in performing this oversight and control function in turn could impede bank staff's ability to provide effective challenges to critical aspects of the bank-fintech relationship, including whether to terminate the contractual arrangement if necessary.”
The RFI notes that these risks may be heightened where the fintech is either not familiar with its applicable laws and regulations, or where it has a different risk tolerance to its bank partner.
For example, non-bank financial companies should be aware of the supervisory powers of the Consumer Financial Protection Board (CFPB), while money services businesses (MSBs) should be aware that they too are subject to certain Bank Secrecy Act (BSA), anti-money laundering (AML) and state law requirements.
