Hsu's OCC Priorities Include Inequality, Climate

Brooks Quits Binance, Gensler Wants to Regulate Crypto Exchanges, BNPL Consolidation?

Hey all, Jason here.

There’s no such a thing as a slow week in fintech, is there? In addition to the usual barrage of funding, product, and SPAC announcements, last week also saw Square announce its plans to acquire Australian BNPL Afterpay and former OCC head Brian Brooks quit his CEO role at Binance.US — after just three months on the job. More on that below.

I’m excited to announce that this Thursday, August 12th, I’ll be participating in a “Creator Ask Me Anything” event with Sam DeBrule of Journal. You can join the event via Slack here.

I’m also super excited to announce I’ll be in New York for CB Insight’s Future of Fintech event on October 5th & 6th — if you’re attending, drop me a line, I would love to meet up!

If you’re an early stage fintech looking to raise equity or investor looking for deal flow, I may be able to help. Get in touch: jason@fintechbusinessweekly.com

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Hsu Elaborates on OCC’s Priorities, including Inequality, Climate Risks

Although there are reports that a new candidate, Cornell law professor Saule Omarova, is being vetted for the Comptroller position, for now, acting head Michael Hsu remains in charge. Hsu testified last week in front of the Senate Banking Committee, outlining the OCC’s top priorities and areas of concern.

Although Hsu’s role is in an “acting” capacity, it is reasonable to assume he’s expressing the position of the OCC as an institution and the Biden administration, and that whomever is eventually confirmed as the Comptroller will be aligned with the priorities he outlined.

In his testimony, Hsu highlighted the following priorities requiring ‘immediate’ attention:

(1) guarding against complacency by banks,
(2) reducing inequality in banking,
(3) adapting to digitalization, and
(4) acting on the risks that climate change presents to the financial system.

Guarding Against Complacency

Hsu gave banks credit for weathering the pandemic and ensuing economic unrest in good shape but expressed concern about the pressure to increase returns driving growing risk appetite, saying in his oral testimony (emphasis added):

“I am concerned, however, that as the economy recovers and pressure to grow returns, over-confidence leading to complacency is a risk—when prudent risk management is set aside in pursuit of profit. I see the losses related to Archegos, the froth in SPACs and crypto, and the recent buzz around buy now, pay later as potential warning flags.”

He also pointed to elevated capital distribution plans, in the form of share buy backs, dividends, and negative loan-loss provisions. Hsu urged caution, noting that as government support measures expire and with continuing uncertainty from the Delta COVID surge, banks may be getting ahead of themselves:

“As these programs expire, and with uncertainty from the Delta COVID variant increasing, the banking industry is at risk of assuming a ‘mission accomplished’ moment.”

Reducing Inequality in Banking

On the topic of inequality, Hsu noted the glaring disparities in wealth along racial lines, particularly when it comes to home ownership and home value, noting (emphasis added):

“Reducing inequality in banking must be a national priority. The events of the last two years have brought our history of financial inequality into sharp relief. Research by the Brookings Institute illustrates the stark economic inequality faced by communities of color. In the average U.S. metropolitan area, homes in neighborhoods where the share of the population is 50 percent Black are valued at roughly half the price of homes in neighborhoods with no Black residents”

Hsu further argued that “banks can play an important role in preventing this and closing the wealth gap.”

He also touched on the need for a coordinated interagency effort to update the Community Reinvestment Act, as well as the importance of promoting safe access to credit, saying (emphasis added):

“We must prohibit predatory and discriminatory practices while promoting financial inclusion and increased access to credit for the unbanked and underbanked. Overdraft programs are a good example. This committee recently shined a light on the harms to consumers from excessive fees related to overdrafts.”

and highlighted the opportunity for Project REACh to promote inclusion by leveraging alternative sources of data, like bank account transaction data and payment histories for rent, utilities, and other recurring obligations (emphasis added):

“Project REACh identified several key barriers to financial inclusion and equity for underserved populations, including lack of usable credit scores, low rates of homeownership, and poor access to capital for minority-owned and small businesses.”

Hsu acknowledged the successful revocation of the “True Lender” rule and indicated the OCC would continue to study fintech-bank partnerships in order to differentiate “harmful rent-a-charter arrangements” vs. “healthy partnerships that expand financial inclusion.”

Adapting to Digitalization

Hsu is clearly aware of the accelerating pace of change in the financial services space, and the opportunities — and risks — that these changes bring.

Comparing the present trends to the “disintermediation” of capital markets and lending in the 1990s and 2000s, he said (emphasis added):

“Today, the financial industry is again being disintermediated but in a different way. Instead of securities firms and capital markets, it is fintechs and technology platforms. Instead of lending, it is payments processing. Instead of financial engineering, it is application programming interfaces, machine learning, and distributed ledgers. These trends cannot be stopped. They bring great promise, but also risks. Banks and the regulatory community must adapt to them.”

More specifically, he acknowledged the need to think through how “fintechs” fit into the banking system. Although the OCC proposed a Special Purpose National Bank charter aka “fintech charter” during the Trump administration, the move was met with numerous legal challenges centered on whether or not the OCC has the legal authority to grant charters to non-depository entities.

No fintech companies have directly applied for such a charter, which is understandable, given the uncertainty around them; Figure’s unique charter application is widely viewed as proxy for the “fintech” charter and has been met with numerous legal challenges.

“Put simply, denying a charter will not make the problem go away, just as granting a charter will not automatically make a fintech safe, sound, and fair.”

On the topic, Hsu had this to say:

“We must find a way to consider how fintechs and payments platforms fit into the banking system, explore the appropriate use of sandboxes to encourage responsible innovation, and coordinate with the FDIC, Federal Reserve, and the states to limit regulatory arbitrage and races to the bottom.”

Risks Climate Change Poses to the Financial System

The inclusion of climate risks in Hsu’s priorities for the OCC raised some eyebrows, particularly on the Republican side of the aisle. That said, perhaps the inclusion of climate as a priority should be unsurprising, given the Biden administration’s commitment to a “whole of government” approach to climate policy.

In his testimony, Hsu identified two key risk areas — the physical risk posed by extreme climate events and the business/financial risks posed by the transition to a low-carbon economy, saying:

“For banking supervisors, the issue is straightforward: banks are exposed to physical and transition risks presented by climate change. Physical risks include the increased frequency, severity, and volatility of extreme weather and long-term shifts in global weather patterns and their associated impact on the value of financial assets and borrowers’ creditworthiness. Transition risks relate to adjustments to a low-carbon economy and include associated policy changes from Congress and other authorities, technology changes, and litigation.”

Dems’ Focus On Overdrafts Conflicts with Another Priority: Helping Small Banks

Alliant latest to scrap overdrafts, adding pressure

Overdraft and NSF fees have been showing up as a hot topic seemingly everywhere in Washington lately: from acting Comptroller Hsu’s testimony last week to Sen. Elizabeth Warren’s (D-MA) recent aggressive questioning of JPMorgan Chase CEO Jamie Dimon.

Amid the renewed legislative and regulatory focus on overdrafts (and competition from startup challenger banks), a number of major banks, including PNC and Ally, have implemented changes to reduce the number of fees their customers will incur — or eliminated the fees altogether. Last week, Alliant, a top 10 credit union by assets, followed suit, eliminating overdraft and NSF fees for its members.

But the increasingly aggressive stance against overdraft fees potentially conflicts with another Democratic priority: fostering competition by supporting small banks. Smaller banks tend to derive a greater share of their non-interest income from service fees, meaning any policy change will more significantly impact their revenue compared to larger banks.

Attempting to encourage competition by making mergers and acquisitions more difficult or proposing programs that amount to subsidies for smaller banks are misguided policies at best and potentially harmful at worst.

Supporting a competitive market is a worthy goal, but some policy proposals appear to try to turn back the clock rather than encourage smaller community banks and credit unions to adapt to the present so they can flourish in the future.

The forces driving declines in the number of banks and credit unions and their branches are extremely unlikely to reverse. Technology, and the designers, product managers, and engineers who create it, are a key differentiator for financial services companies now — not their geographic branch footprint. Because technology scales in a way that physical assets do not, it is unsurprising we’re seeing continued consolidation in the legacy banking sector.

But small banks have something that most fintechs do not: a charter (and everything that entails). Policy and clear and stable regulations that govern how banks can partner with fintechs would be supportive both of the health of small/local banks and of competition.

Square Buys Afterpay. We’re Likely to See More Consolidation in BNPL.

Square’s monster $29 billion acquisition of publicly traded BNPL company Afterpay understandably garnered a lot of coverage last week. My hot take is there is a lot of, yes, synergy for Square in the acquisition.

  • Geographic expansion via Afterpay’s presence in other key English-speaking markets: Australia, the UK, Canada, and New Zealand

  • Square can offer BNPL functionality to its merchants via its existing footprint, increasing utility and stickiness

  • Cash App users can link BNPL transactions to their Cash App account/debit card — improving the economics and keeping users in the Square ecosystem

  • Afterpay’s mostly online/e-commerce merchant base is complementary to Square’s historical focus on SMBs and bricks and mortar

  • Afterpay’s consumer base is more affluent than Square’s Cash App user base, which should help attract more upscale merchants to Square’s platform

But why Afterpay, particularly at a price tag of $29 billion (in stock)? At a market cap of ~$18 billion, Affirm would’ve been a cheaper option. Or, why not, like Paypal, build their own buy now, pay later offering?

  • Above all else, speed to market: while Square certainly could build its own offering, success in the BNPL business model is driven primarily from merchant footprint. If Square built its own offering, it would have the benefit of its existing merchant ecosystem, but would be starting from scratch to win net-new merchants for its BNPL offering.

  • Also, aforementioned geographic and merchant/consumer segment expansion: while Square is predominately a US business, it does also process card payments in Japan, Ireland, Canada, Australia, and the UK — a list that largely overlaps with Afterpay’s markets. Acquiring, rather than building, allows Square to pay to accelerate market share in those countries.

Is the Time Ripe for BNPL Consolidation?

While certainly the largest, this isn’t the first sign of consolidation in the BNPL space.

Since late 2020, you’ve seen Alliance Data, a major white label credit card issuer, acquire BNPL company Bread; Affirm bought Pay Bright as a quick way to enter the Canadian market; and just last month PROG Holdings bought BNPL company Four.

EU BNPL behemoth Klarna has also been on an acquisition spree, scooping up three startups with complementary shopping and e-commerce functionality in July alone.

In a market where the core product is largely undifferentiated, two trends are likely to continue:

  • Consolidation in the core BNPL offering in and across markets in a race to grow market share of merchants and consumers.

  • Acquisitions of companies offering complementary functionality, in an attempt to increase user numbers and keep them within a BNPL company’s shopping and spending ecosystem.

Former Acting Comptroller Brooks Abruptly Resigns as CEO of Binance.US

Brian Brooks, the former acting Comptroller of the Currency, abruptly resigned as CEO of crypto firm Binance’s US affiliate via a tweet on Friday:

Brooks took the role as CEO of Binance.US just three months ago. It’s not clear at this point what spurred Brooks’ decision to resign.

Binance, the world’s largest cryptocurrency exchange by volume, has come under increasing scrutiny in recent months. The firm has faced regulatory actions or inquiries in numerous countries, including the UK, Germany, China, Japan, Thailand, India, the Cayman Islands, as well as from the US DOJ, IRS, and CFTC.

Gensler Wants Congress to Enable SEC to Regulate Crypto Exchanges

Much has been made that recently confirmed SEC Chairman Gary Gensler’s resume includes a stint teaching about blockchain and crypto at MIT. But don’t mistake intellectual curiosity for crypto advocacy. Gensler has made abundantly clear that his focus, within the regulatory remit of the SEC, is investor protection.

“While I’m neutral on the technology, even intrigued—I spent three years teaching it, leaning into it—I’m not neutral about investor protection”

Part of what complicates Gensler’s job is, if applying existing law and regulatory frameworks, how a given crypto can or should be regulated depends on its functionality: it could be considered a commodity, regulated by the CFTC, or a security, falling under Gensler’s purview at the SEC.

A logical starting point is extending the SEC’s regulation to crypto exchanges like Coinbase, Binance, Kraken, and Bitfinex. While some exchanges tout that they’re ‘licensed’ or ‘US regulated,’ this often amounts to little more than a money services business/money transmitter license necessary for interfacing with the USD banking system. Gensler has asked Congress to pass a law granting the SEC the authority to monitor and regulate crypto exchanges.

Gensler is also pushing SEC staff to look at other crypto topics, including initial coin offerings, lending platforms, decentralized finance, stable value coins, custody, and ETFs and other coin funds.

According to Bloomberg (emphasis added):

“If firms are advertising a specific interest-rate return on a crypto asset, Gensler says, that could bring the loans under SEC oversight. Platforms that pool digital assets could be seen as akin to mutual funds, potentially allowing the SEC to regulate them.”

These are the types of accounts/funds that have drawn state regulator attention to BlockFi in recent weeks. While it’s doubtful crypto industry participants want more regulation, better one consistent framework at the federal level than 50 discrete state approaches.

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Other Good Reads

Open banking must be a two-way street (John Pitts in American Banker)

Inside MoneyLion’s quest to become a financial ‘super app’ (Banking Dive)

A Regulated Stablecoin Means Having a Regulator (Paxos)

Fintech Business Weekly Resources

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