Reading Between the Lines: Parsing Regulators’ Recent Public Remarks
Reading Between the Lines: Parsing Regulators’ Recent Public Remarks
NY Fintech Week Preview; Chargebacks911 Helped Shady Merchants Fake Evidence To Beat Disputes, FTC Says
Hey all, Jason here.
Around the time this hits your inbox, I should be working on packing my suitcase (hopefully) — I’ll be heading to New York next weekend, in advance of New York Fintech Week. Looking forward to catching up in person (and having my fill of New York bagels.) Find additional detail on some of the events I’ll be attending/speaking at below👇
If you missed it, definitely recommend listening to my podcast with my former colleague (and ex-CFPB & Connecticut Department of Banking attorney) Jesse Silverman — probably one of the best ones I’ve done yet!
Existing subscriber? Please consider supporting this newsletter by upgrading to a paid subscription. New here? Subscribe to get Fintech Business Weekly each Sunday:
Join us for the future of fintech at Fintech Nexus USA!
Sponsored content: Connect with top industry leaders, innovators, and investors as they discuss topics, such as digital banking, fraud, credit, lending, payments, blockchain, AI, regulation, and more. This is the place to network with senior professionals and explore new business opportunities. Register now for a chance to be part of the premier fintech event of the year!
Reading Between the Lines: Parsing Regulators’ Recent Public Remarks
Between responding to fallout from the collapse of SVB and Signature, continuing macroeconomic uncertainty over persist inflation and rising interest rates, and regular programming, financial regulators have been out in force lately.
While public comments are typically carefully scripted, they provide insight on what is top of mind for regulatory institutions and, often, clues as to how individual regulators are thinking about specific issues.
It’s worth noting that, given regulatory agencies’ differing areas of focus and individual personalities, views of current events and appropriate policy responses are not always perfectly aligned — these rough edges of overlapping authority are, perhaps, the most interesting areas to pay attention to.
CFPB’s Rohit Chopra Chats with the Washington Post
The key takeaway from most analysis of Director Chopra’s conversation with Washington Post’s Lori Montgomery was his view that P2P payment apps, like Cash App and PayPal, could be viewed as ‘systemically important.’
But the wide-ranging interview covered a number of other areas worthy of further examination:
On the Trump-era partial rollback of Dodd-Frank, which increased the size at which banks would be subject to additional regulatory requirements (which passed with bipartisan support): Chopra described the change as a clear “mistake,” and said, “there is no question that some of the deregulation in recent history helped to contribute to it, and there are clearly some major changes that will need not just by on the regulations but also on how the regulators supervise some of these firms.”
Regarding regulation of executive compensation, Chopra pointed to provisions of Dodd-Frank — passed in 2010 — which were never implemented. While Chopra did not comment on specific institutions, some analysis of SVB’s failures suggests executives’ target KPIs and compensation structure encouraged them to take on additional risk in the form of longer-dated securities that led to the bank’s collapse. Chopra said regulators should “look at all of our existing legal authorities where there was law violations to go after individuals.”
Asked about deposit insurance, Chopra, who is a member of the FDIC’s board, defended the unanimous recommendation and decision Treasury Secretary Yellen took to invoke the “systemic risk exception” and backstop all depositors of SVB and Signature. Chopra hinted that the costs of a legally-required special assessment to help replenish the $23 billion cost to the deposit insurance fund would be borne by those institutions that “benefited the most from it” — suggesting that other mid-sized, regional banks, rather than small community banks or the largest money-center institutions, may bear most of the cost.
Chopra acknowledged the need to think about changes to the current deposit insurance framework. Payroll accounts, which, particularly for larger companies, can hold far in excess of FDIC limits, are an example where tailored proposals could help better address risks — for business and banks.
Like other regulators, Chopra acknowledged the role “faster digital communications” — Twitter, WhatsApp — played in the bank run on SVB. But, while noting how instantaneous communications compress the time banks and regulators have to react to a crisis, few who oversee the banking system seem to have any ideas on what to do about it. Specifically, Chopra said, “We now know with faster digital communication, we know with state and non-state actor interference, there can be lots of ways in which information or wrong information can travel quickly, and we have to set the regulatory system up appropriately.”
Regarding P2P payment apps, Chopra highlighted risks vis a vis deposit insurance, saying in part, “[A]pps like Cash App and Venmo, PayPal, have become part of the digital wallets of so many Americans, but many may not know that those — whether those funds are insured or not. I would not want to see a run where people could not get their money.”
Chopra’s comment about P2P apps that caught the most attention was the possibility of designating such services as “systemic,” which would grant regulators additional oversight powers. Specifically, he said, “I have argued that we may need to think when it comes to digital payments and currency of looking at an old provision of law that was also passed in 2010 that would allow the regulators to designate certain payment systems as potentially systemic, which would allow us to make sure they are safe and sound and protecting consumers. So I generally advise consumers not to keep too much in these accounts, to move it to your bank account.”
His comments about “automatic triggers” also garnered significant attention — comments Chopra made in relation to SVB’s rapid growth and reliance on uninsured deposits, saying, “[I]t is time to really take a clearer look and, in some ways, create more automatic triggers to slow down some risky activity. I mean, come on. This bank had an enormous amount of uninsured depositors, and uninsured depositors might be quick to flee. So we need to think about should there be some guardrails or even caps on uninsured deposits that are bright lines. Should there be some automatic triggers on growth restrictions when companies cross certain lines?”
On “Big Tech’s” continuing foray into banking, Chopra said, “[H]ow do we make sure we have an open banking system that's fair and not just dominated by, say, big tech firms and the very biggest banks? We're looking hard at these non-bank companies who are often not supervised in the same — giving the same level of protection, and we've taken some steps to make sure we're gaining oversight into some of them.”
And finally, Chopra argued that digitization and modern reliance on algorithms can undermine so-called “relationship banking,” saying, “We see that digitization can sometimes undermine relationship banking that stymies a consumer from getting answers to basic questions. We're looking at algorithmic bias and using existing authorities to make sure, in appraisals and in the mortgage market, people are not dealing with a biased algorithm.”
He suggested that mirroring China’s approach would be a mistake, saying, “I think it would be a big mistake for the U.S. to just copy, you know, how China's financial system dominated in many ways by WeChat Pay, Alipay when it comes to payments. We need to make sure we have relationship banking even as digitization accelerates.”
FDIC Vice Chairman Hill’s Remarks at the Bipartisan Policy Center
FDIC Vice Chairman Hill, one of two Republicans on the five-member board, gave an address at the Bipartisan Policy Center that had a several arguments worth examining.
Hill noted that previous large bank runs, including 1984’s on Continental Illinois and 1988’s on First Republic Bank of Dallas, were — at the time — described as ‘high-speed electronic’ runs. He said in his speech:
In May 1984, Continental Illinois was the victim of what the FDIC described as a “high–speed electronic bank run.” Similar to SVB and Signature, more than 90 percent of its deposits were uninsured. The run lasted for eight days, until federal regulators broke the run by announcing that the FDIC would provide assistance.
Four years later, First Republic Bank of Dallas experienced a similar electronic run in which corporate depositors, primarily small Texas banks, withdrew $1 billion in a single morning. Then–FDIC Chairman Bill Seidman described it as “a real bank run, even if dressed up in high–tech garb.”
However, Hill was more willing to be critical of some elements of the regulatory apparatus’ response to SVB and Signature’s failures, arguing that speed is of the essence in resolving/selling a failed bank, and that the FDIC needs to be open to all potential acquirers:
This underscores a critical lesson for regional bank resolutions: once the bank fails, the government must be proactive in finding an acquirer as quickly as possible. The FDIC not only needs to be open to any and all bidders, it needs to act with urgency and initiative to solicit bids and make a deal happen. And for a bank like SVB, given the broader implications, this process requires the proactive engagement and leadership of other agencies, including the Treasury Department and Federal Reserve.
Facilitating a quick sale process requires getting required data to potential acquirers — something that was complicated in SVB’s case by the rapid pace of withdrawals. Hill suggests additional refinement around the planning, process, and requirements for “data rooms” would be valuable in addressing future bank failures:
The SVB failure also reinforces the importance of a bank’s capability to quickly populate a data room so that potential bidders can perform due diligence. One obstacle to a quick sale of SVB was the time it took to meaningfully stand up such a platform. The FDIC’s 2021 policy statement related to IDI resolution planning and subsequent FAQs discussed the data room concept, and capabilities testing around this seems a worthwhile area of focus going forward.
And finally, Hill argues that S. 2155 — the bipartisan, Trump-era law that rolled back some regulatory requirements of Dodd-Frank — had “nothing to do” with the collapse of SVB. He said:
I think it is quite obvious that S. 2155 had nothing to do with it. The rule changes did not change the stringency of capital standards for a bank of SVB’s size, the stress tests did not test for rapidly rising rates, and the exact thing that got SVB in trouble – investing in government bonds – is exactly what the liquidity coverage ratio is designed to require. The reasons for SVB’s failure are quite straightforward and easy to explain, and those rule changes had nothing to do with them.
Fed Governor Bowman On “The Consequences of Fewer Banks in the U.S. Banking System”
Federal Reserve Governor Michelle Bowman appeared at the Wharton Financial Regulation Conference, where she spoke on the consequences of the declining number of US banks.
Bowman’s remarks focus specifically on the much slower pace of de novo bank formation — examining data points that she argues indicate there is unmet demand for de novo bank licenses, discussing the consequences of lack of new bank formation, and examining regulatory barriers and possibly policy reforms that would be supportive of new bank formation.
Bowman argues the popularity of “charter strip” applications — in which a company buys an existing bank with the intention of repurposing its charter for a new business model — is because they can be more straightforward and less costly than the de novo process. She says:
Simply put, it is often easier than chartering a new bank by side-stepping the de novo formation process. When evaluating a bank acquisition, regulators often rely on the legacy bank's management performance and the existing supervisory and compliance record. The purchase of an existing charter can also bring efficiencies in terms of avoiding the restrictions that apply to de novo banks, which include higher capital requirements and business model limitations for the first several years of the new bank's operation. Another benefit to a bank purchase over de novo, is that operating banks have existing core systems and other third-party relationships that can speed up the time to market for a new bank model. Therefore, a charter strip of a healthy target bank often results in a faster and cheaper approval than a de novo application.
The shift of activities from banks to non-bank financial companies, which Bowman describes as the growth of “shadow banking,” suggests different regulatory treatment of the same activity, depending on whether in takes place inside or outside the regulatory perimeter. Bowman suggests this shift represents a market assessment that the regulatory cost of de novo formation doesn’t make sense for certain activities:
[T]he rise of nonbank lending also implies that investors have weighed in on the business case for de novo bank formation. Regulatory burdens affect de novo formation and have contributed to the migration of lending from regulated institutions. Nonbank financial entities have a choice about how to operate, whether to seek a bank charter or not, and the regulatory burdens of de novo formation—putting aside the obligations of operating within the regulated banking system—can themselves contribute to this shift in activities.
Bowman also argues the rise of Banking-as-a-Service operating models has been driven, at least in part, by the challenge of obtaining de novo licenses:
If a technology company has a new technology interface and product design that may better serve customer needs, it can be substantially faster to partner with an existing bank than to seek a standalone charter. This can raise challenging operational issues about who should "own" the customer relationship, but more importantly, about who is responsible for compliance obligations. From a policy perspective, there should be no net difference in the compliance expectations for banking-as-a-service and de novo banks that engage in the same underlying activity. The policy goals should be consistency in regulatory and supervisory approach.
Consequences of the Slow Pace of De Novo Formation
Bowman argues that, left unchecked, existing market and regulatory conditions will continue to encourage bank consolidation and a decline in the number of chartered institutions.
This, she argues, will result in reduced competition that can harm consumers and local communities:
When there is a decline in bank charters, and a reduction in bank branches, the net result in local banking markets is an increase in banking concentration—the percentage of deposits and loans controlled by a shrinking number of institutions—and a decrease in competition. Our traditional measures of assessing the concentration of markets, and the competitive effect of bank mergers, is to look at deposits as a proxy for the "bundle" of banking services. While one could reasonably question whether deposits are a reliable indicator of the competition for all banking products, I think it is safe to assume that a reduction in the number of in-market banks is often related to a reduction in competition, customer choice, and availability of credit.
Reduced competition can harm local communities and economies. Banks play a significant role in providing banking services, including mortgage loans, small business loans, and core deposit products like savings and checking accounts. For example, within bank lending, community banks play a significant role in providing loans to consumers and small businesses, construction and land development loans, residential lending, agriculture lending, and land financing.
Possible Policy Responses to Encourage De Novos
When it comes to barriers to de novo formation, Bowman identifies regulatory, efficiency, and transparency barriers, some of which reforms may be able to address.
While aspects of bank business models, like interest rates, are outside of policymakers’ control, many regulatory barriers could be addressed. The solution, she seems to suggest, is a better coordinated, more streamlined, and more predictable de novo application process:
Organizers of a de novo bank face a number of challenges, and the application process itself can be a significant impediment. The application process for a new bank charter often requires multiple applications to different regulators. For example, the formation of a national bank with a holding company requires the approval of the OCC, FDIC, and Federal Reserve. While each regulator may have aspirational deadlines for processing de novo charter applications, the time actually needed can vary considerably, and is rarely quicker than anticipated. The uncertainties surrounding the application timeline may compound the difficulty of attracting capable board members, management, and employees. Even the demands of raising sufficient capital—a vital step in the de novo process—may pose challenges, as the total amount of capital is based on a forward-looking projection of the bank's expected future size.
Bowman also suggests that a more “efficient” approach to regulation and supervision of de novos — in line with existing “risk-based” approaches — could be appropriate:
[P]olicymakers need to consider whether the tight framework of requirements that govern the operations of de novo banks are necessary and appropriate, and whether alternatives may be more efficient. For example, consider whether requiring an up-front capitalization of a de novo institution in an amount far in excess of standard capital requirements is necessary, or whether in some cases a phased approach that takes into account the early performance of the de novo bank may provide similar risk protection with a lower capital burden.14,15
Regulatory obligations fall most heavily on small banks, including both community banks and de novos. While these burdens may evolve slowly over time for existing community banks—allowing banks time to adjust to heightened supervisory oversight—regulatory requirements can act as an additional barrier to entry for de novo banks.
Finally, Bowman argues increased “transparency” around expectations and regulatory support could help foster de novo creation — including regulators’ messaging and “tone” on these matters:
[I]t is necessary to note that even if the regulatory message appears to support de novo activity, the regulatory tone in delivering this message matters. Investors and those seeking to organize a new bank notice when regulators encourage de novo formation. But almost more important than the words, the tone of that message must also be accompanied by actions that support, not inhibit, de novo bank formation. The banking agencies have made some progress by working to clarify regulatory expectations, giving potential applicants greater insight into the application process and by providing opportunities for feedback earlier in the process. But I think we need to ask if these steps are sufficient, and whether they can be improved.
Mark Your Calendars: NY Fintech Week
In less than a week, I’ll be heading to New York, in advance of New York Fintech Week. Here’s hoping the nice weather holds out for me!
It’s sure to be a fun — and busy — week; I count over 30 events scheduled! You can see the full line up of events here.
I’m hoping to catch up with as many folks as possible — if we don’t already have time scheduled, the easiest way to find me is at one of the following events that week:
Tuesday, 4/26: Unit21 & Treasury Prime: Fraud Fighters
I’ll be joining speakers from Unit21, Treasury Prime, and Bangor Savings Bank to discuss the evolving fraud landscape and what financial institutions need to do to respond. More details & RSVP here.
Wednesday, 4/26: Empire Startups Fintech Conference
On Wednesday, I’ll be joining Katie Savitz, cofounder & Chief Product Officer at Cable to discuss key developments in Banking-as-a-Service and how banks, middleware platforms, and fintechs can use tech to navigate the evolving environment. Full details and get your ticket here (use code “JEDI15” for your discount!)
Wednesday, 4/26: Happy Hour & Panel Discussion on What’s Next for BaaS
Later on Wednesday, I’ll be hosting a happy hour and panel discussion at Rise, alongside speakers from across the BaaS ecosystem: Walt Cox (Valley Bank), Amanda Swoverland (Unit), Neepa Patel (Themis), and Nick Farrow (Modern Treasury).
While the RSVP list is full, you can join the waitlist, and if spots become available, you’ll be notified automatically.
Chargebacks911 Faked Evidence To Help Merchants Beat Disputes, FTC Says
A complaint filed last week by the FTC and the Florida attorney general alleges that Chargebacks911, a firm that purportedly helps firms manage and mitigate payment disputes, actually has engaged in a longstanding pattern of unfair and deceptive practices.
According to the complaint, many of Chargebacks911’s customers employed “negative-option” free-trial marketing for skincare and nutritional supplement products.
In negative-option billing, customers are automatically opted in to a recurring subscription, unless they actively choose to cancel before the recurring payment.
Such billing structures are ripe for abuse and tend to generate high rates of disputes.
While the 51-page complaint is worth reading in its entirety, the charges basically boil down to three main points:
Chargebacks911 allegedly used misleading information to dispute chargebacks; for instance, by submitting screenshots of websites to customers’ issuing banks that showed disclosures and terms and conditions, which were not present on the pages customers actually saw and processed payments on.
Chargebacks911 allegedly ignored red flags indicating that the documentation it submitted was misleading and, in some cases, affirmatively edited screenshots to add disclosures that didn’t actually appear on the sites.
Chargebacks911 allegedly offered a service, “Value-Added Promotions,” the purpose of which was to run large numbers of small transactions for merchants, thereby lowering their chargeback ratios by artificially inflating the number of sales processed. This helped merchants to avoid being detecting by and potentially kicked off of their payment processors.
The FTC complaint includes supporting references to internal emails and training documents, that seem to demonstrate not only that officers of the business were aware of the practices, but that the company engaged in them as a matter of standard practice.
“Chargebacks911 blurred out the disclosure in Representment Screenshots it took for a client that operated a pornographic website and superimposed disclosure language that would help win chargeback disputes.” — FTC complaint
For its part, Chargebacks911 released a statement that argues that the company merely provides software to its clients and cannot be held responsible for how they choose to use it.
Per the company’s statement on the matter:
The Chargebacks911 software is very similar to a TurboTax or a DocuSign service in that any user can configure packages/templates, populate/insert information, and transmit their information to their designated destination. As a SaaS provider (Software-as-a-Service), Turbo Tax or DocuSign do not check the veracity of the information sent.
The FTC, however, believes that Chargebacks911 should take responsibility for the accuracy of any data that goes through the SaaS platform, and that any configuration done by the merchant using software is Chargebacks911’s responsibility.
Global VC Funding Continues to Revert to Mean
Last week, we looked at global VC funding for fintech specifically, which jumped dramatically in March, owing to Stripe’s monster $6.5 billion round (much of which will go to pay its tax bill for employee options).
But, zooming out to look at venture in generally — not fintech specifically — reveals that, even WITH Stripe’s round, overall funding continues to revert to the mean:
Other Good Reads
The End of Faking It In Silicon Valley (NYTimes)
Earning the Right to Win in Embedded Lending (Fintech Takes)
The Complex Future for FedNow (Fintech Brainfood)
Social Issues Impact Consumers’ Choice of Banks — Should Banks Take A Stand? (Ron Shevlin/Forbes)
Silicon Valley VCs tour Middle East in hunt for funding (FT)
Listen: Has Apple Missed the Buy Now, Pay Later Boom? (11FS Fintech Insider)
About Fintech Business Weekly
FBW Research Report: Banking-as-a-Service 2023 Market Analysis
Looking to work with me in any of the following areas? Email me.
Fintech advising & consulting
Sponsoring this newsletter
News tip or story suggestion — reach me on Signal at +1-316-512-1571
Early stage startup looking to raise equity or debt capital