OCC Acting Comptroller Calls for Regulation of Crypto Banking

At the American Fintech Council’s Fintech Policy Summit, OCC Acting Comptroller of the Currency Michael J. Hsu warned of the risks of keeping cryptocurrency outside of the bank regulatory system.

Mr. Hsu reported that from 2019 to 2020, digital payments transactions increased 27 percent, from $4.1 to $5.2 trillion, and cryptocurrency market value increased from $200 billion to approximately $2.5 trillion. Mr. Hsu pointed out that this growth was accompanied by growth in consumer complaints and scams, as seen with Paycheck Protection Program loans facilitated by financial technology-based firms (“fintechs”), which saw higher rates of customer dissatisfaction and fraud than did loans facilitated by traditional banks.

Mr. Hsu emphasized that all participants in the banking space need to “level up”: (i) firms he described as “Synthetic Banking Providers” (“SBPs”) must be held to the same standards as banks; (ii) fintechs must put a higher premium on consumer trust; (iii) traditional banks must better serve the underbanked; and (iv) regulators must engage with each other with “less regulatory competition and more cooperation, less parochialism and more teamwork, and less go-it-alone independence and more interdependence” (emphasis in original).

In terms of troubling digitalization trends, Mr. Hsu focused on how SBPs recreated bank activities outside of the regulatory framework and cautioned against a cryptocurrency regime that is partial and selective, as the current system is, because then no one regulator has authority over the firm as a whole.

Mr. Hsu argued that SBPs have “reassembled” the banking activities of taking deposits, making loans and facilitating payments to such an extent that fintechs are vulnerable to run risk and experience regulatory arbitrage. Mr. Hsu stated that money on these platforms “looks less like the spare cash in one’s wallet and more like the cash one holds in a bank deposit,” and coupled with the fact that platforms extend significant sums of money, this leaves platforms, and therefore the larger financial system, vulnerable to runs. Mr. Hsu also expressed concern that fintech supervision falls across federal and state regulatory bodies, on top of which fintechs have been making “technical, and questionable” arguments for their products to remain outside the system, creating an unfair advantage for SBPs. These concerns are further augmented by the fact that fintechs do not have an incentive to become banks because:

  • “banking-as-a-service” and “rent-a-charter” arrangements, usually made with smaller banks, are cheaper;

  • the technology business model looks to monetize data while the bank business model aims for high-quality earnings; and

  • regulators are unpredictable in how they charter new banks and approve fintech acquisitions of banks.

On partial and selective regulation, Mr. Hsu asserted that “fragmented supervision enables obfuscation and harm,” especially money laundering and obscuring excessive risk taking.

Mr. Hsu argued that “universal crypto firms . . . should embrace comprehensive, consolidated supervision . . . and regulators should prioritize the development of policies, staff, and supervisory approaches to bring such firms safely into the bank regulatory perimeter.”

Very few new banks are chartered in the United States and the burdens of bank regulation are substantial (often for good reason). It is hardly surprising that fintechs in the crypto business are not clamoring to be regulated as banks, just as it is not surprising that digital asset firms are not seeking out the SEC for no-action relief. If the regulators want crypto or digital firms to approach them seeking to be regulated, the regulators will have to provide a motivation for these firms to do so. Right now, many firms see the choice as (i) do business and hope that the firm is not hit with an enforcement action or (ii) approach the regulator and be told that the business model is not workable under the regulatory structure. If those are the only two options, the first option will seem attractive to many.

Commentary

Very few new banks are chartered in the United States and the burdens of bank regulation are substantial (often for good reason). It is hardly surprising that fintechs in the crypto business are not clamoring to be regulated as banks, just as it is not surprising that digital asset firms are not seeking out the SEC for no-action relief. If the regulators want crypto or digital firms to approach them seeking to be regulated, the regulators will have to provide a motivation for these firms to do so. Right now, many firms see the choice as (i) do business and hope that the firm is not hit with an enforcement action or (ii) approach the regulator and be told that the business model is not workable under the regulatory structure. If those are the only two options, the first option will seem attractive to many.