Editorial: OCC Fintech Charter’s value depends on the origination volume

Editorial: OCC Fintech Charter’s value depends on the origination volume

We are going to do a back of the envelope calculation of the costs involved in deciding if an online lender should or shouldn’t apply for the newly proposed OCC Fintech charter. Our starting assumptions are that the OCC Fintech chartered institutions will have the same costs as a community bank. I have in the past […]

Editorial: OCC Fintech Charter’s value depends on the origination volume

We are going to do a back of the envelope calculation of the costs involved in deciding if an online lender should or shouldn’t apply for the newly proposed OCC Fintech charter.

Our starting assumptions are that the OCC Fintech chartered institutions will have the same costs as a community bank.

I have in the past contacted the Utah regulator inquiring on the costs and timelines to setup a bank. I was told it will take about 1 year, it will cost about $2mil in setting up expenses and the net capital requirements will be about $20mil.

Furthermore, Basel III, for example, requires banks to fund themselves with 4.5% of common-equity of risk-weighted assets. If we simplify a lot, this will mean that the $20mil in owners equity capital will enable the bank to carry a balance sheet of about $444mil in risk-weighted assets.

There are roughly 6000 community banks in the US. The cost of ongoing compliance for the sum of the community banks, in total, is estimated to $4.5bil per year or $750,000 per bank per year. The cost of compliance per bank appears to be going up at a rate of about $100,000 per year per bank.

In summary, we, therefore, estimate the following costs for the 1st 5 years of a lender that would use the newly proposed OCC Fintech charter to be up to a risk-weighted-assets book of $450mil:

0. The same costs they have right now plus
1. $20mil in net capital
2. $2mil 1st year operating costs
3. $3,600,000 ( the cost of annual compliance, taking into account the $100,000 per year increase).

Therefore the expected overhead costs of the OCC charter should be about $5.6mil in operations and $20mil locked-in, as net capital,  in a bank for 5 years. Please note that these costs are fixed, no matter the volume.

FDIC bank partnership

If an online lender partners with a FDIC bank to passport their usuary state rates nationally, the bank usually charges about 0.5% of the origination volume as a service fee. In addition, most banks also charge a minimum monthly fee that is in the tens of thousands up to about $100,000 per month.

As you can see one will have a relatively fixed costs with the OCC Charter and a variable cost when partnering with a FDIC bank.

At what volume do these costs equal?

If we use the 0.5% origination fee, and we assume it is above the monthly minimum, our calculation shows that $5.6mil (the cost of operating an OCC Fintech charter for 5 years) would be equivalent to an origination volume of $1.12 bil. 

Discussion

In this approach we have not taken into account:

  1. the likely volume discounts in the partnership with the FDIC bank. However, assuming a 50% discount with scale, this will mean that getting an OCC Fintech charter will be worth it above $2bil in origination instead of $1bil.
  2. the costs of the $20mil in net capital. However, this costs is usually paid in equity for the firm and most firms who originate $1bil and above will have this kind of capital on their books. I don’t believe there is a significant cost for this net capital.
  3. the potential need to increase the net capital over $20mil. We used a rough Basel III calculation to show that the $20mil will allow the originator to hold on the books about $450mil in risk-weighted assets. In order to originate $1bil over 5 years, as our calculation shows here, all the originator needs to do is sell their book once in 5 years. Therefore we don’t expect this to be a large issue.
  4. all our calculation have been extremely rough. However, assuming a 200% margin of error, I would feel comfortable saying that once the lender reaches $3bil in originations over 5 years, it is certainly worth seriously looking into the OCC charter.
  5. and we haven’t taken into account the intangibles like reduced regulatory risk due to the OCC Charter resolving the true-lender issues or the increase in control and independence which I value highly in business.

Conclusion

On one side, I expect this OCC Fintech charter, to be fairly interesting to the largest lenders who originate more than $1bil over a 5 year period or $200mil per year.

On the other side, in a nutshell, this new charter, will allow companies to do only one of the 3 bank functions ( take deposits, manage cash, or lend) while it will require that they follow in full the banking regulations.

Explained that way, the charter may seem non-useful due to the apparent cost vs reward of the charter: Why take the whole cost of a bank while being able to do only one function? For example, online lenders would love to get access to both lending and deposit taking as possibly the best source of funds for lending.

If the costs of setting up an OCC Fintech Charter are the same as for a bank, then why not just setup a full bank?

I, therefore, predict the costs of the OCC Fintech Charter to either be significantly lower than a bank’s or for the regulatory burden and constraints from this charter to be significantly lower than a bank’s. In all cases, this seems to lead to a contradiction in the OCC statement itself.

I am therefore not sure where the OCC will be going with this Fintech charter.

Author:

George Popescu

The Age of Regulation Technology : 2002-Present

The Age of Regulation Technology : 2002-Present

As recently as fifteen years ago banks and other financial companies had very little reason to designate a manager, let alone a whole department to regulatory compliance. To prepare for our event on August 25th in San Francisco we are exploring the Regulation Technology space and history. According HR consulting firm, Robert Half International, the average […]

The Age of Regulation Technology : 2002-Present

As recently as fifteen years ago banks and other financial companies had very little reason to designate a manager, let alone a whole department to regulatory compliance.

To prepare for our event on August 25th in San Francisco we are exploring the Regulation Technology space and history.

According HR consulting firm, Robert Half International, the average Chief Compliance Officer earns somewhere between $122,250 – $251,500, depending on the size of the company. This may not seem too unusual as CCO is a commonly found and highly prized position in most financial institutions today.

In 2015, JPMorgan reported that they had hired 8,000 compliance and control staff in recent years and had completed 800,000 hours of compliance training in one year alone. Recently, the Wall Street Journal named Compliance Officer the “hottest job in America.” Before we examine the future of compliance in the fintech industry, it is important to understand what caused the recent rise of federal regulation and stressed importance of corporate responsibility.

Many analysts date the proliferation of the CCO and to US’s crackdown on money laundering in response to the 911 terrorist attacks in 2001. In 2002, SEC Commissioner Cynthia Glassman made a speech in DC about the Idea of “Good” Governance, calling for the need of a “corporate responsibility officer” in America’s public companies. Glassman’s speech came shortly after the collapse of Enron and the enactment of Sarbanes-Oxley Act, but preceded the arguably more troublesome global financial crisis of 2007-08. Since the crisis, the US has seen nothing but an increase in regulatory developments in order to combat issues of fraud and corruption.

How to Prevent “Too Big to Fail” From Failing: An Average of 155 Regulatory Changes a DAY

The task of compliance does not come easily or inexpensively, several high-profile corporations have paid as much as $36billion in settlements and penalties, as well as spent up to $4billion in order to hire and train thousands of compliance staff to prevent wrong-doing in the future. Billions of dollars and thousands of hours are being spent on compliance and here’s why: the federal government is doing just about everything in its power to prevent another financial crisis, meaning regulating risk-taking, protecting against fraud, and ensuring due diligence.

The reason companies are paying good money for Compliance Officers? It is an almost impossible job. According to a Thomas Reuters report, financial regulators issued 40,603 regulatory updates in the 2014 calendar year. Fortunately, companies are finding ways to meet state and federal compliance regulations though automation.  Several technology-based compliance companies, such as IdentityMind, Microbilt/ComplyTraq have created automated systems to help companies and banks prevent fraud and access risk. While the government is doing what it can to limit risk and prevent large corporations that are “too big to fail” from failing, smaller financial institutions and credit companies are using technology and compliance trained employees to maintain an equilibrium between responsibility and profitability.

The Object of the Game is to Reduce Operating Costs

Most business owners would agree that the main problem with regulatory compliance is that generates absolutely no profit, but costs a great deal of money, time and effort. As mentioned in a previous Lending-Times.com article on rules-based compliance software engines, there are anywhere between 10,000-100,000 state and federal regulations applied to the average mortgage. The manpower it takes to sort though and comply to that high number of regulations is costly. To apply a cliché sports metaphor, the best offense is a good defense; in this case, in order for a credit or financial company to earn a high profit, it needs to be able to cut back on costs.

The IdentityMind platform uses a digital system to verify customers/business’ identities in order to prevent fraud and identity theft. Borrower identity verification is the first step in risk evaluation, and through IdentityMind’s automated system, businesses are able to not only cut back on the staff but also the time needed to complete a manual review of customer information. Their IGNITE program is advertised as “the most sophisticated AML Compliance platform available” for Bitcoin start-ups, saving time and money while complying with US and Worldwide regulations.

Rules-Based Software Needs Rules

The truth of the matter is that however, seamless an automated system appears to operate it does still need an operator. Compliance jobs are still on the rise because someone still needs to create the rules for a rules-based software engine. Microbilt Corporation created ComplyTraq, a joint venture with well-known industry veteran and attorney Oscar Marquis. ComplyTraq is a marriage of automated KYC, AML, and ACH software and extensive compliance employee training. They offer services such as credentialing, training, and auditing.

While identity verification and risk assessment can be automated quite easily, interpreting laws and regulations still requires a highly trained compliance staff. It is a pretty well-accepted fact that automation replacing most “routine-job” employees, and while compliance seems like a lot of paper-pushing, it actually had serious implications in the financial industry.  There are many factors in a regulatory compliance position that can be sped along with technology, but the human aspect of compliance cannot be replaced by well-designed platforms altogether.  Automation can save money, time, and resources, but it is not absolute in its ability to comply with complex regulations and restrictions. Hence, the number of compliance officers in the US (and their salaries) have continued to rise, and will most likely continue to do so for some time.

Looking Forward: Could Complytech be the New Fintech?

As noted in a recent Bloomberg article, “compliance, not banking, has been the real growth business since 2008.” While a majority of these regulations have been put in place to protect America’s interests, the burden of compliance is a costly reality. Yes, regulations tend to limit the amount of risk-taking, but several companies have begun honing in on the appropriate amount of risk to take in order to balance compliance with profitability. The reign of the CCO may be just beginning, but the future looks bright with companies like IdentityMind and ComplyTraq already rising to the challenge of corporate and financial responsibility.

Author:

Lauren Twardy