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.
In this approach we have not taken into account:
- 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.
- 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.
- 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.
- 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.
- 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.
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.