In Spite of US Regulatory Roadblocks, Digital Banks Are Here to Stay
When PayPal emerged on the scene at the turn of the millennium, it did so with the promise to revolutionize the entire banking industry. Companies like Venmo, Square, and Zelle followed suit to join the growing trend of “digital wallets.” It may be hard to believe, but ApplePay has only been available since 2014, followed quickly by Samsung Pay, and a later offering from Google. Over the past 20 years, “digital wallets” have completely transformed the way we exchange money. Now, a new wave of self-described “digital banks” are becoming increasingly popular with consumers, but the revolution of banking has just begun. Customers are opening accounts with digital banks citing lowered costs, ease of use, and faster service. However, the depth and breadth of the Fintech revolution in banking is largely stymied by local regulators, making it difficult for these new startups to compete with the old-guard institutions.
What is a digital bank?
To put it plainly, a digital bank is a company that offers some or all of the services of a traditional checking account, except it exists entirely online without any brick and mortar branches and teller windows. In spite of the lack of any physical branches, digital banks offer checking and savings accounts, interest rates on deposits, ability to purchase stocks, ETF and bitcoin, surcharge-free ATM debit cards, and even physical checks. Digital natives, who grew up using Facebook and Instagram, expect to run their lives from their smartphones, and are the early adopters of these new banking platforms. We can expect that baby boomers and seniors limited by mobility and looking for added conveniences will soon make a significant portion of digital banks’ customer base.
Simple.com, established in 2009, was perhaps the first fintech startup to brand itself as a digital bank, and it’s since been followed by companies on both sides of the Atlantic with whimsical names such as Chime, Varo, Revolut, Monzo, Nubank, N26, and Starling, with many more launching later this year. Cogni is one of these coming digital banks, boasting a no-fee debit Visa contactless card with some very cool features like free, instantaneous transfers when sending money within the network. Many of these companies offer lightning-fast accessibility and consumer-loved tools like budgeting, payments and transfer automation, but so far it’s been difficult for them to really challenge traditional banking institutions.
What’s Holding Digital Banking Back?
All this time, the digital banks available to US customers have only been able to operate in partnerships with established and traditional banks who are FDIC insured, largely small community banks trying to lower their cost of attracting new deposits and find new revenue streams. Staple banking products, such as debit cards and checks, can only be issued to digital bank customers through these institutions. Case in point, Revolut’s Prepaid Mastercards are provided by Metropolitan Commercial Bank, and all of Simple.com’s banking services are provided by BBVA Compass.
The revolution in banking is not moving faster in the US because these new digital banks are not able to actually challenge traditional banking. In fact, they have to rely on them in order to exist.
Currently, there is no simple way for fintechs to get a bank charter in the US. Varo is the only American fintech company with a bank charter, but even it is working in partnership with the Bancorp Bank.
And it’s not like digital banking presents any sort of unique regulatory challenges. Numerous countries in the European Union, as well as South Korea and Japan, have already established digital-only banks, with oversight from top-level regulators. Singapore is making strides in this arena as well. In September 2019, the Monetary Authority of Singapore (MAS) officially endorsed the digitally banking industry when it kicked off the application process for special digital bank licences.
In the US, fintech companies are overseen primarily by networks of state regulators, but federal agencies are finally taking an active interest. In July 2018, the Office of the Comptroller of the Currency (OCC) announced a bold (if late) new offering — they were accepting applications for national bank charters from “nondepository financial technology (fintech) companies engaged in the business of banking.” Many described this as a way for fintech companies to “fast pass” to becoming traditional banks. But almost immediately, many of the state regulators, including the Independent Community Banking Association (ICBA), challenged the OCC’s power to issue such a charter, causing companies like Google and PayPal to halt pursuit of the licensing over fears of retaliation by the State Banking regulators.
The OCC is not the only federal regulatory body weighing in on fintech. Shortly before the announcement of their new charter, the Bureau of Consumer Financial Protection (CFPB) and the U.S. Department of the Treasury began unveiling their own initiatives. The CFPB created an Office of Innovation for the sole purpose of “encouraging consumer-friendly innovation” in what they dub to be a “regulatory sandbox,” that will allow fintech companies to experiment with new data, tools and models under the supervision of regulators. The CFPB is also participating in the international Global Financial Innovation Network that aims to “provide a more efficient way for innovative firms to interact with regulators, helping them navigate between countries as they look to scale new ideas.” Similarly, the Treasury released a report, “A Financial System That Creates Economic Opportunities,” encouraging the OCC to move forward with their new charter, while they create another type of sandbox.
A full year after the OCC announcement, not a single company even applied for the charter, let alone got accepted. In October 2019, a federal district court in New York officially ruled that the OCC does not have the power to issue the charter, slamming the brakes on any sort of federal reform on allowing digital banks to become fully-fledged institutions. It is unfortunate, given how far the US banking system has fallen behind the rest of the world in terms of its full embrace of technology to leverage the delivery of financial services.
Consumers obviously want innovation in the sphere of banking, and the entire industry is due for a high-tech overhaul and needs reform of outdated and encumbering regulations. The UK, which has been an innovator in facilitating common sense regulation of fintechs have become a mecca for incubating digital bank startups who have achieved unicorn status. The UK digital banks are true “challenger banks,” and according to a recent Accenture report have racked up some eye-popping customer adoption rates. Customer acquisition has accelerated to 170% during the first half of 2019 and average balances have skyrocketed five-fold from $84 to $422. The challenger banks are getting sticky with their customers.
In spite of the current hand-wringing and defeatist attitudes brought on by the setbacks of the partial solutions contemplated by the OCC fintech charter, digital banking isn’t going anywhere.
The US state and federal regulators, as well as Congress, need to face the reality of how much catching up the digital banking sector in the US has to do with the rest of the world. Are US regulators doing all that they can to help deliver the best that financial innovation and technology can offer?
Victor T. Samuel is Founder & CEO of NV Global Ventures, a consultancy focused on regulatory advisory, blockchain initiatives, innovation consulting, venture building and investments.