RegFi Episode 57: Opening a Path for New Bank Formations

orrick regfi podcast | opening a path for new bank formations with michele alt from the kalros group

RegFi Episode 57: Opening a Path for New Bank Formations
35 min listen

The Klaros Group’s Michele Alt joins Orrick partners Jerry Buckley, Caroline Stapleton and Walt Zalenski to explore actions needed to facilitate new bank formations, which have slowed to trickle in recent years. The conversation highlights a recent letter — cosigned by Michele, Jerry, Walt and other senior banking and financial services advisers — outlining how federal financial regulators can break the logjam slowing applications for de novo charters. Among the recommendations to incoming agency leadership is a call to improve objectivity and transparency and encourage fintech and traditional bank charters to foster greater consumer choice and innovation in the financial system.

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Episode Transcript

Jerry Buckley:	Hello, this is Jerry Buckley, and I am here with RegFi co-host, Caroline Stapleton. Our guests today are Michele Alt, a co-founder of the financial consultancy, Klaros, and our Washington, D.C. partner, Walt Zalenski. We will be discussing a letter to federal financial agency leaders that Michele, Walt, and I and other interested lawyers signed, urging a new approach to the way in which applications for new bank charters are processed. It is a fact that approvals of new bank charters have slowed to a trickle compared to the historic level of approvals and the processing time for these applications, once they are submitted, is painfully slow. This, in turn, discourages applications for new charters at a time when the number of banks in our country is shrinking rapidly. Michele, you took the initiative on this letter. Let’s start by your sharing your experience in helping applicants with new bank charters.
Michele Alt:	Sure, and thank you for having me, Jerry and Caroline. As some of you may know, and I know all of you on this call know, I was a lawyer at the OCC for more than 20 years. That’s how I know Caroline and, of course, how I eventually engaged with Jerry and Walt. Eventually, I went to the private sector and began concentrating on new bank formation. Jerry and I worked on some early erstwhile fintech charter projects around 2016. Walt and I worked on a couple of major applications early in the, well, actually late in the first Trump administration, early in the Biden administration. And to say it’s a frustrating process is probably an understatement. And it’s certainly fair to say it requires a great deal of patience. And I think we all have the battle scars to prove our experience in this area. And I just think it doesn’t need to be that hard. And I’m committed to doing what I can do and with your support to improving the process to make it more efficient, fair, and transparent for all who participate.
Jerry:	Well, the process is a drawn-out process. And maybe you could just chat a little bit about, you know, the kinds of hurdles, if not roadblocks, that a bank might run into.
Michele:	Sure. And to say all of this is to just, as we all endeavor to do with our clients, to be very clear about the expectations they should have going into the process. But it is not to deter those who are willing to go through it. You just should not try this at home. Definitely seek —
Jerry:	It's not for the faint of heart.
Michele:	It’s not for the faint of heart. So, of course, anybody who’s listening to this podcast knows that the U.S. has an unusually complex regulatory system for financial services providers. There are three regulators involved in chartering decisions. That would be the Fed, the OCC, and the FDIC. To boil it down to its essence, the process of getting approvals by three different agencies is cumbersome and very time-consuming. Some of the notable problems is that the agencies often conduct their reviews sequentially, which draws out the review process well past a year in most cases. The agencies also have different review processes, which are hard to sync. And then we can get into some of the nitty gritty as we go on. I would really, Walt, Walt is another of my favorite folks at Orrick, Jerry, because he’s very colorful in his language. And I hope he’s allowed to use some of that on it.
Jerry:	He’s got his podcast filter on, but I’m sure he will be —
Michele:	You know, but Walt and I have seen some really unfortunate results of people getting trapped in some of the unfortunate gaming of the system that its complexity allows at times for regulators to conduct. Maybe Walt —
Caroline Stapleton:	Yeah. Well, tell us, what does that look like if someone’s getting stuck or, you know, where are the pain points that you’ve seen applicants experience?
Walt Zalenski:	Yeah. And Michele, I do need to keep my podcast filter on. But at a really high level, I think one of the things that we take away from our collective experience is that there’s just, have been in the last 15 years or so, just an extremely low priority on new charters. And that seems — It might have been appropriate in the immediate aftermath of the financial crisis, but that period has long since passed. Jerry, you mentioned in your introductory remarks historical lows versus the history. Listen, 15 years is a long time. It seems to be the new normal. But many of our listeners who are not in the industry for more than 15 years, you know, may be surprised to know that the usual run rate historically of new charters was over 100 new charters a year, which in today’s view would seem outlandish, but that was the old normal. What are the specific pain points, Caroline, in addition to just placing a low priority? Outdated application guidelines just because, you know, the application process has been so daunting that there haven’t been so many new applications. That the guidelines are outdated what the regulators now view as the requirements in the post-financial crisis era are not what is reflected in at least public guidance to, uh, to the industry. There’s an inconsistent review process as Michele alluded to based on the three regulators involved in the process. There are supposed to be some concrete regulatory time frames for an application prosecution, and those have long since gone out the window in all practical terms.
Jerry:	Well, because they’ll have the timeframe, but then they’ll say, “I don’t think this application is ready for review,” and send it back.
Caroline:	Exactly
Jerry:	And that can be a delaying tactic that can go on for months. And not on the basis of anything seriously substantive in the application itself, but —
Michele:	And that is one of the ways in which the process is gamed by regulators. And by not deeming an application “substantially complete,” which is the standard that the FDIC uses, OCC uses “complete.” By not deeming it complete, the shot clock doesn’t start running. So, the regulators have been very cynically exploiting this, in my opinion. They say, oh, we stick with our timeframes. Well, sure, if you never turn the clock on, you’re never running out of time.
Jerry:	I think it’s fair to say, Michele, they don’t regard themselves as coaches. They regard themselves as whistle blowers.
Michele:	But certainly, they do regard themselves as the refs. But the play doesn’t start. But we’re probably beating this one to the ground here.
Caroline:	But I think it leads right into wanting to know, you know, and share with our listeners, because I know that they’ll want to know, we’ve heard about these pain points. So, what kind of suggestions to improve this process do you have in the letter? What specifically are you recommending? And I know we can all read the letter, but are there a couple you’d like to highlight for our listeners as particularly important?
Michele:	Let’s start with elevating the stature of the agency’s licensing functions. Of course, that sounds dry and the whole thing sounds dry and technical, I’m aware, to many people, but it’s actually a fascinating topic about who wins, who loses, and why in our bank entry system. And one of the problems has been, as Walt mentioned, post-crisis, the agencies have viewed applicants with suspicion rather than enthusiasm. So rather than welcoming new entrants and seeing them as the source of innovation and additional competition in our economy, they have been viewing new entrants as invaders at the regulatory gates. So, one of the problems is that that results in a low priority at the agencies on licensing functions, the folks who do the day in, day out of processing new applications. Our suggestion on this front is twofold. One, elevate the heads of the agency’s respective licensing functions to the senior-most career management level at the agency in order to signal that new bank formation is an equivalent priority to bank supervision. So rather than just always viewing things through risk and supervision, also keeping in mind the other aspect of a healthy banking system, which is competition. So that’s thing one. Thing two around elevating the stature, and this one is a little bit controversial of a suggestion, is to charge application fees. This is a common practice at the state level, but not at the federal level. It does not cost you anything, at least with regard to the agencies, to submit a bank application. Well, I suggest that charging application fees will make those licensing functions self-supporting. And like their bank supervision brethren, who receive fees from the banks that they supervise for the costs of supervision, they will underscore that priority. So again, instead of invaders at the gate, start treating them like paying customers. And I think you’ll see more discipline in the process and observance of fair and reasonable processing timelines and procedures.
Caroline:	Michele, to your first point, I wonder, you know, given that it’s been now a long time since many applications were being received each year, do you think the expertise is still at the agencies at the level it would need to be to start taking in a higher volume of applications?
Michele:	Well, and that’s an excellent point. I do think the agencies retain a fine bench, an excellent bench of career examiners and other professionals. However, I am concerned about agency resources, which is another reason that application fees are appropriate to ensure the adequacy of licensing resources going forward. I’m very concerned about the report in The Washington Post on the revocation, for example, of job offers to incoming examiners of both the OCC and the FDIC. I think that’s an unfortunate development and outside the scope of this letter, but it just underscores what I think is the need for new entrants to share the costs of their applications.
Caroline:	Walt, what about you? What are some of the high points of the letter from your perspective, the most important changes?
Walt:	Well, in addition to what Michele said is sort of just the prioritizing new charters, which we actually think should be a measure of new agency leadership because it promotes competition. And we’ve had this abnormal and extended fallow period of new charters. So that should be addressed. But for the nitty gritty, it sort of matches up directly to the problems that we’ve experienced in helping people in the new application process. You know, tell us, in black and white in advance what you expect of a business plan. Provide objective standards for what you are thinking as the regulator, as the likelihood of business success. Certainly, harmonize the process between the agencies, which has been a big problem. Make those timelines no longer subject to the perpetually incomplete application. We can certainly talk about frivolous application processes — or protests rather — under CRA, which is always a looming threat. Even if you get closer to the finish line in a de novo bank application require like real written feedback as to whatever reservations the agency has. You know, make a real up or down decision as opposed to the perpetually incomplete application. Have the courage of your conviction, either yes or no, and things like that. Also, let me mention something that we are not suggesting, and nor are we advocating against it, which is a sort of special fintech bank charter of the type that was promoted in the Trump administration by the OCC and even a little bit before that. I, at least personally, view that effort of a special fintech bank charter, which would not have FDIC insurance, as mostly an outgrowth of the type of de novo application logjam that we’re talking about. Back at that time, the OCC was more receptive and the FDIC most notoriously was not. And so, applicants or aspirants to a bank application or bank charter, you know, face this 7-10 split, to use a bowling analogy, where you can knock down one regulatory pin but not the next. So, the unique OCC charter with no deposit activities, or at least no insured deposit activities, was a solution. At least my hope is that if the de novo full-service bank application and de novo chartered process got normalized again, it will essentially accommodate all the pent-up demand in the fintech space.
Michele:	You know, thanks for bringing that up, Walt. It is really important to note that this letter is neutral on the question of charter types. Our suggestions apply to any type of charter. And I believe it’s critical to look at process before one looks at the possibility of creating a new charter. There’s a lot of attention around the possibility of legislation to create a payments charter. But there’s already statutes on the book, as we know, that authorize a wide range of bank types. What is the fact is they have become virtually impossible to obtain, and it’s because of the broken process. So, let’s start with fixing the process first, before we talk about the creation of new charters. The other thing that’s really important to note is the process we describe and the problems with it are not the result of statute. None of the process is statutorily mandated. This is all process the regulators have created. And that means there’s no need for Congress to get involved to fix this. So, the eight steps we outline in our letter are steps the agencies can take immediately. And so we call upon the agencies to do just that.
Jerry:	You know, we’ve talked as if there are only three federal agencies involved in this process. But the fact is that in many cases, the states are chartering and playing a role. And I think it’s fair to say the states have not been a source of delay in this process.
Michele:	No, the states are great. The states have not been the problem. The states, in fact, do welcome new businesses in their states. They are open arms to innovation as a general matter. And in fact, we have provided the letter to the CSBS noting our hope that we will work collaboratively with the 50 states bank commissioners to implement these suggestions. And noting that the suggestions are entirely consistent with the statements that, for example, the CSBS chairman, Charlie Clark, has announced his observations on the need for new bank formation and the priority that is to the states.
Jerry:	And I think Brandon Milhorn is, my every indication is he and the leadership there will be very supportive of his effort. So, let’s just take a few minutes discussing the policy reasons why it makes sense to facilitate new bank applications. What type of companies would benefit by having a charter? What sorts of benefits would inure to the benefit of the public generally? I mean, yes, as a process matter, it is a good thing to make a process work. But what are the benefits society will get from this?
Michele:	Well, and I believe this was Walt’s addition to the letter, one of many, citing a Supreme Court case in which the Supreme Court noted that concentrations in banking lead to concentrations in the broader U.S. economy. And that is not a good thing for consumers. It limits our choices. It tends to raise prices. And it’s important to know that at the same time that new bank formation stalled, fintech exploded. And we are all familiar with the story now. A huge percentage of Americans now rely on fintech for part or all of their financial services needs. I think approximately 80 percent of Americans use fintech services daily. I know I personally could not get by without Venmo because I have to Venmo my kids money like pretty much every day. Caroline, that’s in your future.
Caroline:	I'm not there yet. They don't have phones, but I'm scared.
Michele:	Caroline, you're going to get there. You just count on it.
Jerry:	I'm glad that I was a pre-Venmo father.
Michele:	You had to still write checks?
Jerry:	The family ATM.
Michele:	So, here’s the deal, and we all know this, that the fintechs exploded because Americans are hungry for faster, cheaper, frictionless financial services. Venmo being a good example of its working its way into our lives. And we are all very digital now. We want everything in our hands. And fintechs have been at the forefront of that development. Now, when I’m talking about fintech, in this case, I’m talking specifically about fintechs that provide financial services and products to customers, not just the technology aspect. So how do they do that? As we know, in order to provide products and services to customers, you need access to, say, the payment rails. And you get that if you’re a fintech by partnering with an existing bank and leveraging their authorities and their access. That’s a fine model in most cases, but it does mean that the vast majority of services provided by fintechs, on which Americans rely, are being provided outside the direct purview of the banking agencies. And it simply makes more sense to have a consistent supervisory view over products that to the end user look the same, whether they’re provided through the Chime app or through JPMorgan Chase. And so, Jerry, to your question about what would this look like? And bank formation is not appropriate for all fintechs. You need scale. You need risk management structures that are bank appropriate. There are many, many things involved in meeting bank regulatory standards. For those who can, they get the keys to the kingdom. If they can get a bank charter, they have direct access to the payment rails, they get Fed master accounts, and they get low-cost funding in the form of insured deposits, if it’s an insured depository model as well. I would point out, in return, they get a lot of regulation and supervision, which might not always be welcome. But again, they, and I think the American public, would benefit from expert supervision. And it also removes for fintechs their risk of not having a direct relationship with the regulators. So, if you’re a fintech partnered with a bank, the bank owns that regulatory relationship. The regulators talk to the bank. And much of that conversation is confidential supervisory information, which is illegal to share. And that means the fintechs don’t always have the full picture and can’t get the full picture about their bank partner’s regulatory status. And so, as we have seen in recent years, some fintechs have become very vulnerable to being suddenly off-boarded by their bank partners or having limits imposed on volumes they can move through their bank partners, or their ability to introduce new products and services. So, sorry for the meandering answer there, Jerry. The answer is lots of fintechs could come into the fold as banks, and I think they probably should.
Jerry:	And this is not to say that the banking as a service model is not good in many cases, but this option should be open to the fintechs as well.
Michele:	Absolutely. And we say frankly that in our letter. That, you know, it’s although a bank charter is not appropriate for all fintechs by any means, it should be an option. And that’s what we’re saying, that this should be a viable option. You know, bank charters are statutorily authorized, and they should be open to all who meet the standards set forth by statute, as opposed to sort of secret, unwritten policy preferences at the agencies.
Jerry:	I know Caroline has another question for you, but just an observation on our banking system generally. For the benefit of listeners who may not be as close to banking, our system is different than the system in the rest of the world. We had, when I started, many more, but we still have thousands of banks. And that model has resulted in a lot of creativity, a lot of small businesses being funded and financed. And as a result, the innovation and the jobs come from those small businesses. That model has many attractive features. And if you choke off new bank charters, you are going to limit the ability to continue on the American model, which has been successful. So that’s my little speech. I just wanted to give it at this point.
Michele:	And I’m so glad you brought that up, Jerry, because although we’re talking fintech, what is important to remember is that de novo bank formation, both innovative and traditional, has stalled. And the suggested improvements to the process will result in more new bank formation, including traditional bank formation. It’s not just a fintech issue.
Jerry:	It should be an issue for all interested in preserving our banking system. Caroline, go ahead. I’m sorry.
Caroline:	Yeah, well, I was just, you know, we’re thinking about options and, you know, that this is an option that the letter advocates should be more available for the reasons that y’all have shared already today. What about the option of acquiring an existing bank? Walt, why isn’t that sufficient? Why do we need to have both options?
Michele:	Well, in this fallow period, while a fintech, in particular purchasing an existing bank, has not been extremely common, it has been a marginally more viable option. Does it make sense? First of all, as we said, even thinking about a bank charter is not necessarily appropriate for all fintechs. We’re talking about, you know, folks with the appropriate scale, scope, and maturity as a company. Would purchasing a bank, at least for the fintech market entrant, be appropriate? Sometimes yes, sometimes no, right? I think by virtue of the fact that new charters have been squelched, it’s been used maybe more often than it would have been in other cases. In other words, if de novo charters were an option and an efficient option, that the folks that bought banks would have gone their own way. What are some of the trade-offs of buying an existing bank? Well, you know, you’re buying an existing business with legacy business, legacy personnel, and the like. The bank regulators, probably appropriately, are not going to permit you to transform that institution, turning on a dime. With respect to growth, with respect to going in a different direction, with respect to the business plan and the like. It’s an existing business with existing community ties, and that’s going to have to continue. That is sometimes a culture clash with the acquirer. And, you know, even if that culture clash can be managed, it’s going to be managed over a period of time, and there’s not going to be a radical transformation of the institution. The regulators expect a long-term business plan for acquirers, and you’re pretty much stuck to that in a fairly rigid fashion. And, you know, that involves continuation or slow diminution of the existing business or at least parts of the existing business and growth of what your core business is. In a way that is speed to market in one respect, right, in these past 15 years, but maybe somewhat hampered speed to market in what you really want to accomplish.
Michele:	I think, as Walt said, after an applicant receives conditional approval for a de novo bank, they have 18 months to open their doors, 12 months to capitalize, 18 months to start operations. The acquisition of an existing bank, when it is approved, you have an operating bank. The doors are open. And for some applicants, that is a very attractive shortcut. That’s what we saw SoFi and LendingClub do. SoFi was conditionally approved for de novo and then went ahead and just acquired a bank. It got them to market faster. But it’s really a fact dependent inquiry. You know, I often tell my clients, you know, the good thing about acquiring an existing bank is you get existing systems and management. And the bad thing about acquiring an existing bank is that you get existing systems and management. So, it just depends. It can be very hard to remake a bank. You know, they aren’t exactly ocean liners being turned around, but they are slow moving and the regulators can put further brakes on that.
Jerry:	And one of the issues, of course, is where you have a business that is expanding rapidly because of its appeal to the public. In both the acquisition and in the new charter context, there has to be — not testing by vast amounts of time, but other ways of testing so we can determine that there’s safe and sound activity, but it could be allowed to progress in a way that isn’t hampered by, “Well, let’s just wait and see. Let’s just wait and see.” That doesn’t work where you have a business that is expanding rapidly. And so that’s another aspect of it. It’s an aspect in both contexts, I guess.
Michele:	So, I’m glad Caroline brought up acquisitions. When I was drafting this letter, at first, I intended it to address both de novo and M&A activity and decided we really needed to separate these topics. The acquisition and merger context has different processes, some different traps you can fall into. And so, I would say let’s look forward to the second letter where we’re going to take this on.
Jerry:	Well, you know, Michele, we’ve covered a lot. And our time is running out. But do you have any last observations you’d like to make?
Michele:	Yeah. And, you know, forgive maybe a little self-congratulations, but what I found very gratifying about preparing this letter with you and Walt, the team at Troutman, Mike Nonaka, and a number of other firms who contributed to the project but were precluded by internal conflicts and firm restrictions from signing. What was extremely gratifying was to have a group of people who are normally competitors setting aside that competition because what we are committed to is seeking the best possible outcomes for our clients. And coming together and sort of trying our best, putting our best thoughts forward for refinement among the group was a very satisfying process. None of us made any money off of this. You know, that was not what this was about. It really is a group of people that are strong believers in the regulators. We know they can do better. We understand what some of the competing priorities are that they manage, and we have solutions. And I thought that was really neat that we worked on that together.
Walt:	I’ll second that. We have, to use a phrase that Michele uses, as bank regulatory geeks, we have had other occasions to just say other parts of the process, different subjects altogether than the de novo application process. But other processes are just fundamentally broken. Or the regulators just aren’t getting it. Not necessarily in a way that particularly benefits our clients, but really benefits the system. And in those situations, you know, because of client interest or other demands or what have you, there’s not often an opportunity to just speak for yourself about what would improve the situation. And, you know, with the change in administration, new leadership coming in, this was a great opportunity, a great idea on Michele’s part to at least knock down this very critical issue and give some concrete guidance.
Jerry:	Well, I want to thank both of you and Caroline for participating in this. I hope it’s beneficial to our listeners. We are recording this a couple of days after the release of the letter or the sending of the letter, but it will be coming out in several days. So, we’ll be looking for reaction from our listeners. We welcome any thoughts or suggestions they might have on this subject, and we hope they’ll participate in the discussion with the regulatory agencies as well. Thank you.