In this episode, Yvette Bohanan is joined by Glenbrook Managing Partner Bryan Derman and guests Michele Alt and Adam Shapiro, Partners at the Klaros Group.

The result is a lively discussion about regulators and the impact of the current regulatory environment on banks and fintechs, a topic of utmost relevance in today’s rapidly evolving industry landscape. The economy and all that is at play during a major election year create a fascinating backdrop for this conversation.

 

Yvette Bohanan:

Welcome to Payments On Fire, a podcast from Glenbrook Partners about the payments industry, how it works, and trends in its evolution. Hello, I’m Yvette Bohanan, a partner at Glenbrook and your host for this episode of Payments On Fire. In our education workshops, we stress the importance of understanding stakeholders in the payments industry, the role each stakeholder plays in the payments value chain, whether they are in or out of the flow of funds, and what motivates them to change their behavior.

So why do we think understanding stakeholders is so important? The answer is quite simple. The payments industry is a set of systems. In any system, a change in one component will impact another. So understanding what motivates each stakeholder helps us understand and sometimes even predict what will happen within the system. It’s a land of intended and unintended consequences.

Regulators are an influential group of stakeholders in payments. They establish the frameworks incorporated into a system’s rules, determine who can participate in a system and in what capacity, and monitor the health of core systems and the economic and social impacts of noncore systems. In this episode, we are thinking about regulators and regulations, taking a look at how banks, another important stakeholder, are regulated.

We’ll consider the current economic and political landscape in the United States and how it may influence the dynamics of banks and fintechs in the payments industry, and what that means in terms of each stakeholder’s strategy and operations. Joining me on this episode is Bryan Derman, our managing partner at Glenbrook. Bryan, thanks for being here today.

Bryan Derman:

Always great to be on the pod with you, Yvette.

Yvette Bohanan:

So much fun. And joining us for this discussion are Michele Alt and Adam Shapiro, partners at the Klaros Group. Michele, Adam, welcome to Payments On Fire.

Michele Alt:

Thanks for having us.

Adam Shapiro:

Pleased to be here.

Yvette Bohanan:

I have really been looking forward to this episode. There are so many questions that I have to ask you, as you know, but we’re going to start the way we often do on our podcast: to hear a little bit about your careers. Can you share a bit about how you both got into payments and how you support your clients with the work that you do at Klaros Group?

Michele Alt:

Well, I think it’s probably fairer to say that I’m payments-adjacent rather than payments-focused. I spent more than 20 years as a lawyer at the OCC working on a wide range of regulatory matters. For example, the Durbin Amendment implementation, rules, et cetera. So I certainly am quite familiar with payments issues, but that is not my focus. I spend most of my time at Klaros advising clients on their regulatory strategies, and specifically their bank charter strategies. Adam?

Adam Shapiro:

Yeah. So I started my life as a regulator in the UK. Don’t be fooled by the Texas accent, but I’ve been here 20 years at this point. And I spent a lot of time consulting initially on BSA/AML, where I rapidly learned that you cannot be a good BSA/AML professional without understanding payment systems deeply. It’s simply not possible. So that was sort of my introduction to US payment systems.

I subsequently sort of built a fintech practice who was involved in a lot of novel payments, activities, money transmission, crypto-related work. Spent a bit of time at BBVA building BBVA’s open banking platform in both the US and Spain, which got me into the delights of PSD2. And I tend to focus a lot at Klaros on clients that are working at the intersection of payments and regulation. I do a lot of work on money transmission and crypto, and particularly, which I guess we’ll get into later, payments that take place through partner or sponsor banks.

Yvette Bohanan:

Yeah. We’ll definitely get into that. But I have to say, before we jump in here, I’ve heard PSD2 described in many ways, but delights has never been a word that I’ve heard in the same sentence. This is amazing.

Adam Shapiro:

Yeah. I think the best comment I ever heard about PSD2 was about the regulatory technical standards that I think actually possibly pushed back the cause of open banking in the EU. And someone once described them as, “Well, they’re definitely regulatory. They’re definitely not technical, and they’re only arguably standards.”

Yvette Bohanan:

There you go.

Adam Shapiro:

That summed up working on PSD2.

Yvette Bohanan:

That’s brilliant. Okay. Before we get into specific regulatory topics, there’s so much going on right now regarding the US economy and how that impacts the financial sector, that I thought it might be helpful to just start there with a little bit of context setting of where we are as we record this episode.

We’re in a higher-than-expected interest rate environment that is impacting investment, a floundering commercial real estate sector, lots of write-off concerns related to consumer debt in particular. Banks come in different shapes and sizes, so there’s no single answer to this question. But that being said, what is your perspective on the current state of the economy in the United States, and how is it impacting banks?

Michele Alt:

Well, first of all, I’m no economist, but it’s no secret that the banking industry is struggling to adjust to the effects of a higher interest rate environment. Adam’s and my partner at Klaros, Brian Graham, has written about this recently, pointing out that quite a number of banks have capital challenges despite regulatory capital numbers that look good. So it’s no secret that many banks are struggling with commercial real estate exposures, perhaps especially in metropolitan areas on the coasts.

Adam Shapiro:

I think if we take a step back from that as well for the moment, one thing that always strikes me, coming from a sort of country that, at one point, I think the top six banks accounted for something like 99.8% of the market in some definitions, is just how many banks there are in this country. And there’s a longer-term challenge that the banking sector is facing, which is really sort of about, “Well, the business is becoming more competitive. There’s more competition from nonbanks. There are more returns to scale as technology becomes more important.”

The minimum size necessary to do business, unless you have developed a very strong niche business line where you can add a ton of value and make a lot of money, is going up and will continue to go up in the future. And that means that you have a lot of banks, probably the majority of banks in this country, that look at the future and see uncertainty, and see that they needed to do something different. And a lot of them are unsure what that should be, what their role is going to be in the future.

So I do think we’re going to consider or continue to see consolidation, and I think we’re going to see a lot of banks looking for success stories, like some of the stronger partner banks, the Pathwards and the Bancorps, like Live Oak and what they built in small business lending, as sort of ways to, “How can we ensure that we have a meaningful future that allows us to continue to serve the community we’re doing, but also find a combination of scale and profitable niches that will allow us to do that in the light of these long-term competitive and technological trends?”

Yvette Bohanan:

And I caught the word uncertainty in your comments there, and I think the uncertainty around the economy is one thing. We’re going to get into, a little bit, some of the uncertainty around the regulatory aspects of what’s going on, too. And one area that’s been getting quite a bit of attention is banking as a service and some of the trends there. And one of the things that’s under discussion around KYC in particular is expanding to know your customer’s customer.

And I think that’s giving people a lot of pause in the banking space, is how do we actually do that, and how do we know? How can you be certain that you’re talking to and vetting the right person? What are regulators thinking about when they’re focusing on this, and why are they focusing on it? What type of pressure is this going to place on the banks and the fintechs?

Adam Shapiro:

Well, I think, I mean, if we look sort of more narrowly at the sponsor bank here, and perhaps we ought to define our terms here. By sponsor banking, we mean something like Chime, where Chime is not itself regulated. It partners with Bancorp Bank. Bancorp Bank is basically saying to the regulators, “Okay. We got this from a regulatory point of view. We’re putting ourselves on the hook if anything goes wrong. We’re overseeing everything that Chime does and making sure that it meets bank standards.” And it’s kind of, “If it doesn’t, you can come after us.”

And in that world, there’s been a lot of new entry, partly driven by the trends I just talked about. There have been a lot of banks that probably got the business first and then tried to work out the controls. I think you could probably find some regulators that would privately, over a beer, tell you that they probably didn’t get onto the case on that early enough, and we’re therefore seeing a lot of enforcement activity there.

I worry about how this is going to then play out into the wider payments banking world that I think a lot of the listeners here are in. I think it’s really important for people to understand how you’re interacting here, and you can differentiate, say, a Chime from, say, a Wise operates in the main as a money services business. It is regulated directly. If something bad happens, that state regulators and FinCEN and the IRS can have someone that they can go to directly.

They still need to work with banks for things like connectivity to payment systems, because, obviously, in the US, you have to go through banks. But the banks there are not actually onboarding Wise’s customers, as a general rule on its core service, as their own customers. And so, that’s where I think there are real risks, and we have to draw the line. It’s important for a bank that is banking someone like Wise to understand that they are duly regulated themselves, that they have an AML program that covers the things that it’s meant to, that they have an independent testing report that hasn’t shown major problems, things like that.

But the bank is not banking Wise’s customers. And I think it’s important, if you’re in the payments world, to understand where in this ecosystem you are so that you know whether you have to be applying the bank standards to your own customers and making them customers of the bank or not. But it’s also important that regulators don’t take the lessons from the sponsor bank world and then sort of insist that if you’re banking a money services business or something that is operating under an exemption to regulation, that you’re forcing them to sort of comply with bank standards that don’t actually apply.

And we’re seeing some confusion about that amongst the banks themselves not articulating, which they’re doing amongst payments companies, not being sure how they fit in, but also amongst the regulators starting to apply sponsor bank standards to banking relationships. And a lot of the work we do in this area is trying to help all parties understand not only what they do need to be doing, but what they don’t need to be doing, because they are making sure that they’re doing what they need to, but that they’re not being forced into things that make no sense for their business model.

Bryan Derman:

I also tend to think that the issues seem to get a little hairier when a partner bank has a fintech that it’s boarded, and the fintech is, in turn, trying to board businesses to the bank as opposed to individuals the way Chime does. Yeah.

Adam Shapiro:

So you are talking about what you might think of as some of the BaaS platforms that are in the middle of the connection between that. Yup. I think that’s certainly true, and I think what we’ve learned from what you might call BaaS 1.0 is that you’ve got to be very careful about the incentives here. And to some extent, all of these companies are providing valuable technology that makes the connectivity better for the banks.

And where the problem starts to be is if they’re also effectively acting as a gatekeeper that’s preventing direct oversight from the bank about what the end program is doing. At that point, the bank can’t turn around and look at its regulators in the eye and say that they’re really overseeing it.

And an analogy that I once used was, it’s a bit like, it’s great to have a matchmaking function, but no one would use a dating app that would insist that instead of talking to the person you’re dating, you have to talk to the app, and then the app will translate that and talk to the… Sponsor banking done well is a real relationship thing, and it only works when there’s real clarity about the roles and responsibilities of who’s doing what and direct communication between all parties.

Bryan Derman:

It just seems to me the chains get very long. We’ve got a sponsor bank with a fintech platform who’s boarding businesses. Someone, in turn, needs to figure out the ultimate beneficial ownership of the business, and get all the way through that and say, “Okay. That person deserves to have a US bank account.”

Adam Shapiro:

Yeah. That’s exactly right, Bryan. And the chain gets long in terms of the value proposition and the number of mouths to feed with the economics as well. And, I mean, I think there is a really promising area that if we move away from what we think of as pure fintech into embedded finance, there is a large and, I think, growing market for people that want to embed payments, embed lending into their offerings, but don’t see themselves as fintech or financial services business, don’t want to do the operations.

And I think there is a real role there for a company that can sort of step up and say, “Okay. We can be in the middle. Our bank partners don’t really want to be doing dispute handling or payments, returns operations.” The clients don’t really want to be doing this, and neither of them is actually set up to do that at scale. We can set up and we can provide elements of program management as a service at scale.

And that, I think, is a real opportunity that some of these companies can step up and take that will really help get financial services meeting consumers and small businesses where they are and not forcing them to come and find it. And I think there’s huge potential there, but you have to be very careful about the roles and responsibilities being really clearly defined, and making sure you’re doing it in a way that is acting as a service provider, not a gatekeeper.

Yvette Bohanan:

Yeah. You touched on how people are licensed, how entities are licensed, how fintechs are licensed, and we get this question a lot from our clients contemplating whether or not they need to have an MSB license structure in place and invest in that, which, in the US, is tremendous expense. And just getting the license is the smallest amount, because you have a lot of ongoing compliance requirements, or a banking license to build out their strategy, and they weigh all of that against this sponsor bank construct. Right?

And in the US, banks have direct access to payment systems, and they have access that a lot of companies would love to have. We’re hearing a lot of that, particularly from the cryptocurrency space right now, interestingly. So is it realistic in this current reg environment for nonbanks to be able to persuade the OCC, the FDIC, or the Fed to give them a banking charter? And if it is, what is it taking to get that done right now? I think, Michele, this is right up your alley from what you were saying.

Michele Alt:

Well, Yvette, it’s an uphill battle at the moment. The agencies haven’t approved a bank charter application by a fintech in the current administration. So it’s been since 2020 since there’s been a fintech approved. But there are reasons, nonetheless, to be optimistic, and I would say there are four reasons. First, the OCC recently approved Paycom’s application for a national trust charter. So that’s not a pure fintech, but is certainly a nonbank. And Paycom joins ADP and Ceridian among the payroll companies that have national bank charters.

Second, the current blockade against fintech chartering does not have a statutory basis. Politics, risk aversion, and the personal preferences of agency leadership are a weak foundation for what is effectively an exercise in industrial policymaking, in which the fintechs lose. Third, fintechs need to be able to manage their own risks, and are increasingly concerned about the possibility of being suddenly off-boarded by their partner banks, and that makes them more interested in getting their own bank charter.

Fourth, the rise of embedded finance will predictably push many new nonbanks to start knocking on the regulators’ doors. All of these factors, in my opinion, can be seen as rising waters against a regulatory dam. We’ve been advising fintechs that have been sitting on the sidelines to start preparing their charter applications now so they’re ready when the dam eventually cracks.

Yvette Bohanan:

So when you say preparing charter applications, what sort of charter? You mentioned national trust charter, but there’s this Georgia merchant acquisition charter. Wyoming has the SPDI. Connecticut has an uninsured bank structure. What are those? What are the differences among those, and how should a fintech be thinking about this when we say, “Prepare a charter”? What questions should they be asking themselves or-

Michele Alt:

Sure. Sure. Your prior question was about approval by the federal banking agencies for what are traditional bank charters.

Yvette Bohanan:

Right.

Michele Alt:

The charters you just listed are alternatives to those types of banking charters. So it might make sense to look at those alternatives. The challenge right now to alternative charters is whether they will come with access to Fed master accounts and card network membership. So far, the Fed has denied master accounts to The Narrow Bank, which was a Connecticut uninsured bank, and Custodia, which is a Wyoming SPDI.

And the Georgia charter, despite being on the books for 10 or more years, hasn’t really taken off yet, because a lack of receptivity on part of the card networks. But I’m hearing from state regulators that they are cautiously optimistic on the Fed master account front, because they think the Fed’s recent denials are limited to specific aspects of the applicant’s business models. And Fiserv’s application for a Georgia MALPB, the merchant acquiring limited purpose bank is an indication that Fiserv at least has confidence about card network membership. So these alternative charters are a space to watch.

Yvette Bohanan:

And are all alternative charters state-specific?

Michele Alt:

Yes.

Yvette Bohanan:

And what’s the drawback of that besides the two that you’ve mentioned? Not having a Fed direct account at the Fed. The network’s having some…

Michele Alt:

Trepidation.

Yvette Bohanan:

Exercising the proclivity is what I was going to say. They are the network. They decide who’s a direct member. But besides that, what can that do to limit… Let’s say you’re not worried about the direct Fed account, and maybe you’re not worried about card networks because you’re doing pay by bank or some other innovative thing. Are there other pros, cons to alternatives?

Michele Alt:

These alternative structures are designed in part to avoid the application of the Bank Holding Company Act to the parent company, the alternatively chartered bank. Without going on at length and wrapping ourselves around the BHCA axle here, the way they are designed is to limit specific activities. That will avoid the bank being termed a bank for purposes of the BHCA.

So the drawback, and it might not be a drawback depending on a particular business model, the drawback is limitations on activities, significant limitations on, for example, deposit-taking or lending, traditional activities of banks.

Adam Shapiro:

Michele, is it also fair to say that another possible drawback is that you might find that the charter gets recognized by some state, not others, and so it doesn’t necessarily give you national coverage?

Michele Alt:

It definitely will not. So if you have an alternative charter, you are quite likely, and Adam is entirely right, to still need licenses in other states. You might need a money transmitter license or, depending on your activities, specific activities licenses, lending licenses, et cetera. And so, you do not wind up with the regulatory efficiency that a traditional bank charter will give you.

Bryan Derman:

So I think a way to view that, Michele, is that those charters have limitations compared to a national bank charter, but it isn’t national banks who are going after those charters, that it is nonbanks looking for new powers. Right? So compared to a bank, it’s limiting.

Michele Alt:

Yeah.

Bryan Derman:

Compared to an MSB license, it might be liberating.

Michele Alt:

Yeah. And just to probably put too fine a point on it, a national bank charter is issued by the OCC. It’s a particular type of charter. State bank charters, either state nonmember or state member banks, are regulated at the federal level by the Fed or the FDIC, depending on charter. And all of those banks are typically considered banks under state laws and, therefore, exempt from state money transmitter licensing, et cetera. So it is much easier and more efficient to conduct a nationwide business through one of those three types of charters, national bank, state member, state nonmember, as opposed to an alternative charter.

Yvette Bohanan:

That’s a great point.

Michele Alt:

But sometimes it’s the art of the possible.

Yvette Bohanan:

So it’s drawing on the art of the possible. This can be tricky water to navigate through, right? How exactly do you advise people to choose between… Let’s just go back to just the simple money transmission licenses versus working with a sponsor bank, assuming you’re not advising them to get their charters ready.

Adam Shapiro:

Yeah.

Yvette Bohanan:

How do you help them navigate that?

Adam Shapiro:

So the real benefit of money transmission licensing is that it gives you the regulatory permission to do certain things, send payments, hold value that is not deposit-insured, so you can hold balances for customers, and you’re much more in charge of your own destiny. If you work as a program of a sponsor bank, then every little thing you want to change is basically seen by the bank’s regulators. As you are a program of the bank, the bank has to approve everything, and the bank might not want to approve everything. It might be nervous if you want to start doing payments to Latin America or something.

It may be slow to approve your marketing copy because it is, in fact, the bank’s marketing copy in the regulatory construct. So really, what money transmission buys you is, if you can fit within, it buys you the freedom to act at the speed that is right for you, and to take the level of risk that is right for you. That obviously comes at a cost, and it’s probably about 10 to 20% of the cost of actually going full bore and getting a banking license.

But you have application costs. You have to pull together. You’ll have to enhance your compliance programs. You have ongoing fees to the regulators. You’ll have a succession of states working either by themselves or in conjunction with other states, trooping through your offices, doing examinations, and you need to have a whole machinery to support that.

What we find is that it’s much easier to get going as a partnership of a bank. It’s less up-front costs. You pay more for the payments functionality on a per-payment basis. It doesn’t matter early. Generally speaking, if, let’s say, the sort of all in with capital and application costs and enhanced staffing, it’s like 5 million of investment to apply for money transmission licenses and maybe a million a year.

Eventually, people’s business will reach a scale where it goes from, when they were starting out, “Why on earth would we pay that money to all of this?” to “Well, why on earth wouldn’t we and be much more in control of our own destiny and our own business?” And, I mean, it may be that if it’s a sort of like… You get very large companies that will want to carry on working with banks forever, but generally, that’s where the payments aspect is a smaller part of their business, and it adds value. It’s not the business itself.

And so, we help people understand where they are on that spectrum and what the costs are going to be, what the benefits will be, whether they might be able to do better working with different banks. And you can generalize that into what Michele was talking about as well. I think what we find is that this is always a very facts-and-circumstances-dependent thing, and you have to meet the client where they are and understand their needs.

And where we’ve seen people get into trouble getting advice in this area is where they’ve approached someone that is fundamentally just a national bank expert or just a partner bank expert, and then that person’s tried to put that into what you know. You really want to be, as you evaluate this, working with someone that can understand all the options and isn’t coming with a preconceived notion of what’s going to be best for you before you’ve got to know them.

Yvette Bohanan:

That’s excellent advice. Really excellent advice. Thanks. I think that perspective is something that people don’t realize they need to have when they start down this path. The fintechs are often like, “I just want to be a bank.” And they have no idea what the options are, and they don’t have any idea of what the consequences are of actually succeeding in getting that charter or getting those money services licenses. It’s not a one-and-done. It is kind of like a marriage. It’s a lifelong commitment, best case.

Yeah. So I’m going to switch gears on you a little bit here after diving into that territory. I wanted to ask about your thoughts on Dodd-Frank. And we’ve created in the United States a bit of a two-tier regulatory construct, and Dodd-Frank did that for debit interchange. And banks under 10 billion in that regulation are exempt not only from interchange caps, but also CFPB supervision and some various heightened regulatory standards, which they don’t have to manage to.

And that sort of exempt/nonexempt structure has had some unintended consequences. And most recently, we’ve seen that show up in the proposed Discover and Cap One merger that would exempt that new network from regulated debit interchange under the current construct that exempts three-party networks as part of that status.

Do regulators care enough about the unintended consequences of things like that to reset regulation at this point? I mean, I can’t imagine that back in 2008, ’09, ’10, when all of that was occurring, that they thought, “Oh, wait a second. What if Discover and Cap One or some two big organizations merge and they technically are exempt? What do we do then?” You were in the room where it happened, Michele.

Michele Alt:

I was in the room where it happened, and I think that the Durbin Amendment is exhibit A in the unintended consequences hall of fame. I can tell you that no one was thinking about the potential that Durbin would turbocharge banking as a service, or that you would have the type of enormous volumes going through, say, a Discover-Cap One. That just was not the focus.

At the time, the focus really was on the merits and whether there was data to support the assumption, underlying the legislative history, that putting interchange caps in place would lower consumer prices at retail establishments. That was the debate. This was completely off the radar.

Bryan Derman:

Not work out.

Adam Shapiro:

So I think it’s also important to be fair to regulators here, right? This was established by regulation, and the Fed has implemented the cap according to its best merits. And there’s actually a limited amount that the regulators can actually go and do by themselves to change this absent new legislation. I think the Fed feels constrained by its mandate.

It’s consulted, as everyone here knows, on new nonexempt interchange levels that are going to actually make this discrepancy worse. But it has made, I think, a good faith effort to estimate the actual underlying costs to larger banks above 10 billion, which is what it’s supposed to do under the legislation. And so, effectively, this was a political compromise, and Durbin tagged on to the political compromise that Elizabeth Warren made with the community bankers about exempting them from direct CFPB supervision. And everyone in America loves community banks, or at least the idea of them, and politicians know that.

There was a poll on CNN I saw on the gym on Saturday that said 88% of Americans approve of dogs, which was presumably polled after the Kristi Noem revelations. And I don’t know that the community banks are quite up at dog approval levels, but they’re much higher than most other things that you can think of in American society. So the question, I think, becomes, “Well, is there anything that could cause the politicians to undo this?”

And the one possibility that I see there is in relation to large, especially tech companies that are effectively working with these smaller banks. You could see in the current anti-tech across the aisle that you could get some pressure that would say that, “Wait a second. It was certainly not the intent of this legislation to allow people like Amazon and Apple to get more interchange revenue than a $12 billion bank.” And if you were going to see something that could cause the politicians to reconsider, it’s probably a long shot, but it would probably be that.

Bryan Derman:

It does seem to me there’s some kind of a fairness issue at play here. And when the regulators are forced to write these rules, it sort of becomes a field day for the people out there whose job it is to circumnavigate rules. Right? So if you’re a big deposit bank, it’s a funny environment to be in. You look to your left, and here’s Capital One buying a closed-loop network to run around the regulations in one way. Look to your right, and you’ve got Chime and Cash App, and the names could go on, but people effectively supporting a deposit base way over 10 billion, yet managing to get an unregulated classification, and some sponsor banks who are in… Yeah.

Adam Shapiro:

On the Cap One-Discover point, I mean, I don’t know how much… It will be interesting to see whether regulators regard this as a major policy problem, given that there isn’t another convenient three-party network that’s reliably for sale. And so, it’s not like this is a strategy that other people can go and copy, but I would actually…

I mean, I think there are other antitrust considerations in this deal. That will be interesting to see how it plays out. And you might worry if you were Capital One that even if the deal goes ahead, if Durbin was getting reopened for other reasons, that you could see someone perhaps tagging on something on that.

Bryan Derman:

And it’ll be very interesting to see how it plays out. In some ways, you could make an argument that it moves things in a competitive direction, because if you take Discover and you say, “Well, technically, they’re exempt from the Durbin caps,” that doesn’t mean any merchant needs to accept Discover debit at a certain level of interchange.

It really invites a negotiation between Discover/Cap One and particularly large merchants to say, “Let’s arrive at a market-determined, negotiated kind of interchange rate,” which is probably the direction that everyone would like to see the system head in. So maybe there’s a productive side to it.

Yvette Bohanan:

The other hot topic seems to be competition, and we’re sort of touching on that here, but we also have seen the CFPB and its interpretation of Dodd-Frank 1033. Really focusing on why they’re making the interpretation is really a focus on competition, and it bodes well… By and large, for fintechs, it bodes well. It seems to be a very tall order for banks, particularly in light of everything else we’re discussing, economic headwinds, a lot of uncertainty around things, a lot of investment needs in order to scale, trying to find the right niche, trying to manage their sponsorees, all that kind of stuff.

What are you watching as 1033 moves forward? Do you see this coming to fruition, this sort of regulatory interpretation? And does that unlock open banking? Is it good for fintechs? How should they be thinking about this? And how should banks be thinking about it? Is it opportunity, or is it more uncertainty and risk?

Adam Shapiro:

So, I mean, I think we are going to get a rule. We should get a rule, because Dodd-Frank told the CFPB to act on this. But I gradually give the CFPB a lot of credit for having held off, let the market develop by itself, get a good framework. And I would contrast that with both the EU and the UK, which both, in different ways, legislated early and put in place a much more prescriptive framework earlier, and that actually caused adoption problems that did neither banks nor fintechs. There’s actually a lot more use of open banking in the US as a result of having let the market develop and then tailor a regulation around that.

With that said, I think there are going to be some really interesting things to watch with this legislation. And it is certainly true that Director Chopra has brought his very own personal perspectives to how this is going to work, and he is very concerned about the dangers of middlemen getting involved in the data. He would like everything to be a sort of direct connection authorized by the fintech without people in the middle if he can, because he worries about the more people that touch the data, the more that can go wrong.

And it’s not hard to find examples of that happening if you look broadly enough, and you can certainly find some interesting analogies in the credit reporting world that would cause people to worry. So I think there’s a whole market structure question where it will be interesting to see how far the CFPB go in the final rule in trying to constrain the role of intermediaries.

My view is that the aggregators are necessary here, that it’s just not practical to have all of these bilateral, direct connections between tens of thousands of banks and potentially hundreds of thousands of data users, that you do need to have aggregators in the mix. And it’s a question of finding the sweet spot about how to let them provide a necessary service without causing unintended consequence.

The other thing that I’m watching very closely is where the final rule comes down on payments. And this is something where… I know the banking industry will feel very strongly that they are under no… They are under obligation to provide data to consumers and the people, the consumers’ permission, but they’re not under any obligation to make it any easier to use that data to sort of take payment initiation that the bank has built out of the bank’s hands.

And that’s an argument that I have some sympathy with. Certainly, account information includes the routing number necessary to make a payment, but should you actually then force the banks to accept payments through anyone’s interfaces when actually the person with that information can go and make pull payments? I think you can make arguments either way both on what is reasonable competitive grounds and payment efficiency grounds. And I think where the CFPB comes down on that is going to be incredibly important in shaping the future of the payments market.

Michele Alt:

And I will spare Adam having to listen to me take us all down a rabbit hole here. But I will say quickly that the end of Chevron deference, which we can pretty much count on coming next month or so, puts really all sorts of rules at risk or challenge, and I think 1033 will be top of the list.

Adam Shapiro:

Michele, can I indulge your rabbit hole enough to maybe ask you to explain what Chevron deference is for people that don’t know?

Michele Alt:

Sure. So in 1984, the Supreme Court issued decision in Chevron that basically says, if a statutory provision is ambiguous and the agency charged with administering that ambiguous statute has reasonably interpreted it, then the courts will defer to that reasonable interpretation. So that’s been the law of the land for 40 years. It is the most cited Supreme Court decision in history. It’s really hard to overestimate how impactful that decision has been.

So it’s been cited in at least 18,000 lower court federal cases, challenging various exercises, administrative discretion. More than 70% of the time, the federal agency being sued has won. So there’s an amazing track record of judicial deference to agency administrative decisions and rulemakings. There is a long-standing debate about whether that has encouraged regulators to act to adopt their own policy initiatives instead of hewing to the statutory limitations.

Without going into any of that, the Supreme Court is expected to overturn, or at least modify, the Chevron decision. I think we can expect a fair amount litigation. If you are no longer up against automatic deference to an agency’s determination, you are more likely to litigate against it. And the CFPB is already facing challenges on other fronts, as are the banking agencies, for example, with their Community Reinvestment Act rules. I think we’ll see more litigation. And it doesn’t matter what the outcome of the election is. This is just the outcome of a Supreme Court decision, which we expect in the near term.

Yvette Bohanan:

But what is the near term?

Michele Alt:

Well, the Supreme Court typically starts issuing its opinions for the term in June. So I would think June or July.

Yvette Bohanan:

Interesting summer ahead. That’s a great rabbit hole. It’s a very informative point that you’re making, and something I don’t think is on a lot of people’s radar, unless they’re very, very close to watching some of this.

Michele Alt:

And just the thing is this: Chevron was an EPA case. A lot of the concern and the commentary about the end of Chevron is connected to environmental regulation, but it is not limited to that context at all. And the banking agencies, for example, have enjoyed Chevron deference in some major cases. So it’s all type of federal and federal agency actions.

Yvette Bohanan:

Fascinating. We have to have you back, Michele, when the Supreme Court makes their decision so that we can discuss.

Michele Alt:

Okay.

Yvette Bohanan:

So you mentioned the election year. So before we wrap up, all of the stuff going on, there is this backdrop of a big election year here in the United States. Do you have any thoughts on postelection implications of any of the regulations that we’re talking about under one administration versus the other?

Michele Alt:

Let’s talk first about fintechs seeking bank charters. Yeah. I think fintechs seeking bank charters may find a more receptive regulatory climate in 2025, either because a Trump administration will bring with it new regulators, or because the regulators in a second-term Biden administration may feel freer to open the entry gates. So that’s bank charters.

For many of the other topics, really in terms of particularly CFPB rulemaking, putting aside Chevron deference, if Trump wins, I think we will see a very rapid replacement to Rohit Chopra at the CFPB, and that will drastically influence the final rule on 1033, for example. And that will carry over to the other agencies in different ways when the FDIC board will be reconstituted automatically so that the current vice chair becomes the chair, so a Republican leader at the FDIC that has a very different outlook and approach at the FDIC.

The board of governors serve 14-year terms, so that is less rapid turnover. But there’s a lot of scuttlebutt that Jerome Powell may not be interested in serving out the remainder of his term. So a lot of moving parts. And then, ultimately, the thing to keep in mind for any prospect of legislation is the outcome of the congressional elections and who controls which house.

Adam Shapiro:

I think the other thing that will be really interesting to watch whoever wins is, who are the people in the new term? And, I mean, certainly, the first Trump administration actually went long in the banking, financial services area, more generally in appointing people, the serious policymakers and practitioners in that world, not the more ideological end of that.

And so, Michele mentioned, by implication, Travis Hill, who’s the vice chair of the FDIC and comes from that time, and he’s a very serious, thoughtful policymaker that also happens to be a Republican. There’s a very big difference between an agency that is run by someone like that and an agency that is run with someone that is coming in with more of an ideological take. That’s also true on the Democratic side as well.

The FDIC is probably the hardest agency to deal with in terms of anything that relates to innovation in financial services, and a lot of the tone from that comes from the current chairman. And if, at some point, he decided to retire and you got a new Democrat, that could materially change the way the agency looks at innovation and payments issues without there being any change in control of anything. So the people matter too, and that’s true on both sides of the aisle.

Yvette Bohanan:

So it’s going to be an interesting year ahead of us, for sure.

Adam Shapiro:

It’s like that old fake Chinese proverb about the three curses, “May you live in interesting times.” It’s apparently fake and was written by an Englishman in the 19th century that had never been to China, who just claimed that it was of an old Chinese proverb.

Yvette Bohanan:

Yes. It’s still a good one. Who penned it?

Adam Shapiro:

The other two were, “May you come to the attention of important people,” and, “May you get what you want.”

Yvette Bohanan:

Oh, yes.

Michele Alt:

Sort of a catch-all.

Yvette Bohanan:

Kind of a catch-all. Yeah.

Michele Alt:

Kind of like a trifecta.

Yvette Bohanan:

A trifecta of curses wrapped in a bow. So it’s that special time. We have to close here. So this has been a super informative, interesting conversation. Thank you so much for joining us on this episode, and I do hope we get to talk again.

Michele Alt:

My pleasure.

Adam Shapiro:

Pleasure. It’s been great to be here. I look forward to further conversation.

Bryan Derman:

Thanks, Adam.

Yvette Bohanan:

Bryan, always a pleasure.

Bryan Derman:

For me too.

Yvette Bohanan:

And to all of you listening, thanks for joining us. And until next time, keep up the good work. Bye for now. If you enjoy Payments On Fire, someone else might too. So please feel free to share this podcast on your favorite social media outlet. Payments On Fire is a production of Glenbrook Partners. Glenbrook is a leading global consulting and education firm to the payments industry.

Learn more and connect with us by visiting our website at glenbrook.com. All opinions expressed on our podcast are those of our hosts and guests. While companies featured or mentioned on our show may be clients of Glenbrook, Glenbrook receives no compensation for podcasts. No mention of any company or specific offering should be construed as an endorsement of that company’s products or services.