The proliferation of “neobanks” has recently drawn the attention of lawmakers and regulators. “Neobanks” are financial technology companies that offer bank-like services through a digital interface. These companies often advertise themselves as serving low- to moderate-income individuals who are underserved by traditional banks. Neobanks offer a variety of services, like deposit accounts and paycheck advance programs. While these services are similar to those offered by traditional banks and payday lenders, neobanks are not subject to the same regulatory frameworks that govern more traditional entities. As a result, neobanks occupy a regulatory gray area that regulators and lawmakers are currently working to define.
How Neobanks Operate
In practice, neobanks provide many of the same services as traditional banks, but they differentiate themselves by advertising to a broader customer base. Companies like Chime and Dave welcome customers with less-than-perfect credit histories because these companies do not require a customer credit check. Although customers can open accounts with neobanks, the neobanks hand over the actual banking to other institutions. For example, Chime customers interact with the Chime digital interface, but two FDIC-insured regional institutions actually hold customers’ money.[1]
This model leaves neobanks in a regulatory no man’s land. According to Alex Horowitz, senior research officer for the consumer finance project at the Pew Charitable Trusts: “When you have a fintech that is the consumer interface, they don’t have a primary regulator,” he said. “They’re primarily regulated as a vendor to the existing bank, because banks are required to manage their vendors and they’re responsible for third-party relationships. But it’s still a step removed.”[2]
Neobanks also offer wage-advance services like those provided by payday lenders, but they offer those services in a manner that occupies a regulatory gray area. Unlike nondigital payday lenders, neobanks don’t have any recourse against users. And unlike nondigital payday lenders, neobanks do not charge customers a fee before giving them a loan; instead, neobanks seek optional “tips.” This model does not fall neatly within the current laws that address payday lending.
Increased Scrutiny of Neobanks
Despite the unsettled regulatory landscape — or perhaps because of it — lawmakers and regulators are looking at neobanks with increased scrutiny. In July, Sherrod Brown (D-OH), the chair of the Senate Banking, Housing, and Urban Affairs Committee, sent a letter to the Consumer Financial Protection Bureau (CFPB), calling on it to evaluate the risks associated with apps that offer banking services. In the letter, Senator Brown highlighted the potential risks posed by nonbanks offering financial products and services. These risks include the potential for apps to shut down, leaving consumers “unable to pay their bills, [become] subject to late fees, become delinquent on bills, and put at risk of losing their homes to eviction or foreclosure.” In addition, Senator Brown called on the CFPB to “offer any guidance on any gaps in the regulatory framework that may require Congressional action.”
The CFPB has already initiated its own investigations into neobanks. Last summer, the CFPB opened an investigation into Dave to examine that company’s cash paycheck advance business.[3] In particular, the CFPB was interested in Dave’s compliance with consumer protection laws around unfair or deceptive practices, the Electronic Fund Transfer Act, and the Truth in Lending Act. The CFPB ultimately decided not to pursue an enforcement action against Dave.
Neobanks have also drawn attention from state regulators. In 2019, the California Department of Financial Protection and Innovation began an investigation into Chime after receiving complaints about an outage in Chime’s system that prevented consumers from accessing their accounts. After investigating, the agency concluded that Chime violated state law by describing itself as a bank, which the agency found “was likely to confuse consumers” because “Chime itself is not licensed or insured as a bank.”[4]
Likewise, the New York Department of Financial Services and officials in 10 other states, along with Puerto Rico, are investigating the neobank industry. Their investigation focuses on whether neobanks violate consumer protection and payday lending laws — in particular, these regulators are evaluating whether “tips” or monthly membership fees collected by neobanks are usurious or otherwise unlawful.[5]
Takeaways
The nascent neobank industry offers a glimpse into the challenges that arise when traditional industries move online. It will be interesting to watch whether regulators continue to initiate investigations into neobanks on a piecemeal or company-by-company basis, or whether lawmakers will act to fill gaps in the regulatory framework.
[1] See https://www.propublica.org/article/chime.
[2] Id.
[3] See https://www.law360.com/articles/1428712/banking-app-says-it-cleared-cfpb-s-paycheck-advance-probe.
[4] See https://www.propublica.org/article/chime.
[5] See https://www.dfs.ny.gov/reports_and_publications/press_releases/pr1908061.