Why This Matters: Imitation Banks: Abusing the Public’s Faith in Banks

December 6, 2023

Over the last several years, predatory financial firms have made headlines—and lots of money—in marketing themselves as safe and sound institutions while promising unusually high returns. For the millions of Black and brown Americans who have historically been locked out of the traditional finance and banking sectors, these new financial technologies (fintechs) can seem like attractive options for wealth building. But while many of these fintechs market themselves as foolproof banking options, many aren’t safe—or even regulated—at all.

So-called “imitation banks” are a new variant of an old problem in the US financial system: financial institutions functioning as banks but skirting the banking regulations that keep such institutions stable and keep customers protected. Imitation banks use their online-only platforms to imitate banks, conducting many of the same activities as banks but marketing themselves as atypically lucrative investment opportunities to lure in unsuspecting customers.

In a new brief for the Roosevelt Institute, “Imitation Banks: Abusing the Public’s Faith in Banks,” Roosevelt fellow and assistant professor of law in the Robinson College of Business at Georgia State University, Todd Phillips, shines light on the problem of imitation banks, drawing parallels between today’s imitation banks and shadow banks.

Phillips demonstrates that, though individual companies may rise and fall, the motivations driving the creation of imitation banks are nothing new. Time and again—from the tech tools that helped create the housing bubble of the early aughts to the rise and fall of cryptocurrencies in recent years—exploitative financial firms put people and their livelihoods at risk. Phillips writes:

Imitation banks, despite how much they rely on modern technology and exploit the language of innovation, carry similar risks to the general public whose money is at stake. Like other shadow banks, imitation banks are at risk of running, yet are not subject to capital, liquidity, disclosure, and other regulatory requirements, nor to prudential or consumer protection supervision; do not have access to the Federal Reserve’s discount window; and have depositors that do not receive federal deposit insurance. But unlike other shadow banks, imitation banks use the misleading language of banking, not investment, to appeal to depositors. And like the rise of crypto assets over the past decade, imitation banks tend to promise unusually high returns, thereby marketing themselves as attractive options for the millions of low-income and/or Black or brown Americans who have been historically locked out of more traditional paths to wealth building.

As Phillips explains in his brief, the imitation bank strategy to market themselves as banks is intentional—and purposeful. It allows them to lure in customers by leveraging the faith the public has in traditional banks. Regulating banks as unique institutions—ones that engage in activities critical to depositors and the macroeconomy such as deposit-taking and lending—is a foundational component of the US financial regulatory regime. Because of bank rules and regulations, the public has, by and large, strong faith in the financial institutions that underpin the US economy. When imitation banks pose as real banks, prospective customers can be tricked into thinking that the imitation bank is just another bank abiding by the same set of rules that aim to keep banks stable. By extension, they can also be led to believe that they, as customers, are eligible for the federal policies in place to protect the public when banks fail—such as deposit insurance.

Because this problem is so pernicious—in that these unscrupulous fintechs are, intentionally, operating under the radar of the existing regulatory regime and doing so only online—we need a broad and coordinated governmental approach to rein them in. But promisingly, as Phillips details in his new brief, the problem of imitation banks is one that can be (at least partially) solved with existing policy and agency authority. The Securities and Exchange Commission (SEC), prudential bank regulators, and the Consumer Financial Protection Bureau (CFPB) could each take steps to crack down on deceptive imitation banks, while Congress could consider new legislation specifically aimed at imitation banks.

Ultimately, as Phillips writes,

The internet has enabled great efficiencies in finance, but it has also opened new horizons to exploitative finance. Imitation banks, which could only exist because of the internet, pose risks to their depositors. Like crypto issuers in years past, they make specious promises of high returns to gain ground with consumers who may have been historically locked out of more traditional wealth-building opportunities. And they’re doing so without the necessary government oversight and accountability mechanisms to ever make them safe for consumers or the US financial system as a whole.

When financial institutions conduct banking activities outside of regulatory oversight, they’re behaving unlawfully. And, perhaps worse, they’re borrowing on the public’s trust in banks in order to turn a profit. Customers’ livelihoods—and the underlying faith the American public has in the financial sector—are at stake. Regulators and Congress must act to address these growing harms.