Should fintechs be regulated like banks?
More than a few bankers believe fintechs (and would-be fintechs) should play by the same rules they do. And they’re certainly not alone.
Just hours—literally—after Facebook announced its intention to launch the Libra cryptocurrency, members of both parties in Congress expressed alarm and annoyance. Think: When was the last time Democrats and Republicans agreed on anything?
Thus began the avalanche of public scrutiny, which in short order spotlighted: a) how the Facebook employee who thought up Libra was 26 and has barely more than two years with the company; b) Facebook isn’t exactly known for keeping user data safe; and c) this is, after all, the social media company that coined the infamous motto “Move fast and break things.” Like a stable U.S. financial system, perhaps?
All this to say Libra may never see the light of day while overall, fintechs could eventually fall under the sway of conventional banking regulators. Still, that process remains as slow as interest rates are low.
Last summer, the Office of the Comptroller of the Currency (OCC) announced it would accept “special purpose national bank charters” for fintechs that mostly exist online to do anything from payment transfers to portfolio management. The announcement of a “Fintech Charter” came on the heels of a 223-page Treasury Department report on fintech innovation.
Yet banking regulation—glacial in conception and practice—has failed to keep pace with the explosive growth. According to the U.S. Treasury report, more than 3,330 new technology-based financial services industry were founded from 2010 to the third quarter of 2017, creating industry investment worth more than $22 billion: a thirteen-fold increase since 2010. Lending by these firms now makes up more than 36 percent of all U.S. personal loans, up from less than 1 percent in 2010.
Banking regulation tends to be highly deliberative; it often takes decades to change laws. Thus, the emergence of fintech into the mainstream is significant in a number of ways.
First, the current administration has signaled its support for non-traditional banking. Second, fintechs may eventually gain access to low-cost lending through the Federal Reserve system. And third, a new umbrella federal regulation model may supplement the current and confusing patchwork of national and state laws governing lending, credit and financial services. That state of affairs is addressed in a four-page Treasury Department report, “A Financial System That Creates Economic Opportunities: Nonbank Financials, Fintech, and Innovation.”
As more customers flock to their phones, tablets and computers for financial advice and services, fintechs are gaining more market share because of speed, convenience and a wide array of services.
New banking customers are increasingly going the mostly cyber-fintech route rather than bricks and mortar. Younger customers want a streamlined banking relationship—and are more likely to start online, according to a recent BAI Banking Outlook report.
“When customers do open an online account, two-thirds of the time it’s at an online-only bank, according to our 2019 Outlook research,” writes Karl Dahlgren, BAI’s managing director of research. “Such organizations don’t have the overhead of a branch network or the burden of legacy data systems that don’t efficiently talk to each other.”
“Although borne out of a mostly entrepreneurial culture, many fintechs are embracing the advent of traditional regulation,” notes Amy Zirkle, interim CEO of the Electronic Transactions Association (ETA), which represents fintechs, stated “ETA views the OCC’s FinTech Charter as a positive step toward the development and implementation of solutions to broaden access, affordability and security across the payments technology ecosystem.”
What’s more, “The charter creates a consistent and uniform regulatory framework for fintech companies to quickly deliver their financial products and services,” says Zirkle. “Unlike traditional banks—which take deposits and provide many other banking services for their customers—fintechs often narrowly focus on specific services and market segments but often serve customers across the country.”
Still, how will fintechs be policed in an environment marked by a tangle of regulations imposed by multiple state and federal agencies? That’s where the OCC proposal comes in. One set of national rules in theory could create a more efficient way to usher fintechs into conventional banking.
“Given the number of regulators who may have jurisdiction over a potential fintech chartered bank,” Zirkle observes, “regulators need to be on the same page. The OCC is working closely with regulators to ensure a smooth application process for potential fintech-charted banks.”
Of course, transitioning from an unregulated startup to highly regulated banking institution won’t be smooth for many fintechs. That’s why “regulatory fintech sandboxes” are emerging globally to provide fintechs a safe space in which to see how regulation would work. With some $60 billion invested in fintech during 2018 alone, new companies will need solid guidance in a structured, controlled environment. Regulators in more than 21 countries, including the Consumer Financial Protection Bureau in the U.S., now sponsor sandboxes.
“Regulators establish sandboxes for various reasons but the most common is to promote competition and efficiencies in financial services markets through innovation,” notes a study by the World Bank.
Other issues loom that challenge the brick-and-mortar model: the growing use of artificial intelligence, cryptocurrencies and peer-to-peer lending, which are virtually unregulated at the moment.
Mick Kless, CEO of the Compliance Education Institute in Ocean, New Jersey, sees fintech regulation as a win for the entire industry and the consumer. With P2P payment companies such as Venmo and Zelle, and cryptocurrencies gaining widespread acceptance, “If I’m a fintech, I should be focused and concerned about complying with [new] regs,” Kless says.
“Cryptocurrencies alone have attracted more scrutiny because of anti-money laundering concerns,” Kless adds. “Regulatory controls don’t stifle innovation; they’re meant to protect consumers and the financial system. Regulators need to embrace innovation from fintechs and determine the extent to which regulations apply or need to be modified.”
Ultimately, fintechs will continue force massive changes in how customers use, transfer and manage money. They can now obtain most of their services on mobile devices. And the automated services they use tend to be faster, cheaper and more efficient than older technology. That puts pressure on financial institutions to compete on cost and convenience.
“Competition fosters innovation and vice versa,” Kless notes. “That’s good for everybody and it keeps financial institutions from becoming complacent.”
And by the same token—cryptocurrency or otherwise—smart regulation might keep the Facebooks of the world from overzealously pushing ideas like Libra: in which case the scales could literally balance out just right.
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John F. Wasik has written 17 books and contributed to The New York Times, Wall Street Journal, Forbes, Financial Planning, Bloomberg and Reuters. He also serves as an elected board member in Lake County, Illinois.