Regulating fintech

Blockchain. Virtual currency. Marketplace lending. Crowdfunding. Roboadvisors. Finance has always been at the forefront of providing new and innovative services, but now there’s a tidal wave of new fintech services simultaneously washing ashore.

For the OCC (Office of the Comptroller of the Currency), the primary regulator of all US federal and many state-chartered banks and bank-like institutions, this is both a blessing and a curse. They want to enable next-generation financial possibilities, but they also need to ensure that risk is kept in check so that there’s a level-playing field for all participants. As the Comptroller of the Currency Thomas J. Curry states, “At the OCC, we are making certain that institutions with federal charters have a regulatory framework that is receptive to responsible innovation along with the supervision that supports it.”

At this point, it’s only a ‘perspective’, an initial white paper with calls for feedback from industry players. But, as there are so many interests involved, it’ll take some time to finalize. Many traditional banks feel that new fintechs are being given a free pass on many regulations, while fintechs feel they are hampered by onerous rules that aren’t applicable to their situation. Some fintechs and banks are collaborating, while other fintechs are going it alone, trying to bypass the status quo. The situation is political but, also, very practical; with the enormity of the technological possibilities, these regulatory determinations will have ramifications far into the future.

Guiding Principles for Responsible Innovation

To guide developing its framework, the OCC has created 8 principles:

  1. Support responsible innovation
    Currently, communication on innovations is on ad-hoc basis; there’s no formal procedure or standard decision-making process. Providing clear expectations would help, whether through better guidance, formal meetings or education materials. Perhaps there could be a central office of innovation or a regulatory sandbox to test innovations on a small-scale.
  1. Foster an internal culture receptive to responsible innovation
    As the OCC has such a serious oversight role, it is no wonder that it has a culture that has a low tolerance for risk and a deliberate vetting process. To help develop a more forward thinking culture they can provide better internal communications and training, bring in outside experts and run an overall evaluation of its policies and procedures.
  1. Leverage agency experience and expertise
    The OCC already has deep expertise in the financial system and has a thorough and growing knowledge with the innovations happening across the industry. By better using front-line examiners, who work intimately with the banks, they can have ongoing discussions about what innovations are appropriate for that institution. The OCC can also consider designating lead experts to guide specific innovations.
  1. Encourage responsible innovation that provides fair access to financial services and fair treatment of consumers
    New financial innovations offer a substantial opportunity for financial inclusion. In the US, 68 million are currently underserved by the financial system. With the promise of lower costs and easier access, fintech can deliver a great public good. Innovations need not be limited to hardware and software. New ways to extend credit, spurring small business and community funds, and innovative tax programs can all be improved by new models and processes.
  1. Further safe and sound operations through effective risk management
    The new fintech era will require corresponding changes to GRC (Governance, Risk and Compliance). Cyber risk, data aggregation, data sharing and other new possibilities will require new risk assessment procedures. The OCC now has the National Risk Committee to assess current and emerging risks and to communicate that information to examiners and banks.
  1. Encourage banks of all sizes to integrate responsible innovation into their strategic planning
    Base innovations on the nature of the bank, its strategic plan and its capabilities, not on availability of a technology. What is best for the health of the bank and the customers it serves?
  1. Promote ongoing dialogue through formal outreach
    The OCC plans to bring together various stakeholders in forums and workshops to better understand, share and promote developments in the field.
  1. Collaborate with other regulators
    The OCC entails to improve communication channels with other national and state regulators to provide a more cohesive regulatory environment.

A National Charter?

One major headache for fintech upstarts are the state-by-state licensing requirements. If fintechs don’t require the full permissions of a national license (and the corresponding requirements), they face a daunting task of getting approvals from each state they want to operate in.

One proposed solution is a national charter, whereby the OCC licenses fintechs nationally, for limited purposes. There is an issue of ensuring that there’s a fair playing field and a high level of compliance; “I would be very concerned, for example, if we were to authorize a federal license that offers the benefits of the national bank charter, including preemption, without any of the safeguards or responsibilities that apply to banks and thrifts,” said Curry on the matter.

However, there are advantages to leaving fintechs under state jurisdiction. With the level of competition and innovation, a ‘regulatory competition’ can create innovation clusters by having the market determine the most appropriate regulatory model. This model will encourage innovation, both by states and by entrepreneurs;   “They're going to go where they see the most friendly regulatory environment," according to Ray Grace, the North Carolina Commissioner of Banks.

"Sooner or later, if it's a really compelling product or service it will find its way to any market — just not as quickly as some in the fintech industry would like.”

In the end, the OCC, state regulators, banks, fintechs and other interested parties will have to come together for the benefit of all US players.

“The financial industry needs to devise a three bears outlook on financial regulation,” advises Stephen Ufford, CEO and Founder of Trulioo. “Not too fast, not too slow, but just right. New technologies promise many benefits from lower costs to easier and faster services. But all parties need to effectively manage the risk, or fintech will take the blame for the resulting havoc."

Other countries, with simpler regulation regimes, are already creating new financial possibilities. Look at the UK, they already have a regulatory sandbox in place. The OCC, by creating Guiding Principles for Responsible Innovation, are taking a major step in the right direction. Stay tuned to the twists and turns on how the new financial regulatory environment will evolve!