The question of whether the current regulatory environment is adequate or unnecessarily impeding positive innovation is gaining importance as technology continues to allow nontraditional companies to provide financial services in new ways.
How federal policymakers respond to the emergence of fintech disruptors will have far-reaching consequences. Among the regulatory proposals are efforts to rationalize rules for fintech firms that have a national footprint. For example, one legislative proposal would grant technology companies federal preemption powers, so they could avoid having to comply with multiple state regimes. The Office of the Comptroller of the Currency is also considering a "limited-purpose" national bank charter for fintech firms.
But as these reform efforts gain steam, policymakers need to weigh the unique realities of this market. The array of financial services providers that use technology in some form is very diverse. There are large fintech insurgents getting the most attention in federal reform discussions that would benefit from preemption. But there are also smaller local nonbank providers — that use technology to varying degrees — that serve local needs and for which the state-level regulations were created. They stand to lose if federal fintech laws are imposed on them.
For example, the federal government has authority over interstate commerce, which has been defined very broadly, too broadly perhaps. Let's say a local brick-and-mortar lender, which only serves customer face to face decides to use the Internet — available in all 50 states — to expand its marketing efforts. If financial technology providers are suddenly bound by a federal framework, that lender could suddenly find itself subject to federal jurisdiction via the "Commerce Clause" since it is using a "channel" of interstate commerce. This could be even if it never seeks to do business across state lines.
Just as it doesn't make sense to force companies that serve a national market to comply with a patchwork of inconsistent state rules, it also isn't fair to ask businesses that only operates in a state or two to abandon the laws that work for them. Needlessly sweeping small local firms into a more comprehensive federal regime could also overburden federal regulatory, supervisory and enforcement resources that could be better used elsewhere.
Marketplace lenders, which use the Internet to make loans on a nationwide basis, need a federal framework. Storefront payday lenders that serve local areas but use the Internet to advertise or post information do not. Similarly, the PayPal's of the world could benefit from a federal solution, but not small money transmitters that operate a storefront to transmit money for people off the street.
Nationwide consistency is vital. However, the new rules should also avoid imposing a one-size-fits-all regime built for fintech firms with diverse business models and expansive geographic reach on companies with a limited scope. Balancing these goals is tricky but possible, provided policymakers and regulators exercise wisdom and humility — and construct a system that offers choice and scalability.
Any new federal regime should be optional. Sure, making rules optional may seem silly. After all, isn't an optional rule just a suggestion? But in this case, it's important to remember that the status quo isn't a lack of regulation. Already, there is a body of law that exists at the state level for many fintech transactions, such as nonbank lending or money transfers. While these state laws may be inconsistent, cumbersome and counterproductive for companies that use technology to operate on a national level, they may make sense for traditional brick-and-mortar establishments that only operate locally or regionally. Forcing companies that have only had to comply with one or two states' laws to change to a national standard may do more harm than good.
A choice between a federal regime and the existing state-by-state approach would also respect the ability of the citizens of a particular state to create rules in cases where the costs, benefits and all of the relevant parties are within that state, while preventing the cumulative burden of each state's actions from hampering national markets.
It would also continue to allow the states to innovate and compete to create the regulatory system that best serves the needs of entrepreneurs and consumers. It is even possible that the states could create sufficient uniformity that state-by-state regulation becomes attractive enough to compete with the federal system for national-level companies.
Crafting rules that give innovators tools to compete with incumbents on the national stage but exempt small-scale companies from a regulatory regime not suited for them will be challenge. But policymakers, motivated by the great benefits of such a system, can and must meet the challenge.