Fintech is rapidly expanding access to financial services products as new technology-based firms are able to achieve instant national scale. But a factor potentially stifling innovation is the uncertainty of fintech's regulatory environment.
Without a clear and consistent federal regulatory framework, fintech companies find themselves in a difficult position. For example, online nonbank lenders and payment service providers (two industries primarily regulated at the state level) can choose either one of two paths, neither of which is optimal. One option is to get licensed by and comply with the laws of every state they operate in. The other choice is to engage in "regulatory engineering" by partnering with banks or other regulated providers that enjoy federal preemption powers. These partnerships are not driven primarily by business or economic concerns, but rather by a desire to mitigate the costs and complexity of the fractured state regulatory environment.
Not surprisingly, the inconsistent regulation of fintech has led to controversy. For example, some banks argue that insurgent payment providers are under-regulated, while litigation casts the bank-partnership model for non-bank lenders in doubt. Some fintech companies are changing their business models or taking other steps to stay ahead of the regulatory curve. In one example, Lending Club altered its contractual relationship with a bank partner in an effort to ward off legal challenges.
Fortunately, it appears that policymakers and regulators are starting to look at how to clarify the fintech regulatory environment. Rep. Patrick McHenry, R-N.C., announced that he will propose legislation to provide fintech firms with regulations more suited to the national nature of their market, and the Office of Comptroller of the Currency released a white paper describing the principles it plans to adopt to better address fintech. These moves are cause for optimism, but they should also be viewed with some trepidation. While positive regulatory reform could be an enormous benefit to both fintech companies and the customers they serve, unduly onerous or poorly executed federal regulation could dramatically stifle innovation and access.
While multiple issues will need to be addressed, achieving consistency is particularly important. Creating good substantive regulation should be the goal, but even if rules fall short of perfection, entrepreneurs can work within them, provided they are consistent and certain. Almost any suboptimal rule can be handled. But multiple redundant suboptimal rules, or rules viewed as unclear or fickle, along with the associated costs can prevent entrepreneurs from committing the talent and capital required to build durable businesses and robust competition. Federal regulation that provides certainty and consistency will provide a huge benefit to existing firms and new entrants.
This doesn't mean that the federal government needs to start from scratch. There are some areas, such as anti-money laundering, where the federal government has been the dominant player. In many areas, however, like nonbank lending and money services businesses, states have done the lion's share of work.
While forcing companies to comply with a web of inconsistent state regulations is obviously unacceptable, state regulation can still be leveraged. This can be accomplished either by adopting the best ideas from states into a federal regime or by regulatory exportation, where a company can export its home state regulations into the national market. This would not only dramatically simplify companies' compliance burden, but it would also incentivize states to create rules that best support both innovation (to attract companies) and consumer protection (to protect their voters). While the exact methods are open to discussion, simplification and consistency are crucial.
Lastly, while consistent rules are vital, so is a rational and transparent regulatory structure. As the Government Accountability Office recently pointed out, the U.S. financial regulatory structure is so complex and fragmented it may actually be counterproductive. The complexity is even worse when one considers the web of state regulators that are involved. In its whitepaper, the OCC tacitly acknowledged the issue of multiple regulators when it cited collaboration with other regulators as a pillar of its innovation initiative. Voluntary collaboration could provide some benefit by helping companies better understand and navigate the regulatory environment.
For example, the Federal Trade Commission recently announced a multi-agency web-tool designed to help companies building health apps determine what regulations applied to them. Something similar could help fintech companies that offer product which often cut across regulatory jurisdictions. While informal collaboration may be helpful, Congress could also consider more formal streamlining and processes that mandate coordination to communicate clear lines of authority to innovators. This could include creating a formal interagency process that requires all relevant regulators to engage with companies seeking guidance, or more formally creating a simplified regulatory structure with less overlapping authority among regulatory agencies.
While clarity and consistency obviously are not the only issue to be addressed as part of fintech regulatory reform, they are essential to creating a fairer, more open and more inclusive market for financial services. Ultimately, isn't that what fintech is all about?