By Mark Smedley, VP Financial Services Solutions, Oracle
Over the past several weeks, I’ve been repeatedly drawn to the question of how the financial technology (fintech) sector should be regulated in the U.S. and abroad. As a former regulatory and industry participant, I believe the question is pivotal to the evolution of digital financial services.
Rather than present another reaction to the OCC’s specific proposal (many have offered their comments ranging from tepid support to outright opposition), I’d like to contribute a few thoughts focused on the state of digital disruption to both legacy technologies and business models underpinning financial services generally, and banking in particular.
In December of 2016, the OCC, under Comptroller Thomas Curry, offered special purpose national bank charters to fintech participants willing to abide by national bank regulation and examination requirements. State banking regulators, led by New York State Commissioner Maria Vullo, generally lined up to express their opposition based on a variety of grounds, notably asserting the OCC’s lack of legal authority, and inability to effectively regulate innovation taking place in local jurisdictions.
Notwithstanding the obvious conundrum between national and state jurisdiction, regulatory arbitrage, inevitable jurisdictional "turf battles" between and among the primary federal and 50 state regulators, it’s my assertion that the OCC proposal and the reaction it has generated thus far both miss the mark.
Witnessing the rapid expansion of financial services delivered by fintech, the OCC looked to existing authority and found legal justification to offer special purpose national bank charters to fintech companies. Arguably, this is the best that can be done without congressional intervention, and Mr. Curry perhaps sensibly decided that legislation was out of the question in the near term.
Offering a regulatory framework for fintech participants to opt into, while an admirable objective, should be based on forward-leaning considerations as opposed to existing national banking regulations, which are arguably not responsive to the pace of digital disruption posed by fintech entrants, or the real risks posed by the digitization of financial services. The reality is that the business of financial services is structurally shifting to become more agile, mobile, social, customer-centric and ubiquitous.
Compliance under the special purpose charter differs little from the compliance requirements of a full national bank charter, and traditional risk measures such as liquidity and capital may not capture the true risks posed by fintech participants.
The business of banking has been undergoing disruption by technology-savvy entrants far longer than the addition of "fintech" to the lexicon. The advent of a national currency, the creation of the Federal Reserve system, the emergence of the ATM, and ubiquity of PayPal all exemplify paradigm shifts in the traditional banking business.
What’s new, in my opinion, is the pace of change, low barriers to entry, and the low cost of technology. This genie is unlikely to go back into the proverbial bottle.
Looking back a decade, Dodd Frank was a delayed reaction to a host of business and financial innovations (some might say "excesses") occurring within the context of then-existing business and regulatory models—namely, the marriage of securitized loans in an overheated housing market, with speculative underwriting standards, a lax supervisory model based on laissez faire oversight, and a financial industry dedicated to maximizing fee income through creative securitization. And, of course, overwhelming global demand for these securities.
The lessons of Dodd Frank still echo in the halls of Congress and federal regulators, who may view fintech participants through a similar lens.
However, today’s business and technology environment bears little resemblance to that of 2007-08. For example, smart graduates from the world’s leading universities are able to hypothesize, test, validate and go to market with ideas requiring minimal computing or infrastructure investment. The risk of failure has little impact on systemic risk. Few think of themselves as "banks," and more likely view their products and capabilities as logical (though disruptive) extensions of current social and technology platforms. These market entrants think about solving a problem, curing an obvious market distortion, serving customers and having impact, and only tangentially think about how to comport—let alone comply—with the heavy burden of banking regulation.
Any effective regulation or supervision of the fintech sector should both contemplate this current state of affairs, and focus on the likely future of the industry in the digital and global economy. Contemplating current and future risks both to individual institutions and current banking models, as well as systemic risk in a future digital economy, is an emerging competency. Applying existing regulatory structures to a rapidly changing and dynamic industry, fueled by innovation and low-cost computing infrastructure, seems to miss the mark.
In a perfect world, we’d be able to ask ourselves a few fundamental questions framing how we might think about financial regulation in a future digital economy—particularly around two fundamental competencies that uniquely define the business of banking and which justify or underpin current regulation:
What risks and opportunities will the digitization of banking present to future global economic growth and stability? Regulators should arguably be focused on this future state now. No one can confidently predict the future, however there can be no more effective way to understand and rationalize these risks and opportunities than direct engagement.
In that regard, a model worth considering is the Monetary Authority of Singapore (MAS) which made a clear decision to foster future innovation and facilitate safe passage via a "regulatory sandbox." The OCC has apparently rejected a similar approach, which begs a fundamental question as to which approach will provide regulators with the insight and confidence to properly shape the future of financial regulation.