This Election Season, It’s Time to Rethink Our Approach to Financial Innovation

The political conventions are over, balloons have dropped, and promises have been made. There was a lot of talk about needing to “do something." As we move into a more digital financial system, the next President is going to have to do some things to ensure the U.S. remains at the forefront of responsible financial innovation. Whoever wins in November will impact our financial future, so it's imperative they have a plan and be prepared to act.

The next administration will take over at a time when digital innovation is transforming how we spend, save, manage, and invest our money. Today, eight in 10 Americans use a financial technology or fintech app. However, many of our current financial laws and regulations were written for the analog age of banking in person. Regulators need to modernize these rules to meet today’s digital reality and reflect the range of fintech products in the market.

Financial technology companies differ significantly in scope and products. “Fintech” is a broad term encompassing all types of financial products and services that involve technology. Fintechs specialize in sending and receiving digital payments, moving money across borders, storing funds, credit underwriting, investing, lending to small businesses, or expense management, just to name a few use cases. Understanding these nuances is critical.

The next President has an opportunity to unlock the next era of financial prosperity and secure the U.S. as a world leader in financial innovation. To make that a reality, we need financial rules and regulations that are fit for purpose, provide optionality, and reflect the unique nature of different digital financial products.

Using Data to Inform Appropriate Financial Regulations

Recently, federal banking regulators issued a joint request for information (RFI) on bank-fintech partnerships. The joint RFI – ideally enhancing regulators’ knowledge about these partnerships and potentially resulting in greater regulatory clarity – is the right place to start. While bank-fintech partnerships have existed for decades, they are evolving rapidly.

Instead of relying on assumptions or dated information, the agencies are correct in seeking input from the industry and others. Hopefully, the comments will give regulators a better understanding of how technology is currently used and the critical role of bank-fintech partnerships in the financial landscape.

As Federal Reserve Governor Michelle Bowman observed in a recent speech, much of the recent bank regulatory framework was developed in response to moments of crisis. We now have the opportunity to study technology’s impact on the marketplace and regulate it appropriately.

“We need to consider whether we have an appropriate bank regulatory and supervisory framework when it comes to innovation,” Bowman said. “Transformational technology requires clear, consistent, and transparent guardrails and expectations to govern the activities that are allowed into the regulated financial system.”

Building More Sandboxes for Safe Innovation

Providing a safe space for innovation allows companies to engage in dialogue with regulators so that future rules can reflect the marketplace and customers' needs. It's key to bring back avenues for technology companies to innovate safely within the regulatory perimeter. These forward-leaning measures include sandboxes, pilot programs, no-action letters, tech sprints, public-private dialogues, and related regulatory tools.

Modernizing Our Payments and Chartering System

The unique nature of the U.S. dual banking system – with options to license and charter at the state and federal levels – bakes optionality and diversity into the regulatory landscape. As independent commercial actors, some fintech companies seek charters to offer customers banking services.

Unfortunately, U.S. banking regulators currently limit such avenues, which undercuts competition. From 2011 to 2022, only a handful of new FDIC-insured bank charters were approved. Recognizing the constant evolution of the business of banking is sound policy and will lead to greater financial services dynamism and competition.

At the same time, not all fintechs aspire to take deposits and become banks. The next administration should support a range of chartering options to reflect the diverse business models of fintech companies. That includes state-chartered ILCs (industrial loan companies) and federal legislative efforts to create an optional and tailored charter for payment companies. An optional federal payment charter would complement state money transmitter frameworks, tailor prudential requirements to specific risks posed by payment companies, and grant chartered entities direct access to the Federal Reserve settlement and clearing system.

Supporting the Development of Faster Payments

To further promote competition and diversification in our financial sectors, it would be ideal to support the development of faster, more interoperable payment rails and ensure payment companies have direct access to our national payment system. Doing so would bring the U.S. in line with other developed economies by not requiring payment companies to use a bank intermediary to move funds safely and efficiently. Direct access saves end-users time and money. When the U.K. gave nonbanks direct access to its payments system in 2018, companies reduced prices for U.K. customers by 20 percent.

Establishing Digital ID Standards

Facial recognition technology is used in various applications, including financial services. The U.S. must establish digital ID standards and modernize fraud requirements that balance reduced friction with bringing more people into the financial system and enhancing safety and security. This effort will require interagency support to build standards for digital identity documents, verifiable credentials, and consumer protections to ensure consistent application of this technology.

Refining Artificial Intelligence Governance

It will also be necessary to refine regulatory frameworks for AI governance, including national privacy legislation to govern the data that feeds Artificial Intelligence/Machine Learning (AI/ML) systems. Currently, AI/ML usage is well regulated in the financial services sector, and these requirements set the standard for how existing law can apply to traditional use cases transformed by algorithms. However, policymakers can do more by enacting a federal data privacy standard. Regulators should support the responsible use of AI and, as necessary, clarify the application of existing frameworks.

There are more policy areas that to consider, but the next President should consider embracing an innovation mindset and driving changes that create fit-for-purpose regulatory frameworks. Rather than forcing fintechs into regulations built before the internet was invented, our laws should be modernized to meet today’s digital reality and embrace the diversity of new financial models to remain globally competitive.

 

This article was written by Penny Lee from Forbes and was legally licensed through the DiveMarketplace by Industry Dive. Please direct all licensing questions to legal@industrydive.com.