Today was a busy day for financial regulatory policy. In the morning, the Department of the Treasury released its long-awaited report on nonbank financials, fintech, and innovation. A few hours later, the Office of the Comptroller of the Currency announced that it will start taking applications for a special purpose charter for “fintech companies engaged in the business of banking.”
Over the eighteen months since President Trump signed an executive order outlining the core principles for financial regulation under his watch, the fintech sector has been gripped by policy uncertainty and the looming threat of regulation by enforcement. Today’s events bring much-needed clarity on the Trump administration’s outlook for financial innovation, and the likely way forward.
At 222 pages, the Treasury report is a mammoth document. However, in grappling with the chief ailments of the U.S. financial regulatory framework, the report starts a discussion that will hopefully lead to major revision of existing rules and regulatory approaches.
Three problems afflict the current edifice of the financial regulatory system. Firstly, it was largely designed at a time when most of the technologies that are changing financial services provision did not exist. Secondly, there is a great deal of fragmentation, both horizontal—with rulemaking, supervisory, and enforcement power dispersed across many federal agencies—and vertical—with competences distributed between states and the federal government. Thirdly, it is by design a precautionary system, focused on protecting consumers at all costs, often at the expense of beneficial innovation.
Comprehensively addressing these three problem areas will take more than a sympathetic attitude from the executive. However, the report helpfully points the way forward in seven areas.
1. Clarity about how financial providers talk to consumers
The rules governing communications between financial providers and their customers stem from the Fair Debt Collection Practices Act (FDCPA) and the Telephone Consumer Protection Act (TCPA), passed respectively in 1977 and 1991. Unsurprisingly, both laws fail to take account of the increasing reliance on text and email communication via smartphones—and the Federal Communications Commission has given a wide interpretation to statutory provisions, constraining providers’ ability to reach their customers using new media. The Treasury report finds that the reach of current regulations is overly broad, an assessment vindicated by recent court rulings. It recommends changes to the FDCPA and TCPA to make it easier for consumers to revoke consent to be contacted. It also calls for greater clarity about the ways in which providers can reach consumers and the information they can disclose over email and voicemail services.
2. Data access and use by fintech firms
More people are making use of technology platforms for budgeting, saving, investment, and debt management. Enabling fintech applications to gain access to one’s financial data can improve consumer welfare by making it easier and cheaper to refinance loans, manage bank accounts, and learn about suitable new financial products. But banks and other established financial firms are reluctant to give access to customer data to third parties—partly because it is a competitive threat but also because it can compromise the confidentiality of those data, for which banks could be found liable. The Treasury report calls for increased efforts to improve data aggregation. It favors private-sector action and standardization of applications to make data-sharing easier and more secure but doesn’t rule out federal standards.
3. Credit scoring
One of the key ways that financial innovation is improving consumer welfare is by helping to model risk and predict default in more accurate ways. This lowers the cost of credit and expands access to marginal borrowers. For instance, a recent Federal Reserve paper finds fintech credit scoring to lead to better default estimates and lower interest spreads than FICO scores. The Treasury recognizes the value of alternative data use for better credit scoring, but it is wary of potential discrimination. Growing empirical evidence, on the other hand, suggests that better outcomes can be achieved without undermining equal treatment laws.
4. Harmonizing or federalizing money transmitter and nonbank lender licensing
As Brian Knight from the Mercatus Center has discussed at length, a key weakness of existing financial regulation is its fragmentation across states. The Treasury is aware of the onerous licensing and compliance costs that such fragmentation imposes on providers, and its report encourages voluntary harmonization by states, via passporting rules. If states cannot achieve the requisite degree of equivalence, the Treasury advocates federal action. Given New York’s fierce opposition to any perceived dilution of its financial rules, it looks like federal preemption will come sooner or later. Federalization would foreclose healthy regulatory competition, but in light of the operating costs imposed by fragmentation, the trade-off may redound to the benefit of consumers.
5. Codifying valid-when-made for banks and nonbank lenders
Legal precedent for two hundred years has established that, if a loan extended by a national bank did not violate usury laws at the time or location of its issue, then it is valid at a subsequent time and location within the United States. More recent judicial decisions have expanded the application of this doctrine to nonbanks, but a recent case involving defaulted credit card debt questioned the principle, throwing interstate marketplace lending into disarray. The Treasury rightly calls on Congress to codify the valid-when-made doctrine. In fact, the House already passed a bill that does exactly that.
6. Rescind the BCFP’s payday rule
Nobody likes high-cost short-term credit, but the accumulated evidence—contrary to popular wisdom—shows that payday loans serve many customers much of the time—especially those with urgent need for funds and no access to alternatives. Despite this evidence, the Bureau of Consumer Financial Protection (BCFP) under its previous director sought to apply new rules on payday lenders that would have required them to verify the borrower’s ability repay. These checks would be inappropriate precisely because payday loans are a last-resort emergency product, meaning that some non-negligible proportion of borrowers will indeed end up not paying them back. That makes payday loans costly to extend, but it does not mean they do not help the typical borrower. The Treasury recommends that this draconian BCFP rule be rescinded. Instead, the emphasis should be on removing regulation to encourage a broader spectrum of lower-cost small-dollar products provided by banks and nonbanks alike.
7. Adopt regulatory sandboxes as a spur to innovation
Existing rules aiming to protect consumers may not pose a threat to established institutions, but they do raise barriers to entry for challenger firms, reducing competition. A pragmatic way to maintain existing protections—even though the case to do so is often dubious—while encouraging innovation is to allow for regulatory sandboxes: in which new firms can begin operations under regulatory supervision, but without being subject to the full corpus of regulation. Leading financial jurisdictions such as Britain and Singapore have implemented sandbox programs. The Treasury report calls for similar policies from U.S. regulators, and, if needed, congressional action to facilitate innovation and preempt state barriers. While the sandbox approach eschews the broader question of whether existing rules are appropriate, it almost surely will improve the environment for innovators.
The above is not a comprehensive discussion of the report, but a summary of its key proposals. The tenor of the Treasury’s recommendations is laudable and many of the specific reforms much-needed. However, perhaps the thorniest of issues goes unmentioned, namely, whether the sheer number of regulators and regulatory restrictions placed on financial services firms is making the financial services industry less dynamic and innovative than it could be. That is the question underlying present efforts, however modest, at regulatory relief for banks, nonbank lenders and new players such as cryptocurrency issuers and exchanges.
The tone of the Treasury’s report suggests an answer, but it remains to be seen whether executive and legislative action will measure up to the challenge.