Fintech: Foundations, Payments and Regulations


Module 1: Overview of FinTech & Market Size

Lecture slides

  • Discover key areas in which fintech and financial apps have gained traction
  • Analyze the reported valuations of selected robo-advisors
  • Examine the growth of fintech in both insurtech and global markets

What is Fintech

  • At the core, the main goals of FinTech are reducing transactions and service costs, as well as reaching market segments that are untapped or new, and which would otherwise be potentially impractical, too costly, too uneconomic to engage. Creating or taking advantage of economies of scale, and improving customer experience. Potentially allowing the possibility of segmenting the marketplace, as we've already begun to see in the robo-advisory space.


  • The pure vision of robo advisory has not yet purely been achieved, in part because, it is so important for humans to touch humans.
  • From the perspective broadly from industry, the robo models also are very important because it makes clients with potentially low levels of investable assets, economically viable to service. This is a very interesting and important theme throughout much of financial technologically enabled advisory, in part because of recent pushes toward a fiduciary standard in the investment advisory space, that would apply to brokers as well as investment advisors alike. Inducing a kind of pressure or impetus or motivation for certain players to segment their books as the cost of advice, is expected to arise. Sorry, to increase. This notion of costs increasing, may, although it's yet to be entirely settled, push higher cost per dollar clients more toward technologically enabled platforms where scale is possible as opposed to taking them on in person.

Defining the market size

  • As a subclass, payments and remittances technologically enabled, which we call digital payments, was the largest component of transaction volume in the FinTech subcategory with just under $4 trillion worldwide.

Attitudes towards financial apps

  • the adoption of these attitudes in the activities that are involved has rapidly developed in just the last five years.

Insurtech Market


The Global Market

  • in 2018, reveals that only about 40 percent of the deals done, the largest deals, were based in the United States
  • China: The pattern across time, both by deal count and capital invested, follows the pattern we saw in the US. A general increase in activity money flowing into the space, deal counts being somewhat cyclical, having a recent downturn but a general upward average trend, indicating ongoing potential interest here, once again, in China (downturn in 2018)
  • Similar trends in UK and Europe
  • Another important emerging area within the FinTech cluster is real estate technology. The global market snapshot of venture investments reveals very interesting patterns that correspond to what we saw previously. Namely, some measure of weakness in 2018, but historically increasing deal flow. NeueHouse, Juniper Square, Zesty, raised between 13 and $30 million.
  • the global real estate tech market is strong. NeueHouse, Juniper Square, Zesty, WhyHotel, Dazhu Facility, Home Hero and so on, have multiple approaches, are globally represented, not just in the United States but East Coast and West Coast, not just the United States but China, Israel, India, and the UK, globally targeting technology in real estate, B2B, B2C, and peer-to-peer.

Module 2: Key Considerations in FinTech

Lecture slides

  • Examine millennial behavior and attitude toward financial advice
  • Discuss the surge in impact investing and risk aversion in millennials
  • Assess the key components and characteristics of both a successful financial advisor and financial algorithms

Key Considerations in Fintech

  • millennials stand a good chance of inheriting in the US as much as $45 trillion of wealth over the next 30 years. Millennials have lived through and witnessed financial crisis, and give a kind of opportunity to companies who target not just their current wealth but the present value of their future wealth.
  • They want to interact with technology in a different way, and especially important for FinTech, they have varying levels of trust for financial organizations. Which make a kind of push-pull relationship with financial technology. In addition, issues of trust are bound more generally across demographics when it comes to adoption of technology, when it comes to belief and trust in algorithms
  • It is now widely understood that how we give clients and consumers, and investors. A series of choices for the selection of products and services is critical. The number of choices, the characteristics of choices, and in no other area than financial technology make this be a determining characteristics of success.
  • And finally, what we can know about customers, extracting from social media gives us a view into what the future might be like. If we are ever going to see a pure robo solution or we see enhanced bionic versions of the robo model.
  • just about 40 percent of the global adult population in 2015 we would classify as Millennial.
  • Nielsen reports a greater percentage of double millionaires are Millennials 14.7% than Gen X and Young Boomers 12.9% in 11.8% respectively.
  • they are more diverse and are more diverse especially in the extremes. To say it one more way, they represent at the same age lower levels of wealth except in the millionaire class
  • Millennials have what we might characterize as a skeptical view toward financial advice. They are generally characterized as having optimism about their future. Yet half Millennials think there will be no money for them from government subsistence programs like Social Security when they retire. Only 6% of Millennials expect to receive Social Security payments at levels available to current retirees in a recent survey.
  • That having been said, some recent research from the Federal Reserve Bank of St. Louis in its income stability unit, has found that 60% of US Millennials have zero exposure to public equities. That may be inherently contrasted with the fact that they may own their own businesses or have entrepreneurial aspirations.
  • trust is an issue, which for those of us who live to the great financial crisis, and market shocks that were potentially viewed by Millennials, is not that much of a surprise. A characteristic of Millennials is a perennial low level of trust, not in themselves, but in others
  • However, while they may be skeptical and less trusting about others, and although they may generally have lower levels of wealth and income currently compared to previous generations, they are nonetheless the most optimistic generation about their financial futures.
  • let's take for example the Millennial young generation 18 to 29. We see in 2011, 45% of that cohort use mobile banking, 20% use mobile payments. By the end of 2015, it had gone to almost 70% for mobile banking and about 30% for mobile payments. That's an increase of 50% for mobile payments and about 40% for mobile banking.
  • It is not the case that adoption of financial technology by way of mobile apps is a Millennial-only phenomenon, or the growth rate can be only attributed to Millennials, but it's predominantly a Millennial thrust. For example, if we look at the 60 plus cohort in 2011, only 5% reported using mobile banking apps and 5% reported using mobile apps. By 2015, that had gone to almost 20% for mobile banking and about 13% for mobile payments
  • where do the time variation come from? Sociologists certainly will continue to research the matter, but we do have some knowledge from our understanding of the implications and the impact of market volatility on behavior. That's the area of risk aversion or risk tolerance. And it turns out that with respect to the millennial cohort, but also more generally market volatility has probably changed behavior, and we can see it in the numbers.

Risk Aversion

  • Although we've had an enjoyed one of the longest runs of equity bull market experience in history, we still have had equity market volatility over recent horizons. And over and across the great financial crisis, and the market volatility associated with it during and after. It turns out that this affects investors, and is a critical piece of what we might think about in the fintech space
  • Sociologists know this effect as being the behavioral characteristics and actions taken or not taken by those who lived through The Great Depression in the United States in the first part of the last century. Or, in fact, as it turns out, the behaviors of their progeny. They're often reported as being less tolerant of risk, and being people who save more. Some sociologists tell us that they're actually less garrulous, and perhaps at the margin might be more introverted than previous generations. Researchers have found that this characteristic is not one only of deep market volatility or market crashes, or economic depressions. But may in fact, be a characteristic simply of traditional levels of volatility as well as the extremes.
  • They found that investors who have earned low stock market returns in the past are less likely to take financial risk. Are less likely to participate in the stock market when they are taking risks, and investing less more generally, given that they have had recent low stock market returns. It turns out that more recent experiences have stronger effects on investors' risk appetites. And that especially when these risk experiences happen earlier in life, they can have longer lasting effects.
  • What we find when we look at their results in the graph in front of you, is a positive and strongly statistically significant relationship comparing previous market experience, market results to future stock market participation. In other words, when stock market returns were low in the past, future stock market participation was low. When market returns were high in the past, future market participation was high. In other words, people's ability to take risk was not just about the Great Depression. It was about market experiences and the continuum of market experiences.
  • The Malmendier and Nagel results were born out. The younger cohorts had a greater affect in their experiences facing market volatility than older cohorts. And in fact, they have still not recovered back to the 1998 levels.
  • one of the most important target markets of FinTech activities is not only risk averse today, compared to historical levels, they're most sensitive to risk,. And as Malmendier and Nagel remind us, it could take decades for them to move back into risk. That holds open the promise for robo advisory. Representing both a tailwind, but also a potential headwind to the actual activity of risk taking and financial advising.

Millenials and Social Impact

  • To say it another way, impact investment strategies have risen to high level of importance for millennial asset owners, not just today, but in the way they answer questions about the future. A 2018 U.S. Trust survey found 88% of millennial respondents owned or are in interested in social impact investments
  • A recent World Economic Forum survey of about 5,000 investors across almost 20 countries, showed results suggesting that over a third of millennial respondents felt that improved society should be the top priority of business. That contrasts with what Milton Friedman is often described as suggesting which is that the only social responsible activity of business should be producing profits. If you look at the data, purpose and profit were the top two scored primary purposes of businesses for that millennial demographic.

Trust in FinTech

  • We can often think of levels of trust construed along these dimensions. For example, trust in technical competence. So now, how do I trust that you know what you're doing? Second, especially important in financial transactions and financial service and relationships, trust and ethical conduct and character. Do I trust you not to steal money from me? Important of course in an obvious way. Third, trust in the ability to be human, trust and empathetic skills, maturity, emotional intelligence. If I tell you personal things about myself or my family, can I trust that you, an advisor, will handle that well and can provide counsel?
  • We did a survey of thousands of financial advisors and their clients. The kind of clients who might be purchasers of FinTech Services at some level, at least from a consumer perspective
  • the trustworthiness of an advisor appears to matter at the margin more for advisors than clients but for both incredibly important.
  • The millennials segment also has specific attitudes toward this idea of knowledge, transparency, and communication. In some research published in the Journal of Financial Planning, Johnson and Larson reported results from a survey of millennials on the attributes of financial advisors that were most important and they dichotomized under two scenarios. One, where there is a simple decision to be made and a second where the information was complex and the decision was complex
  • By way of statistical significance, it was knowledge and friendliness that dominated and of course to a lesser extent the degree advanced training, and so on were important.
  • in a high complexity scenario, friendliness and approachability which we equate roughly with safety was more important than technical capacity. For a low complexity financial planning scenario, again at more than the margin, latest financial techniques and models were rated most highly.
  • To summarize it in one more way, when high complexity scenarios were at stake, the human element dominated when low complexity scenarios were at stake. The technical element dominated although they were both important across the board.
  • trust was a function of age and with contact in particular. These results which were developed in an ongoing way as recovery from the financial crisis was happening found that especially among retired people trust levels were low. However, trust levels were especially low when clients had not been contacted by financial advisors recently either because they hadn't been contacted proactively or they hadn't sought out advice. The results suggest here that a proactive element of FinTech advisory just like it is for human advisory will be important.
  • In a fascinating bit of research published in the Journal of Experimental Psychology and elsewhere, Dietvorst, Simmons and Massey in a pen working paper discovered that people displayed algorithm aversion and the article is titled Algorithm Aversion. People erroneously avoid algorithms after seeing them. In this groundbreaking research, they found that people prefer humans over algorithms generally.
  • They also found that trust in algorithms is lower when humans view them at work. In other words, before they see algorithms work they trust them more than afterward even if they're better than competing human technologies. Finally, they found that when an algorithm was perceived to make a mistake it was especially bad.
  • More than that, your belief in advance was a function of whether you saw a model or a statistical algorithm perform even if again was better. So your confidence in advance made a difference.
  • the idea that the combination of humans and machine might give the best result is highly supportive of the FinTech proposition in some ways especially as it relates to trust in algorithms and ultimate outcome for clients.

Choice Architecture

  • complexity matters when numerous choices are available. Research over many years has suggested that showing "Too much information" Can affect the way the choices are made. It can skew risk perceptions. It can slow or make impossible decisions and decision-making. It can also impact the way people feel about their decisions and make them less happy about it.
  • Other studies have suggested that when faced with many choices, investors choose not to participate.
  • In a famous study of 401(k) defined contribution plans over a large number of participants, almost a million participants, across 660 companies, the number of choices as they increased caused decision or decision-making paralysis, we call it analysis paralysis. For every increase in options by 10, overall participation in retirement plans themselves declined by two percent. Framing decision-making thus turns out to be important.
  • complexity interacts with trust. First, not having an answer leads to declining trust and second, when the client asks a question involving a complex scenario, a product service and so on, if an advisor did not know an answer, it was better than making up an answer.
  • was simply saying, "I don't know better." Absolutely.
  • In the FinTech space, having unclear actions and unclear responses, as well as a heightened sensitivity to algorithms and potential mistrust and algorithms, come together both to represent a tailwind and a headwind for the industry.

In conclusion

  • what can we say about what we know about the FinTech space generally and in particular about robo advising. Well, first it's here to stay and it's part of the way the world will work it seems ineluctable judging from both supply and demand. The increasing in size and number of deals. The upward general trend despite some market cycle variation. The global nature of the industry as well as how it's construed across sub-components. All tell us that FinTech as part and parcel of the world in the way forward. In addition, millennials matter in the heart and minds of millennials which seemed to be so much in the cross heirs of financial services firms already legacy firms as well as disruptors and entrepreneurial enterprises, underscore the avenue both the supply and the demand of FinTech providers. However, the traditional notions of trust not just in the financial industry but specifically in what is special about FinTech, algorithms and potential exposure to technology all come together. Traditional challenging areas like those of choice architecture arise. It's going to be nothing different for FinTech.

Module 3: Payments

Lecture slides

  • Examine the history of payment methods and current global trends in payment methods
  • Inspect inherent issues and solutions within the credit card payment system
  • Discuss key aspects behind complex payment processes and the regulation behind payment methods

History of Payment Methods

Credit cards

  • From the consumer perspective you worry about things like credit card fraud which has emerged as a leading concern. From the merchant perspective, the nature of these markets which we're going to spend some time talking about in this lecture, resulted in a few large card networks having considerable control over this market, and that creates some problems that regulation is trying to address. From the merchant perspective, the main problem is that the fees for processing these transactions tend to be very large. This is a concern both for antitrust regulation but also a concern for financial innovation going forward.

Current Global Trends in Payment Methods

  • In the early 1990s, almost 90% of non-cash transactions were done with check.
  • Cash is still the most common means of purchase in the US, however, its share is declining quickly. And by 2022, we anticipate that there's going to be a growth in new kinds of payment instruments, like eWallets, that FinTech technologies are developing continuously.
  • Since the financial crisis, debit usage has actually dominated credit usage. One reason that people think this may be is because especially millennial consumers are still operating in the shadow of the crisis and worry about taking on too much credit card debt.
  • However, in the future, going forward, the belief is that credit will dominate debit. And that new payment instruments, like eWallets and Apple Pay, are really going to dominate the payment landscape.
  • For many years, Visa and MasterCard cards in China were dual-badged with UnionPay. But a 2017 regulation prohibited this dual-badging going forward. As all Chinese cards issued for domestic use now have to be UnionPay-branded and banks are typically issuing UnionPay-only cards. This means Visa and MasterCard's ability to compete in the Chinese market has all but been depleted.
  • As the Chinese appetite for tourism has grown substantially, so has the number of countries where UnionPay cards are accepted. Today, these cards can be used in over 150 countries, even though those of us who transact in the US have likely never seen them.
  • The financial crisis was really a quite interesting inflection point from the perspective of the payment system. In the decade leading up to the crisis, credit card use really quite exploded as card networks introduced rewards cards that incentivized consumers to transact with them. Following the crisis, there's been a real substantial growth in debit relative to credit usage. Particularly for a certain class of consumers, precisely millennials, who lived through the crisis. There appears to be a bit of a distrust with respect to using credit cards that couple transacting and financial borrowing from large financial institutions. Around 70% of millennials tend to believe that debit cards are as safe or safer than credit cards and prefer transacting with these instruments.
  • The three years following the crisis, from around 2012 to 2015, were the largest growth in credit usage in the decade prior. Which suggests that overall credit usage in terms of volume is growing quite substantially. Even though there are certain classes of consumers who tend to be a little bit wary about transacting with credit instruments.

Two-Sided Payment Markets

  • Two sided markets are quite distinct from traditional markets because they involve the choice of not only a price but also a price structure. In a traditional one sided market, like let's say the market for widgets, the producer of the widget says a price for the widget. And all consumers who value that widget at that price, and are willing to pay it, are going to purchase that widget. In a two-sided market, like a card network system, the card network is essentially the intermediary between two different, distinct, traditional markets. The intermediary with respect to consumers, and the intermediary with respect to merchants who accept these cards. And so they have to choose not just prices on both sides of the market but also a price structure. How much to levy the cost of processing these particular transactions, on consumers relative to on merchants.
  • Card networks are far from the only two sided network and this is a canonical set of issues that are discussed in the economics literature. The nature of how costs are distributed between two different sides of this market vary depending on the kind of market we're talking about. So for example, for newspapers, we tend to not really charge consumers significantly for reading the news. But we charge advertisers quite significantly for advertising on those platforms.
  • Note that one issue with traditional two sided-market relative to a one-sided market, is just having a cost that's elevated relative to what you think the true cost is on one side of the market, isn't necessarily indicative of market failure. So one side of the market, you often treat as a loss leader in the perspective of card networks, that's the consumer side of the market, where consumers actually have a negative cost on that side. The negative cost that consumers have means a higher cost than you would set in a traditional one sided market, is going to be born by merchants in this setting.
  • From an antitrust perspective, this poses some complexity for antitrust authorities because simply seeing an elevated cost relative to what you would expect on one side of the market isn't by itself indicative of a market failure. So even if you set really attractive credit card terms and give consumers a ton of rewards, your platform is valueless unless you can also convince merchants to accept your cards.
  • The costs though, are quite significant depending on the payment instrument and depending on whether it's a debit card or credit card or what particular card network you operate with, merchants can pay between 1 and 3% of transaction value in the form of processing fees. That's quite a significant sum, and as card usage has really exploded in the last 30 years, these interchange costs, as they're referred to, are often the second highest cost of operation for merchants after labor.
  • in the early 2000s transacting online for goods was less than 1% of total retail sales. In 2018 it was almost 10%
  • From a distributional perspective, those consumers who don't have access to a debit card, let's say because they're unbanked, or those consumers who don't have access to a credit card, let's say because they're subprime consumers who are risky borrowers that banks don't want to lend to in this manner, are actually shut out from an important means of being able to transact for goods online through e-commerce.
  • A long with e-commerce another significant driver of growth of card usage has been the expansion of credit card rewards programs.
  • Following the financial crises as regulation that we will discuss in a later module restricted the ability of banks to generate revenues from debit processing fees. This regulation left untouched credit processing fees, and so banks and card networks had every to try and encourage greater use of credit cards. Credit cards also tend to have higher processing fees generally making, from the bank's perspective, it really attractive for consumers to try and tack primarily with these credit instruments. In order to get consumers to use credit cards more frequently, card networks and financial institutions realized that they could do well by offering really attractive rewards and cash-back loyalty programs to consumers for their transactions.
  • Consumers tend to be highly responsive to the offerings of rewards and to the transact much more with cards when it is attractive to them from a rewards perspective. Recent work by the Federal Reserve Bank in Boston finds that consumers generally spend more and increase their debt when offered 1% cash back rewards. And evidence from Credit Bureau data confirms that consumers substitute their spending from other cards to the card with cashback, and decrease debt on their other cards in order to take advantage of attractive rewards programs. This is quite important, because it suggests that consumers are increasing their indebtedness past the level which perhaps is socially optimal, in order to take advantage of the existence of attractive rewards programs.

Complexity of Payment Process

  • One problem in the payment network system is that it involves a really complicated series of transactions that need to be authorized, authenticated, clear, and settle in a process that at least in current iterations is not at all in real time.
  • Note how many different participating institutions are required just to get an exchange from the card holder to the merchant, for purchase of a retail good in this setting. Compare this complexity with the simple cash transaction where the card holder has a $100 bill, and provides it to the merchant in order to pay for the groceries set she requires. Perhaps unsurprising given this incredibly complicated chain of transactions, but in the United States today we are far from a real time payment system. This means that every piece of this transaction chain takes significant time in order to settle or clear. So it takes time for merchants to be able to get the funds that they are owed when consumers make transactions. It also is unclear from the consumer's perspective, for the merchant's perspective, even the bank's perspective whether the funds are actually available to be dispersed at the time when the transaction is made.
  • this is a problem that exists in the United States more so than interestingly in countries with better real-time payment systems like China, and one that the Federal Reserve is quite attuned to and paying attention to. Recently, Lael Brainard governor on the Federal Reserve Board noted that consumers and businesses expect to be able to send and immediately receive payments at anytime of the day, on any day of the year. Given that our economy is a 24/7 one, it is important for the payment structure to be as well. This is why she advocates that the Federal Reserve in the private sector come together to try and make investments in real-time payments to create a more secure and more efficient payment structure for the future.
  • Most existing real-time payment systems around the world offer instantaneous 24/7, interbank electronic transfer fund services that can be initiated through a variety of channels like on your smartphone, or through a digital wallet, or through the web. In such a scheme, low value real-time payment requests can be initiated that enables instantaneous payment fund transfer, and a secure transaction that can be done with much less complexity than in our current scheme.

Cost Burden for Merchants

  • In addition to the complexity of these series of transactions that we've outlined, another problem in the payment system is that there tends to be a substantial cost burden for merchants at various points in this transaction chain.
  • All in all, these fees can total between one and three percent of total transaction value for merchants or at least did historically in the US before recent regulation restricted the ability of banks to levy debit interchange fees on merchants though credit card interchange has been left unregulated.
  • The high cost associated with payment processing suggests an opportunity for financial technology companies that use e-payment services to come in and usefully disrupt the industry and benefit merchants by creating a lower-cost processing system, but also, consumers by eliminating the inconvenience of card minimums being required in order to complete transactions.
  • Some innovators in this space include large merchants like Starbucks. Rather than having to bear a processing fee every time a consumer goes and buys a latte, what Starbucks has done is essentially created an app where consumers buy a gift card let's say, $50 or a $100 gift card and keep that gift card on their consumer wallet. That means that Starbucks now only has to pay a processing fee every time you reload or purchase a new gift card, rather than every time you go and buy your latte.
  • The point that the founder of PayStand, Jeremy Almond makes sort of quite profoundly, is that in this movement toward a cashless society that seeks to more efficiently allow consumers and merchants to transact with payment instruments like credit and debit cards, it will be imperative to move away from high processing fees that tend to inhibit the growth of these particular platforms. This requires a substantial investment in technology for decentralized networks that will allow merchants to receive their funds, but not require a substantial penalty in the form of a high processing fee for these particular transactions.

Who Pays for Credit Card Reward

  • What card networks and financial institutions realized that they could do, and did successfully in the decade leading up to the crisis, is introduce sort of new payment instruments rather than just the standard credit cards they offered in the form of rewards cards. These rewards cards encouraged transactions by providing consumers incentives to use these particular instruments, things like airline miles or cash back for completing significant transactions. Something we as consumers don't spend that much time thinking about is why exactly it is or who exactly bears the cost associated with the attractive rewards that we receive.
  • in reality, a large portion of the credit card rewards that we receive are actually borne by less sophisticated, lower income consumers who don't have access to, or who don't transact with rewards instruments.
  • As a result of a 2013 settlement between Visa and MasterCard and a group of merchants, they're now sort of technically able to surcharge consumers who are using expensive forms of payment for transacting. However, in reality, there still exists a variety of legislative barriers, like rules in 11 states that explicitly ban the practice of charging higher prices to consumers for the use of more expensive payment instruments. This means that practically merchants have very little ability to charge different prices for those who use more expensive rewards cards. And in response what they do is simply increase the costs of retail goods across the board for all consumers to cover the cost of processing fees for the few of us who transact with rewards cards. Or in the very extreme, it means that airline miles for sort of billionaires like Warren Buffett and Mark Zuckerberg are being subsidized by a cash payments and food stamps payments by very low income consumers amongst us.
  • the Federal Reserve Bank of Boston has made this point quite explicitly and tried to quantify it. They point out that on average, every cash-using household pays around $151 annually to card-using households. And each card-using household receives around $1,500 from cash users every year in the form of a transfer through their ability to get access to attractive rewards. This in essence is an incredibly regressive transfer from low income to high income households. The legislative fixes for this sort of transfer are a little bit complicated and perhaps not politically that attractive.
  • a more politically palatable solution to this regressive transfer would be focusing on making it easier for merchants to charge differential pricing to consumers who use differentially expensive payment instruments to process. That way when you use your American Express at your local grocery store, you can make the decision of whether the 2% extra you'll be charged in order to cover the processing fees for that transaction are actually outweighed by attractive awards that you're going to be offered. You, the consumer that's causing the merchant bear the extra processing fee, are the one who has to make the decision about whether you want to pay that extra processing fee rather than unfairly the processing fee associated with your transaction being spread out across consumers who aren't receiving the rewards that you are.

Introduction to Regulation

  • With respect to debit cards, in the decade leading up to the financial crisis, the fastest growing source of revenue for financial institutions was from fees that they collected from their customers. These fees included for example, overdraft fees that are charged to consumers who unwittingly overdraw on their accounts. When overdraft was first introduced as a product, the way that banks decided whether they would complete the transaction and charge consumers an overdraft fee, or decline the transaction and simply refuse to let it be processed with this payment instrument, was on a case-by-case basis determined by the nature of the consumer that they were dealing with and also the nature and size of the transaction itself. In the decade leading up to the crisis, what banks realized with the help of third-party vendors who emerged in this space, was that, overdraft could be a really profitable revenue source for financial institutions. If they instead of discouraging consumers from relying on overdraft for example, by in some instances declining these transactions or on a case-by-case basis, instead encouraging consumers to turn to overdraft as a product with a series of practices that we now think of as rather nefarious. For example, what became commonplace in the period leading up to the crisis, was for banks to order your transactions in a way that made it most likely for you to incur the maximal overdraft fees.
  • Only 10 percent of consumers are responsible for around 85 percent of overdraft revenue that's generated. This means that, there are frequent overdrafters, those who overdraft with great regularity, tend to subsidize the existence of things like free checking accounts for the rest of us. These consumers are disproportionately low income, less financially sophisticated, prone to the kind of mistakes that result in overdraft. But also, mechanically more likely to overdraft because they simply have less funds in their checking accounts.
  • Around 70 percent of customers who were surveyed reported that they wish that these transactions had been declined, rather than completed with the significant overdraft fee. In response, what regulators chose to do in the aftermath of the crisis, was change the default rules around overdraft.
  • In the aftermath of the crisis before the banks are able to levy these overdraft fees, consumers are now required to affirmatively opt in to banks overdraft protection.. This has reduced the share of customers that are even capable of incurring overdraft fees from 100 percent, so essentially all of US bank customers, to around 15 percent of customers, and decreased overdraft revenues substantially for financial institutions.
  • I call this approach a salience shock for consumers and have in mind a text message that you would receive when you're in that line at Starbucks telling you that, "If you pay with your debit card and complete this transaction is going to charge a high overdraft fee." I have reason to believe that this will be an effective way of discouraging overdraft incidence. In the UK, they've adopted such an approach, where they alert consumers via text message when their account balances are getting low and overdraft fees are likely to be incurred, and they find that this approach decreases overdraft incidence by around 25 percent for consumers.

US Credit Regulation

  • A concern in the credit card market that emerged well before the financial crisis, was the fact that consumers tended to bear high delinquency fees for missing payments on credit, missing their credit card payments, and that financial institutions tended to without fair warning, increase the interest rates that consumers owed them in a way that felt unfair to particular consumers.
  • The nature of the CARD Act was to provide greater transparency for consumers on the actual price of the credit that they would have to pay. This eliminated or reduced the ability of banks to charge very high late fees for consumers who miss their credit card payments, and also limited the ability of financial institutions to increase interest rates significantly without providing fair warning to customers.
  • They went from being on average a page in the 1970s, to 40 pages by the time the crisis hit. This meant that whatever expectation you had for consumers to read a single page contract, even the most sophisticated among us would never read a 40 page credit card contract and understand and appreciate the terms associated with their borrowing. This means that what you actually pay attention to as consumers, is the teaser rate that's offered to you that's listed on even the outside of the envelope which gives you a credit card solicitation. That's what you think the price of credit is, without realizing that that teaser rate is going to expire very quickly, without realizing that if you are delinquent on your credit card payment, you're going to bear high fees.
  • the Durbin Amendment targeted only debit interchange and left credit interchange fees unregulated. This is a strange regulatory intervention given that if anything we view debit cards as a safer payment instrument, and credit cards as a more dangerous payment instrument because they coupled transacting and consumer borrowing. The idea the reason that Durbin offered for this intervention being focused on the debit market was that, in the aftermath of the recession there was a concern that restrictions in the credit market or further restrictions in the credit market, would restrict credit supply at a moment in time when the recovery was barely underway, and it was important for consumers and businesses to be able to get access to these funds for borrowing. In reality though, the decision to focus on debit rather than credit interchange, made the Durbin Amendment a rather complicated regulatory intervention in an undesirable one from the perspective of consumers. What banks did in the aftermath of Durbin was that, they decreased credit debit card rewards and all but eliminated them, and significantly increased credit card rewards in order to convince consumers to use credit cards which were left unregulated by this intervention. Since credit interchange was still very profitable to financial institutions, they wanted to encourage all consumers to use credit instruments and discourage the use of debit instruments that tend to be associated now after Durbin with lower interchange revenue for banks.
  • instead what large financial institutions like Bank of America and Wells Fargo and JP Morgan did in response to Durbin, was they increased the account fees that they charge consumers to generate this lost revenue. So prior to Durbin, around 80 percent of customers at large financial institutions had access to a free checking account. This means a checking account that has a zero dollar maintenance fee no matter the size of the account. Following the Durbin Amendment, banks put a extra fee on consumers for having an account on the order of let's say five dollars a month for consumers, who didn't have a sufficiently large account balance or didn't have direct deposit in their accounts that generated revenue in other sources. This again is an unintended consequence of Durbin and a regressive one, because the only consumers who are bearing these higher account fees are those who don't have sufficiently large account balances.
  • All in all, estimates suggests that consumers as a group lose around $3.5 billion from the Durbin Amendment, and that this particular regulation ended up hurting precisely the consumers at sought to help since these higher account fees are born disproportionately by low income and less financially sophisticated consumers. The Durbin Amendment case study illustrates the effect of interchange regulation that economists who study this particular two-sided market long suggested would occur.
  • In two-sided markets, the idea doing cost-based regulation like the Durbin Amendment, which required that the Federal Reserve promulgate rules that didn't allow merchants to be charged a cost that was higher than the actual cost of processing the transaction, are a little bit complicated. Because remember, that these are two-sided markets which means that the intermediaries generate profits both from the merchants and from the consumers. So loss leader pricing where one side of the market is subsidized at the expense of the other, might mean that one side of the market in a totally competitive world with no monopoly market power concerns, bears a cost that feels elevated relative to the true or actual processing cost in this space.

International Credit Regulation

  • Australian regulators chose to implement a percentage cap on credit interchange. Interestingly, note that Australia targeted credit and not debit interchange, and so a result of this intervention was a decreased proclivity of card issuers to have credit rewards and a decreased use of credit as a result of this intervention.
  • in Europe, there has been a push towards limiting the ability of card networks and card issuers to generate revenue from interchange, resulting in an interchange cap that's on the order of 0.2 or 0.3 percent for card transactions relative to interchange rates that are more like two or three percent in the US. It is quite interesting that the exact same card networks, like Visa and MasterCard, that tend to charge merchants for processing transactions in different countries, depending on where the merchant is situated, have an ability to do so that is dependent highly on the country in which the merchant operates, and particularly, their entire interchange structures that are deeply different in different kinds of regulatory regimes.

Future of Payment Networks

  • technologies like Ripple, which allow for consumers to send money globally using the power of blockchain in a way that is secure and has fewer payments attached to it than traditional remittance technologies. As well as low or no cost applications that allow for consumers to be able to pay bills and make purchases, transfer money to other user and make payments stores through the use of their smartphones.
  • There's a concern that some of these technologies may disadvantage those who don't have access to smartphones to be able to complete their transactions in this manner. Of course, this is not a reason to discourage innovation, but rather a reason to think about the distributional effects of some of these technological advancements and how it's possible to use the leverage the power of technology to make financial technology more broadly available to consumers who don't currently have access to some of these great innovations.
  • Looking forward, there are several questions that we must think about as we think through both the structure of payments and also how best to intervene as regulators, as policymakers, as academics is interested consumers in this space.

Module 4: Perspectives on Regulation

Lecture slides

  • Analyze the balance between regulation and innovation and its tradeoffs
  • Discuss the the Great Recession of 2008 and its impact on regulations in the financial industry
  • Evaluate benefits and issues with the emerging field and various approaches to regulating FinTech

Perspectives on Regulation

  • The traditional like Chicago style, economic view of regulation has been a suspicious one. So George Stigler who famously won the Nobel Prize for the theory of Economic Regulation, made the following observation.
  • This Stiglerion perspective is a bit about the nature of regulatory capture. So because regulation will be made by government regulators even well-intentioned regulators, those entities with resources like large financial institutions who can lobby and persuade the regulators that their concerns are incredibly valid, can use regulation as a tool to try and conform regulations so it is best equipped to deliver precisely what the industry requests.
  • This can mean both under regulating financial institutions or in general under regulating industry. But it can also mean aggressive regulation in certain settings for the purpose of keeping incumbents with significant market power in these domains, and making it more difficult for new competitors to emerge and comply with existing regulatory burdens.
  • Milton Friedman view of regulation is very similar. His point made very vividly is that, "Corruption is government intrusion into market efficiencies in the form of regulations." So the view is that the market functions well, it functions freely, and regulation is going to just come in and muck up a well-functioning market and for the purpose of advantaging certain industry participants who are best able to control the regulatory process.
  • Christine Lagarde has made the point that regulation fields especially necessary in sectors like the financial sector, where large scale crises in this sector like the Great Recession can expose entire countries around the globe to substantial and significant catastrophic effects, if there is in fact a crisis like the recession.
  • Jamie Dimon the CEO of J.P. Morgan makes the point that, good regulation should simultaneously be conducive to business and to consumer protection, allowing businesses to innovate and create structures that will be advantageous to consumers without worrying about having to comply with overly burdensome regulation, but simultaneously protecting consumers from the risks that they encountered in the Great Recession.
  • George Soros makes the point that the problem with the Milton Friedman conception of markets being freely operational and regulation being a means of corrupt interference in well-functioning markets, is that in his conception markets in fact are imperfect. So you'd need regulation, but of course regulators are also imperfect. So the regulatory process requires simultaneous adaption, both by industry and by regulators to come to a set of processes that are going to well protect consumers in these markets.

The Regulation Innovation Tradeoff

  • It's interesting from a conceptual perspective before we dig deeply into financial technology regulation specifically to think about how we as consumers in these markets tend to view the desirability or the usefulness of regulation broadly. This Gallup poll illustrates that concerns about regulation have actually risen since the early 1990s about overly burden in some regulation with consumers voicing distrust in government's ability to best police these markets as well as concerns that bureaucratic red tape can hinder significant advancements that occur in other countries with less stringent regulatory frameworks.
  • Regulation is meant to help consumers by protecting them against risks that emerge in different markets, but regulation can also ill-serve consumers by making certain markets less competitive and providing incumbents or tremendous advantage in those faces. This was of course the concern if George Stigler and one that manifests itself today with respect to for example occupational licensing in the United States. The percentage of occupations that require a state license in order to participate in that occupation have increased from less than five percent of workers in the early 1950s to a quarter of all workers in 2015.
  • Jobs that require such licenses range from jobs you would expect things like physicians and lawyers, but also very intense licensing requirements for occupations like barbers and manicurists and the expectation that they re-license themselves with tremendous regularity in order to remain licensed practitioners in these particular occupations.
  • The existence of these licensing requirements does many things from their perspective of consumers. On the one hand, it makes these occupations more expensive to work in and as a result makes the prices that consumers pay for their manicures, and for their haircuts higher but it also hurts individuals who work in these occupations because it reduces worker mobility and tends to increase inequality and provides a stark barrier to entry for individuals who seek to participate in these particular industries as a way for career advancement.

The Great Recession

  • The losses of the Great Recession were large and widespread. In the US alone, over eight million Americans lost their jobs, eight million American homes were foreclosed upon, 2.5 million businesses were closed, there was a 12 percent decline in median real family income, a 40 percent decline in median real net worth, and a 4.3 percent decline in real GDP. These are substantial decreases in the wealth of the United States as a whole. But also are born primarily by actual real American consumers who lost their jobs or found their homes foreclosed upon with little ability to remedy the situation and recover the losses that they had suffered during the crisis, in often instances because of no malfeasance of their own.
  • In the United States, the most significant post-crisis financial reform was the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
  • A very significant reform following the crisis was in fact the creation of the Consumer Financial Protection Bureau, whose entire mandate is to regulate these institutions from the perspective of consumers to supervise these institutions to pass rules and require them to comply with behaviors that are going to best serve consumers, and be sure to rid these markets of unfair, abusive, and deceptive acts and practices.
  • Another significant reform following the crisis in the banking sector in the United States, was to drastically increase the amount of capital banks are required to hold in order to engage in business practices like lending to small businesses and lending to consumers. As a result of these interventions, large financial institutions are today much better capitalized than they were before the crisis and much better equipped to whether the next crisis whenever it will hit. This is a substantial improvement relative to the pre-crisis financial system. Additionally, we've created a framework for regular annual stress-testing of large banks to make sure that they're going to be able to hold sufficient capital to withstand the next crisis and tailoring the capital requirements that they're required to hold to new risks that emerge in financial markets as time progresses.
  • importantly, as we've made substantial improvements on the regulatory framework for a traditional financial institutions, we've also created incentives for activity that used to happen in this regulated traditional financial sector to shift out of the traditional sector and instead be initiated by less regulated shadow banking entities, who are able to perform these services at much cheaper costs.
  • One of the consequences of this movement has been that traditional small business lending is now being done by the less-regulated, nonbank sector. In fact, these authors observed that in places where big banks have left the business of small business lending most substantially. Peer-to-peer lenders like Prosper like Lending Club, have come in to fill the void that's been left by these financial institutions. The concern is that if this activity is being driven out of the traditional financial sector and into shadow banks, well, the traditional financial sector at least has some regulatory framework but as they exist currently and as we're going to talk about over the course of this series, it's unclear that the shadow banking sector has either a framework or regulation in place to ensure the safety and stability of these markets.

Emergence of FinTech

  • in reality, it's quite interesting to try and place some of these financial innovations on a bit of a spectrum from totally new ideas and new kinds of businesses, things like Bitcoin, to traditional businesses, things like Bank of America, getting involved in and taking advantage of new technologies that exist in the world.
  • the reason why it's important to bifurcate the layers of newness in financial technology is because the kind of regulatory framework we will want to adopt will be a byproduct of the existing regulation that already exists in that space. So, when you think about traditional financial institutions doing traditional financial activities, albeit with new technologies, the sort of new regulatory framework that you have to conceive up for that setting is much less extreme than in the case of something like bitcoin, which involves an entirely new asset class in essence, entirely new business practices that regulators really having conceived of in the past.
  • while we tend to talk about and tend to think about FinTech as one thing, one group, they include these well-regulated sort of well-established firms who are used to doing financial service provision, like the JP Morgans of the world that are doing totally new things like launching their own cryptocurrency. FinTech also involves startups doing existing finance differently. Things like Venmo in the payment space, or Prosper and Lending Club in the lending space, or robo advisors in the investment advising space. And they involve startups disrupting the way we think about the financial system altogether. Things like these decentralized blockchain based marketplaces.

FinTech Growth & Benefits

  • Developing countries those like Latin America and Africa, are really hoping to use the power of technology to be able to provide more to their citizens and to better serve consumers who have traditionally lacked access to basic financial services. The real benefit of financial technology is that it improves banking access for consumers. Mobile banking allows consumers to interact with banks conveniently, for example those who live far from traditional banks. Crowdfunding allows entrepreneurs without access to conventional loans to fund their new businesses, to be able to get funding for these businesses from crowdsourcing investments.
  • In the United States today, around 20 percent of consumers are reportedly underbanked and around 7 percent of consumers are entirely unbanked. This means that unbanked consumers who have no access to the traditional financial sector, and underbanked consumers who may have access to the traditional financial sector but tend regularly to turn to expensive financial services provider alternatives like payday lenders and check cashing facilities. For these consumers, a real benefit of FinTech is the ability to create a much more inclusive financial sector. One that is able to best serve and cheaply serve consumers in a secure and efficient way.
  • These numbers are significantly higher in developing countries, where consumers don't have access to traditional financial service providers but incidentally often do have smartphones. So being able to provide more financial services to consumers through the technologies that they already have access to, will be a way to create a globally more inclusive financial sector
  • Another real benefit of financial technology providers, is that they bring more efficiency to the financial sector. For example, there are financial technology innovators who through payment apps or remittance services or crowdfunding platforms, have made it much easier, and faster, and cheaper, to be able to get access to basic financial services.

Issues with FinTech

  • Financial technology can solve a lot of problems that exist in the financial sector with respect to both consumers and firms. For example, it can help those who don't have access to the traditional banking sector be able to get access to financial services at lower costs than expensive alternative providers, and from the perspective of entrepreneurs and firms, it can help new businesses who might not have access to sources of funding from traditional financial institutions be able to crowd fund at relatively low cost in order to fund their new enterprises, but that's not to say that there aren't also problems that exist with respect to financial technology service providers and new challenges for regulators as they think through how best to intervene and to help facilitate the growth of these markets.
  • The potential for a data breaches and cybercrime attacks is one area in which financial technology fields especially vulnerable.
  • One case study that's quite helpful to see the issues posed by data breaches and potential cyber criminality is of course, Equifax is recent exposure to hackers of its customer's personal information. Equifax technology allows consumers to interface what their credit scores online, and stores personal and consumer information on its web-based platform service. The enterprise technology that Equifax relied upon how to vulnerability which was identified months before the breach but not fixed, and so hackers were able to steal personal information of approximately half of the United States population. That means that hackers were able to get access to social security numbers for around a 143 million US citizens.
  • this is far from the only instance of the cyber criminality and fraudulent stealing of consumers personal information that is made available by financial technology service providers. Large financial institutions are often the targets of these Internet hacks, those like JP Morgan Chase and eBay and T-Mobile, and online payment structures like, Target and Apple, and there's a question for how regulators should think about harnessing the power of technology, and allowing for innovation in these new sectors while simultaneously being cognizant of the fact that protecting consumer information is a difficult and important task
  • Financial technology also creates a set of problems that are really quite unique to these new innovative platforms and pose a special confusion for regulators who have yet to have to deal with the concerns that are being implicated in these markets. So for example, recently, cryptocurrency investors were locked out of a $190 million after the founder of a particular Canadian exchange died prematurely without making provisions for the future viability of this particular cryptocurrency. There would be no such concern at a bank that deposits of individuals or of firms would magically disappear even if the founder of one of these large financial institutions was to pass away prematurely.
  • Another divergent example involves peer-to-peer lending schemes. The nature of peer-to-peer lending is individuals apply for a loan and that loan is given to them by the peer-to-peer lending platform, and then repackaged and sold to the other side of the platform which the nature of peer-to-peer lending makes it sound like it's another peer of yours, but in reality it tends to be large institutional investors, and in this particular context, the loans that were being resold didn't meet the buyer's criteria. The buyer in this case was Jeffrey's bank but they were doctored by the peer-to-peer lending platform to make it appear that they did, and this became a cause for concern of the FTC in their context of Lending Club, and eventually led to the resignation of Lending Club CEO.
  • Estimate suggested that around 70 percent of the transactions that occurred on the so-called Silk Road involved illegal activities such as drug trading. This suggest the need for more regulation and also more direct intervention in this space, and points to the idea that it is important for us to develop use cases or think through what the use cases for crypto assets maybe that simultaneously improve the lives of consumers and allow us to transact more easily, more quickly, more efficiently, but also preserve a role for and provide a venue for appropriate regulation, and control over activities that we may be concerned might happen outside of the traditional financial space.

Issues Regulating FinTech

  • Alfred Kahn the Nobel laureate said this with respect to regulation generally. That it almost was an inevitable game of Whac-A-Mole, what is Whac-A-Mole? Well, you worry that when you restrict one particular kind of practice of a financial institution or a financial technology provider. Then inevitably, another sort of very similar practice is going to emerge and the regulator is kind of going to always be playing catch up with respect industry. And that's especially true with respect to FinTech, where the entire nature of this industry involves leveraging new technologies in innovative ways successfully. And so it's kind of inevitable that regulators will be one step behind the innovators and have difficulty figuring out how best to supervise in this setting.
  • More broadly, his view for regulation was that just as a sort of as industry is clever and there will inevitably be holes in the dike, dike is like a container for water let's say. The role of the regulator is to, as there will always be holes that emerge in the dike, there will always be new fingers that sprout for the regulator to sort of try and restrict water from flowing out. And so the point is, that regulator have to and the industry will always evolve and financial technology in particular will always reform itself. And adjust to sort of work around regulatory frameworks in ways that our profit maximizing for institutions. But what regulators must do is they must be clever and thoughtful and adept and quick in responding to new risks as they emerge in these markets.
  • Another issue with respect to financial regulation broadly and financial technology regulation specifically, is that we are struck by the fact that these markets are actually inherently global. And if there's no sort of global coordination around regulatory framework, this becomes quite difficult even for countries which decide that it's important to pay attention to risks as they build up in these new sectors. So for example, if there is very strict regulation of new financial technology service providers in the United States, which tends to be on one side of the spectrum in these discussions. Then there's concern that first innovation will gravitate outside of the United States. But second, the risks that build up in other countries with respect to financial technologies that the US doesn't have jurisdiction over may still harm consumers in the US market. And so how do we deal with the fact that risks are really global rather than national in financial markets.
  • I happened to work at the White House in the aftermath of the crisis and as we were conceiving of the new post crisis financial regulatory framework. What was hoped for and conceived of as a massive innovation was to create a structure where one particular regulator was kind of in charge of overseeing the entire financial services industry. In reality, individual regulators still maintain significant power over regulating their particular domains. And in many industries, participants are required to meet the standards of a swath of different financial regulators.
  • there are real concerns with having such a fragmented regulated system. Two concerns that we had at the White House with respect to the financial regulatory framework were first that having such different authorities be responsible for different aspects of the financial sector meant that information would get stuck with one regulator and not find its way to the other. Even though together these two different agencies set of impact information might hint at risks building up in a particular sector of the economy. And so there was a concern about the lack of ability of information to flow very freely between regulators. There's also a concern that from the perspective of industry if you could be regulated through a state banking charter or you could be regulated through a federal banking charter your incentives are a structure to try and find the regulator who's going to be easiest on you. There's empirical evidence that is exactly what financial firms do. So it seems quite important to create a regulatory structure that allows for information to flow freely, and discourages the sort of regulation shopping, that we know is commonplace among sophisticated financial players.

US FinTech Regulation


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  • The issues of not having a single framework responsible for regulation are well illustrated by a series of examples. Currently, new digital payments firms or cryptocurrencies in the current regulatory environment are regulated both under the Federal Banking Security Act and so have to register with the Treasury as well as gain state licenses in order to operate. There is no national consensus on the ability of peer-to-peer platforms to operate in different states across the country. LendingClub is able to operate in more states than prosper and there are states where individuals can take out loans from LendingClub but not purchase loans and be on the other side of these transactions. These sorts of differences create opportunities for regulatory arbitrage on the behalf of firms and also create a set of restrictions that are very difficult to comply with from their perspective of new and emerging industries and new and emerging financial services providers who would like some clarity about what requirements they have to meet in order to operate but don't have the resources to be able to meet high regulatory burdens that are differential depending on the state in which they seek to do business or gain new customers.

Global FinTech Regulation

  • The idea behind a regulatory sandbox is in this imaginative environment of play. Innovators have the freedom to explore and think about new solutions, and new products to existing problems that exist in markets without being overly burden by regulatory frameworks that are more appropriate for mature industries. One idea of how to think about the regulation of financial technology going forward and one idea that's been proposed roughly between the Euro areas, the United States, and Hong Kong is to come together to form a global financial technology sandbox to provide a reprieve for new and emerging industries and new, and emerging firms who seek to innovate and provide financial services to consumers in ways that they haven't before, and to seek to provide financial services to consumers who have traditionally been left out of the financial sector.
  • Australia
  • The UK is attempting to create a global FinTech sandbox with the help of helping financial technology companies who have cross-border ambitions grow in a way that is safe for consumers but also facilitates the emergence of these new industries. The UK's had significant success with respect to its regulatory sandbox. The idea behind each sandbox is that it partners with firms that meet a set of requirements, and allows those particular institutions to test products without complying with the full set of regulations that are typically required of financial services providers.
  • Singapore has also adopted a regulatory sandbox to enable financial innovators and existing financial technology players to use this opportunity to experiment with innovative financial products or services. The idea behind the regulatory sandbox is to under the guidance of regulatory supervision, test new financial technology products, and determine whether they're well suited, and likely to solve an existing problem that exists in the financial marketplace.
  • China is an example of a country that has taken a relatively loose approach to regulation over financial technology. Their attitude is to think of the whole country as a regulatory sandbox where new technologies can be tested, and new ideas can be implemented without concern over a significant litigation threat, or concerned that you would run awry of financial regulators. However, some regulation has indeed been implemented.
  • The Ministry of Industry and Information Technology has begun to produce ratings for blockchain products and Beijing has banned initial coin offerings, and blocked websites that offer cryptocurrency trading services. This interventions have been mostly with respect to blockchain but in general, China has tried to really encourage the growth of innovation in financial technology, and tried to encourage entrepreneurs who are developing in this space to locate it in China where they'll have access to significant testing for new financial technologies, and also be able to think about how best to scale up the industries that they're developing.
  • For all the experience of financial technology regulation and the experience of financial regulation more broadly, suggests that the best case scenario for regulators going forward would be the true development of a global framework for regulation in the space.
  • The country's specific requirements for different financial services providers are complicated given that financial markets are incredibly global, and so having different requirements in different countries in which you operate is burdensome from their perspective of industry but also creates tremendous incentives for gaming requirements in order to pick the country's or the regulatory authorities that are going to be most friendly to your risk-taking activities. One bright note for the future of financial technology regulation is the suggestion that new global regulatory sandboxes be considered to facilitate both singular framework for the regulatory compliance for these nascent firms, but also to facilitate cross-border growth of these new industries that have significant potential to help best serve consumers.

RegTech and Looking Forward

  • The idea behind RegTech is that it is actually financial technology that helps financial institutions address regulatory challenges and facilitates the delivery of and the ability of these institutions to comply with existing regulatory requirements.
  • RegTech was created in order to address challenges that arise from compliance in risk management and things like data reporting, and is especially useful for nascent financial firms who don't yet have the capacity internally to be able to create these sorts of technologies for their own use.
  • Another example is RegTech provider called Trulioo, which provides ID verification for companies like PayPal, Stripe, and Amazon, and helps them comply with new know-your-customer and anti-money laundering rules that have become of significant importance in a significant regulatory burden for these institutions, particularly in the aftermath of the financial crisis.
  • Looking forward, as we think of the future of financial technology and financial technology regulation specifically, it's important for us to think about whether we should regulate FinTech as an industry in and of itself or whether FinTech comprises a series of industries depending on whether it involves traditional financial services providers doing new things, new financial services providers doing traditional things, or is totally new means of transacting and means of exchange that didn't exist in the financial system previously.
  • It's also important that we be aware that the kinds of choices we make about regulation in this industry are inevitably going to impact the decisions the entrepreneurs make with respect to where they locate and where they innovate, the ability of consumers to be protected from new risks that emerge in these markets, and the ability of consumers to be able to benefit and leverage the power of new financial technology to serve them in ways that existing financial institutions prior to this FinTech revolution were simply unable to.
  • It's also important for regulators to bear in mind that financial regulation, and particularly financial technology where so much of the transacting happens on the Internet, which is inherently a global platform, would be best served by regulation through a singular global framework.
  • So one concern about over regulation or one concern about overly burdensome regulation in this setting is that we are going to push activity outside of a sector which we understand and have some framework for regulating into sort of the shadow banking sector where our ability to manage risk is much less strong. So as regulators and interested audiences in this space, it's important for us to understand that when we trade off in the context of regulation, it's not just trading off between innovation on one side and consumer protection on the other. But in fact striking the right balance not having overly cumbersome regulation, that's going to encourage activity to fly out of the regulated sector and pose a threat to financial stability, but one that we don't have a good handle on how best to address.