In this past holiday season, many of us gave and received “techie” gifts and gadgets. Some of these are things that didn’t even exist a year ago. Inventors are building, fast, on the foundation of digitized information that has been laid down for us. Some of their creations are solving problems that had always seemed unsolvable, or had not even been perceived as problems at all, because there were never ways to solve them. It was just ... how things were.
As we begin a new year, imagine a tech-driven, problem-solving “gift exchange” among the people who care about finance, financial regulation, and technology. The circle would include banks (small and large); fintech, regtech, and tech companies; regulators, law enforcement, and legislators; and consumer advocates, nongovernmental organizations, and academics. They would be in the U.S. and other advanced economies—and also in the developing world.
Each of these groups often feels misunderstood by the others because they deeply know important things that the others don’t. What if they could, metaphorically, take the thing they would most like to have understood, place it in a box, wrap it in bright paper and ribbon, and present it to another group who would open it, examine it, and miraculously grasp everything the giver knows about it? What problems might be solved if we could all see the changing financial world more holistically?
Here’s how the exchange might go.
From fintech and regtech firms to regulators and banks:
Both finance and financial regulation are transforming from analog to digital design. This is because data and computing power used to be scarce and expensive, and now are abundant and cheap. Digitization will change finance and financial regulation just as it changes everything else, making it all faster, cheaper, and better, and spurring innovation we can’t yet imagine. Help us shape this transition to optimize benefits and manage risks.
From regtech firms to countries fighting terrorists and traffickers in drugs, guns, and people:
We can help you stop them. The U.N. says the world catches only 1% of the $1.6 trillion in annual financial crime. We have new technology that can turn the tide in this battle, but we can’t use most of it until the laws and rules are modernized for technology, and to update our focus on law enforcement outcomes.
From regtech firms to political leaders concerned with the opioid crisis:
You’re missing what might be the best tool for solving this epidemic—again, new technology can find the laundered money and help shut this down.
From fintechs to regulators:
Innovation has the potential to solve most of people’s problems with financial inclusion and financial fairness, if you regulate it right.
From fintechs to consumer advocates:
Same. Look at the upside potential for consumers, and also help us understand the risks you fear so we can design solutions. Please help the regulators see the positive opportunity and encourage them to try new approaches.
From regtech firms to regulators:
We can improve policy outcomes and reduce costs at the same time. We know that sounds too good to be true, since historically cutting costs almost always compromised results. Now, though, digitized regulation can be both cheaper and better.
From regulators and advocates to fintechs:
These innovations can help people, but also harm them. Help us think through new regulatory standards.
From regulators to fintechs:
We can’t let high-risk activities into the banking system, no matter how promising they are. You can’t be a bank, or work with a bank in ways that endanger its customers or its stability, if you have a high risk of failure.
This isn’t about bureaucracy or traditionalism. We have to guard the safety and soundness of the financial system and in turn, U. S. and global wellbeing. Help us learn to bring innovation into the system without risking it.
From regtech firms to community banks:
We might be your regulatory salvation, because we can dramatically cut your compliance costs, and cut your risks, at the same time. Help us make the regulators comfortable with our new regulatory solutions.
From policymakers and advocates to the tech world:
You’re at risk of losing public confidence in innovation due to data breaches and some companies engaging in unethical behavior. Help us build public and cultural consensus on standards, including ethics for using data and artificial intelligence.
From fintechs to fair-lending advocates and regulators:
If you’ll let us use alternative data, we can make lending more inclusive and also more sound. The traditional tools exclude qualified people. Let us prove it to you.
From regulators and fair-lending advocates to fintechs:
If we allow use of alternative data on lending, we’ll have to monitor how it fares through an economic downturn.
From the developing world and financial inclusion advocates to regulators:
“De-risking” to comply with Know-Your-Customer rules has become the new redlining. It’s blocking deserving people from economic access everywhere, and especially in the developing world. New technology can enable fast and inexpensive identity verification for almost everyone, improving both financial access and risk. We need to use it.
From government to financial and tech companies:
We have to do better on data protection and cyber-security. We can’t sustain an online economy that’s fundamentally unsafe. Data needs to be protected from criminals, from inappropriate use by you, and from inappropriate use by us. We know data is the life-blood of innovation. Help us find new standards and technologies to use it well.
From fintech firms to policymakers and consumer advocates:
Protecting people from identity theft and cyber-threats requires moving beyond social security numbers. Government-issued ID numbers were designed for the paper-based era. Now those forms of identity are the easiest of all to steal, use, and sell. Criminals enter stolen identity information online more accurately than real customers enter valid data, because their programs don’t make typos. We need high-tech authentication like biometrics, digital attestation, and data-based verification. Look to the developing world as the leaders.
From fintechs to community banks:
We might be able to solve your growth challenges. What if you could grow in place by enlarging your market vertically? Instead of having to add geographic locations, add new products, or locate in a growth market, you can grow inside your current footprint by soundly serving more of the people already there.
The breakthrough is three technology trends:
1. New data analytics enable more accurate underwriting of people who fail traditional risk screens.
2. New technology enables consumers and small businesses to manage their financial lives more easily, so you can equip people with tools that make them better customers.
3. You can grow inexpensively through mobile delivery instead of branches.
Remember, lower-income people are disproportionately high users of mobile financial services. People have phones. They know how to use them. They interact with them constantly. Put your bank there.
From fintech and regtech firms to regulators throughout the world:
Look to the U.K.’s Financial Conduct Authority for inspiration and models on both how to regulate fintech and how to use regtech. They are far ahead of the rest of the world, although several other countries also stand out.
From fintech and regtech firms and banks to U.S. policymakers:
The fragmentation of the U.S. financial regulatory system is a serious problem. Despite U.S. agencies’ helpful innovation initiatives, it’s getting worse.
Innovation is breaking the molds of regulatory structures that were designed around old industries and products (consider the intersection of Bitcoin and IPOs, and the resulting “ICOs”—initial coin offerings).
The U.S. has five federal regulators that directly supervise depository institutions, plus several dozen other federal agencies involved in financial policy, plus the 50 states.
Innovators sometimes don’t know who regulates them. Many can’t scale up efficiently or even engage with banks.
Good innovation may choke to death on regulatory confusion.
Banks may lose competitive market share because it’s so hard for them to change. Other countries want to build regulatory bridges with the U.S., but can’t tell which agency to connect with.
U.S. regulators need new models for close collaboration, rapid shared learning, and decision-making.
From U.S. regulators to legislators:
We need leeway to try new things and to communicate and collaborate more easily with each other and with industry.
Old laws impede fluid communication, from the Administrative Procedures Act to the sunshine and anti-deficiency laws, all of which serve valid goals but need reexamination for the digital age.
We also need your support as we undertake careful experimentation with both fintech innovation and with using regtech. We need to hire people like data scientists. We need objective research in areas like artificial intelligence and new uses of data. We’ll have to figure out where to get new resources.
Importantly, we—and you—need real expertise in how technology is changing finance and financial regulation.
From law enforcement and regtech firms to policymakers:
Here’s a question guaranteed to stir debate: Are we sure it still makes sense to try to block money launderers from the financial system?
It did when our AML laws were written, but back then we lacked today’s huge data sets and machine learning that can analyze patterns in how people move money.
Maybe we should let the launderers in, identify them, watch them, and catch more major criminals. At the very least, we need much more high-tech use and sharing of data, including anonymized data typologies that the whole system can use to spot priority crimes.
From industry and regulators to academics:
We need objective research and testing of financial innovation, producing data that policymakers can trust. We need ways to do this quickly, to keep pace with today’s rapid cycles of technology change.
From fintech and regtech firms to regulators:
You will have to speed up.
Not to accommodate us—but because the risks you guard against will rise unless the regulatory system can keep pace with technology change.
We respect the fact that your agencies are designed, for good reason, to be careful and deliberate and risk averse. But technology is changing faster than traditional regulatory processes.
Increasingly, the highest, more complex risks will arise because policy is lagging behind.
We’ll need deep rethinking of regulatory design.
From banks and fintechs to regulators:
We need to get together, or at least, most of us do. We know there are legitimate concerns, but please consider special third-party risk guidelines for bank/fintech partnerships of all kinds, and include leeway for experimenting with whether and how we can team up.
From regtech firms to universities:
We need people who are experts in both law and technology. Law schools should teach coding. Tech schools should teach regulatory design.
We need new specialties in both professions building hybrid knowledge. We also may need new professional codes of conduct, like those in law and medicine, for data ethics.
From the developing world to the advanced economies:
Look to us for innovation. Our countries are ahead in some areas for two reasons.
First, we’ve had much faster expansion of mobile financial services because we’ve had such rapid and broad adoption of cell phones. (More people now have access to phones than to plumbing.) This also means we have hundreds of millions of consumers who are getting their first-ever access to the financial system, so we’ve been learning how to serve and protect them.
Second, some of our financial regulatory systems are younger and less entrenched than in the developed world. This makes some things harder, but it also makes it easier to change.
In both mobile services and regulation, we’re essentially doing a digital leapfrog over the advanced economies. We will soon have virtually ubiquitous financial inclusion, through the phone, and we’ll be leading the way on regulatory systems.
From U.S. big banks to regulators and advocates:
We need to modernize the Community Reinvestment Act. It was written 40 years ago when most banking was done through physical branches.
Now we can serve lower-income consumers and businesses better with mobile services. Give us CRA credit for doing so.
From fintechs to banks and regulators:
Banking has always embraced technology and innovation, and it’s tempting to view today’s changes simply as further evolution.
Partly that’s right, but mostly, today’s technology is different.
Past innovation was mostly about automating processes that had been designed in the analog era. It accelerated traditional activities that were originally paper-based, essentially by adding a layer of automation on top of them.
Digital technology sets aside the old process and starts fresh, acheive the goal by leveraging data, machine learning, and artificial intelligence.
It’s truly new. Better—and cheaper.
From fintechs and banks to regulators:
Let us move into the cloud. It’s not less secure -- it’s more secure, if done right. It’s also less expensive, enabling more financial services that can serve more people affordably.
From all banks to regulators:
Consider how you can help the industry bite the bullet on modernizing our IT.
Most banks have old systems, often accumulated through long-ago mergers and acquisitions that were never deeply integrated.
Some of this ancestral technology uses programming languages no longer taught in college—and our cadres of experts will retire before long.
The seams between these systems are full of problems, from security risks to compliance mistakes.
Furthermore, we can’t readily use our own data, which we’ll have to do to compete.
Fixing this is expensive. What’s the best regulatory environment to move toward a new system?
From regtech firms to everyone:
Some regulation could be issued in the form of computer code. It could be not only machine-readable, but machine executable —self-implementing. This could drastically cut both costs and risks.
Of course, this new regulatory model would not work for everything, but where it fits, it could be introduced gradually and voluntarily.
Meanwhile regulators should build data portals allowing firms to connect directly through application program interfaces (APIs) that enable real time, full-data monitoring for signs of problems or trends needing human review.
Sampling-based risk review is a relic of the days when full data was hard to get and analyze. Now risks can be detected early, system-wide, and even be prevented. This approach, too, could be introduced gradually and be optional for the industry, so policymakers would not have to force it on the whole system at once.
Early adopters might be fintechs and community banks with relatively simple product lines. Maybe this kind of monitoring could have prevented the subprime meltdown and financial crisis.
From innovators to regulators:
Start small. You will need reglabs or sandboxes as test beds to see how innovations perform, in safe environments where customers can’t be hurt and systems aren’t threatened. Look at how the U.K.’s Financial Conduct Authority is doing regtech “tech sprints,” gathering policymakers, industry, and academics in “hackathons” to fashion new approaches in areas like regulatory reporting and digitizing the rule book.
Progress requires collaboration across the ecosystem, to try things out and learn fast.
From the tech world to policymakers:
If you have an important problem that’s always been unsolvable—either because people disagree on the solutions or just due to the nature of the issue—consider whether today’s technology can fix it, or at least make a big dent.
Again, new technology really is different. It’s not a panacea, and of course it creates some new problems. Still, we can use it to meet huge challenges, including some we’ve traditionally attacked through regulation and public policy, often with poor results. In finance, we can achieve full financial inclusion. We can make it easy for people to manage their financial lives in healthy ways. We can improve regulatory outcomes and reduce costs, at the same time. We can start winning the wars on terrorism, illegal drugs, and human trafficking by actually catching the laundering. We need to come together to do these things, and much more.
For myself, I’m starting into 2018 excited about all these issues. I’ll be tackling financial crimes through Hummingbird and helping foster financial inclusion and health through Barefoot Innovation Group and also continuing to chair the boards of Center for Financial Services Innovation and the newly-formed FinRegLab, which will be conducting empirical research on financial innovation.
I’ll look forward to working with all of you in the new year!
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