T echnology capabilities and customers’ expectations have contributed in shaping the financial services industry. The new upsurge of innovations in financial technology or “fintech” is accelerating change in the financial sector. Fintech conveys both opportunity and potential risks to the traditional understanding/concept of financial services. U.S. regulators are taking steps toward bringing the emerging fintech companies within the agency’s jurisdiction to properly regulate them in a way that protects the public and embraces innovation.
Customer expectations have fundamentally changed. Customers are open to new ideas and look for innovative and real-time services to stay up to speed with their daily needs. These changed expectations opened the door for fintech companies to develop new products and services to satisfy customer needs and facilitated the booming of fintech in several countries around the globe.
The availability of new technology used by experts and talented visionaries drove the development of new products and services, including the use of e-mobile, digital payments, e-commerce, money transfers, personal loans, data and analytics, cloud computing and others. These innovations offer consumer convenience, speed, as well as reliability for some. In addition, the evolving technology enables new risk management techniques and provides the ability to access and analyze big data in a quicker, more efficient and sometimes cheaper way than before.
Balancing Fintech’s Potential and its Risk Management
The financial industry is progressing to keep up with the evolving expectations and improving the customers’ experience and satisfaction by embracing this change as technology and new business models emerge and evolve.
In the face of these rapid changes and coupled with heightened regulatory scrutiny, financial institutions worldwide are required to comply with the applicable laws, rules and regulations. In the U.S., financial institutions need to preserve Bank Secrecy Act requirements pertaining to information security, customer privacy, data security and third-party risk management to ensure customer protection and the safety and soundness of the financial industry. In the EU, the General Data Protection Regulation (GDPR) (EU) 2016/679,1 a regulation in EU law on data protection and privacy for all individuals within the EU, is implemented. This regulation becomes enforceable on May 25, 2018. The GDPR extends the scope of EU data protection law to all foreign companies processing data of EU residents; therefore, it has a worldwide impact.
Fintech’s Risk Management
In addition to regulatory and compliance risks, financial institutions’ risk management functions will also have to cope with new types of risks associated with fintech. As noted by the Financial Action Task Force (FATF): “The greatest risks of Fintech are often the lack of oversight or governance and the anonymity they can provide.”2 Fintech requires new skills and innovative automated tools, including the use of biometric technology and centralized databases as a means of verifying customers’ identities, the development of artificial intelligence and machine learning toward more effective monitoring and screening systems for suspicious financial activity. These tools need to be paired with a compliance culture. In addition, developing an enhanced framework to efficiently and effectively identify and manage fintech’s potential and its related risks may be warranted.
Regtech refers to regulatory technology. Financial institutions are facing challenges balancing regulatory compliance while meeting the demands of outstanding customer service. This resulted in a need to leverage its capabilities in the following ways:
- Provide excellent customer service in a competitive environment counting technology-driven companies;
- Be equipped with innovative tools, including advanced artificial intelligence and robotic automation;
- Ensure that skilled and talented employees are in place to guide the development of innovative tools and to manage its implementation;
- Proactively understand and comply with the regulations and obligations to ensure safety, security and soundness of the financial system; and
- Update the policies, standards, procedures and processes.
In the U.S., the Office of Comptroller of the Currency (OCC) defines responsible innovation as “the use of new or improved financial products, services and processes to meet the evolving needs of consumers, businesses and communities in a manner that is consistent with sound risk management and is aligned with the bank’s overall business strategy.”3 On October 26, 2016, the OCC issued guidance on the “Responsible Innovation Framework.”4
The OCC has established an Office of Innovation and has implemented a framework supporting responsible innovation. The office serves as the central point of contact and clearing house for requests and information related to innovation.
OCC’s release means that fintech companies offering bank-like services and products are required to comply with laws applicable to national banks, as well as consumer protection regulations administered by the Consumer Financial Protection Bureau (CFPB) and the Federal Trade Commission.
The OCC expects that the application of a uniform supervision and regulatory framework will promote consistency and enhance the safety and soundness of the financial system.
On the other hand, at the state level, U.S. regulators are undertaking efforts to streamline and integrate the system of licensing and supervision for fintech companies. In May 2017, state regulators, operating through the Conference of State Bank Supervisors (CSBS), issued a policy statement establishing the 50-state goal.5 On February 6, 2018, seven states (Georgia, Illinois, Kansas, Massachusetts, Texas, Tennessee and Washington) agreed to a multi-state compact that standardizes licensing processes that are in place in order to provide money-licensing services. Other states are expected to join this compact.
Key regulators working with fintech include the following:6
- The Federal Reserve: The primary federal supervisor of state-chartered banks has chosen to join the Federal Reserve System. The Fed also supervises all bank holding companies, which in many cases have subsidiary banks supervised by other agencies. In addition, the Fed fosters payment and settlement system safety and efficiency
- Federal Deposit Insurance Corporation (FDIC)
- States’ banking agencies
- Commodities Futures Trading Commission (CFTC)
Financial institutions have recognized the new competitive landscape of fintech, embraced the change and started engaging with external technology solutions and changing their organizational culture by attracting new skills and discovering new areas of growth. Big financial institutions will utilize fintech partnerships to integrate the back-end infrastructure of data gathering, analytics and machine learning with their research departments.
Partnerships between financial institutions and fintech help create better products and services and deliver them more efficiently. In addition, working together on mutual goals will take into account the customer-friendly space and build a financial system that works for everyone.
- “Regulation (EU) 2016/679 of the European Parliament and of the Council of 27 April 2016 on the protection of natural persons with regard to the processing of personal data and on the free movement of such data, and repealing Directive 95/46/EC (General Data Protection Regulation) (Text with EEA relevance),” EU Publications, April, 27, 2016, https://publications.europa.eu/en/publication-detail/-/publication/3e485e15-11bd-11e6-ba9a-01aa75ed71a1/language-en
- David Lewis, “Accessibility of Financial Services: Challenges and Opportunities for Development,” FATF, July 1, 2016, http://www.fatf-gafi.org/publications/fatfgeneral/documents/speech-international-financial-congress-july-2016.html
- Jason P. Boova and Rory M. Birmingham, “Industry Advisory: OCC Aims to Promote Innovation in Traditional Banking,” Treliant, April 19, 2016, https://www.treliant.com/News-and-Events/Announcements-and-Releases/Announcements-Details/ArticleID/26991/INDUSTRY-ADVISORY-OCC-Aims-to-Promote-Innovation-in-Traditional-Banking
- Bryan Hubbard, “OCC Issues Responsible Innovation Framework,” Office of the Comptroller of the Currency, October 26, 2016, https://www.occ.gov/news-issuances/news-releases/2016/nr-occ-2016-135.html
- “State Regulators Take First Step to Standardize Licensing Practices for Fintech Payments,” CSBS, February 6, 2018, https://www.csbs.org/state-regulators-take-first-step-standardize-licensing-practices-fintech-payments
- “Key Regulators Working With Fintech,” Federal Reserve Bank of San Francisco, https://www.frbsf.org/banking/fintech/regulators/