Regulators can’t afford to wait any longer in developing a framework for their oversight of the fast-rising fintech sector. The number of fintech companies, and the amount of investment in them, is growing too rapidly for regulators to hope that they can supervise the sector by applying existing regulations for banks to fintech companies on an ad-hoc basis. That will only create gaps in regulators’ monitoring of the sector, and confusion among fintech companies trying to grasp the complexities of financial regulation in the U.S. Such gaps and confusion are already evident: Many fintech companies are failing to implement best practices in securing customer data, and many of them are also unaware of how existing regulations apply to them.
I addressed the security issue in a previous article, but regulators should be just as concerned with clearing up the confusion in the market. That’s because the government has a legitimate interest in encouraging fintech growth, which would be boosted by a clear regulatory framework. Some fintech companies serve customers that have been ignored by banks in recent years, bringing them into the financial system. For instance, companies like OnDeck Capital, Kabbage, Lendio, Square, and others are filling the credit needs of small businesses that banks have been hesitant to lend to ever since the Great Recession. Regulators should be careful about imposing standards that gash this new source of credit for underserved small businesses. Also, some new technologies that fintech startups are working on, like the blockchain, can improve regulation and compliance throughout the financial services industry.
Build Relationships Early
How can regulators help foster innovation without sacrificing security and integrity in the financial system? For one, they should start their interactions with fintech companies as early as possible to encourage innovation while also safeguarding customers. This means providing guidance to companies while they are still developing and experimenting with their solutions, so companies can incorporate compliance into their products early on. If regulators wait to offer guidance until after products have already been developed or released on to the market, then regulators will become an unnecessary obstacle to innovation.
U.K. regulators are taking steps to develop relationships with fintech startups early on to offer guidance on their solutions. At the end of 2014, the U.K.’s Financial Conduct Authority (FCA) announced it would launch a regulatory “sandbox” where fintech companies could test new solutions. When companies use the sandbox, the authority waives some of the compliance requirements normally applied to pilot tests for new products. Banks can also use the sandbox, and the authority guarantees that it won’t take enforcement action at a later date regarding any tests that the banks run. The sandbox experiment will go live later this year, and U.S. regulators should watch it carefully and explore similar initiatives.
Regulators also need to give fintech companies a hand in navigating the complexity of the U.S. financial regulatory system. There are so many different regulations and so many different agencies enforcing them, it creates a landscape that can easily overwhelm a small startup. Banks can sympathize with this issue; but fintech companies don’t have the compliance budget, knowledge and experience that banks do.
One way to eliminate all of this confusion would be to create a separate regulatory agency for fintech companies, but there are such a wide variety of fintech companies now offering solutions in almost every category of financial services, one agency couldn’t deliver effective oversight with such a broad scope of coverage.
Instead, existing regulators need to be more proactive in their outreach with fintech companies. Engaging with new startups as early in their development as possible will help with this. Regulators could further eliminate some of the confusion in the market by creating a central registry for newly formed fintech companies before they launch their products. The registry would collect some information about the company and its work. That information could then be used to determine which regulatory agencies it should report to, and provide some guidance on which requirements it must be mindful of.
Some fintech companies will certainly be averse to more regulatory oversight. However, a more refined regulatory framework that ensures security and eliminates confusion will be a blessing for the fintech sector. Right now fintech regulation is a big question mark, and a critical risk for fintech investors. Removing that risk will improve investors’ confidence in the fintech sector, helping fintech companies gain the venture capital they need to get off the ground.