New Rules for Digital vs Traditional Banking

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It is the greatest magic trick in modern history. A string of fintech and crypto companies across the globe collapse and seemingly lose track of billions of dollars, but the blinding glow of technology continues to mesmerize everyone to the risks. The contrast in the financial services industry is stark. Banks are not permitted to budge without extensive regulatory approvals and oversight, but financial technology companies can introduce new forms of money and payments systems with far less regulatory review. It raises a fundamental question: Should the United States continue to regulate financial services based on what companies call themselves rather than what they actually do? 

Technology has managed to acquire a Teflon veneer because of its sense of inevitability. There is no more over-used word in government and private sector reports evaluating technology these days than “innovation.” Innovation is indeed a pillar of dynamic economies, but it isn’t a shield that obscures issues that require thoughtful consideration. Just because technology has the ability to take a picture of our homes from space, collect information about us and dissect it thousands of different ways, it does not mean that these are lawful or appropriate intrusions into our lives. Yet, by the time such questions are asked, there seems to be a collective throwing up of hands because the world has moved on as practices become a fait accompli. The horse is often long gone from the barn by the time someone asks for a legal opinion determining who owns it. 

The innovation that technology can create should be encouraged, but its novelty should not automatically make it immune from conformity to traditional concepts of financial safety and soundness. Indeed, when it comes to financial services, perhaps fintech products and delivery channels would be better under the regulatory umbrella enjoying its benefits and adhering to the responsibilities that are imposed on those who handle other people’s money. The problem is that technology is underscoring how broken and obsolete the current system of financial regulation is.

Congress needs to drag itself into the 21st century and evaluate in the clarity of today’s light what types of financial companies should be prudentially regulated and to what degree, whether they are commercial banks, S&Ls, mortgage bankers, investment companies, fintechs or asset managers. Prudential regulation should no longer be determined simply according to whether a company is an FDIC-insured bank. 

In the 1930s, when the basic structure of financial regulation was established, it made sense because banks controlled 95 percent of the flow of the country’s economic dollars. Measuring the market today simply by the total bank deposits and assets under management with mutual funds, money market funds, hedge funds and private equity funds, banks now control less than 40 percent of those dollars.

In short, even before considering the growing impact of fintech companies, policymakers now devote the vast majority of their regulatory resources to overseeing the safety and soundness of entities that make a little more than a third of the country’s financial services system. 

The inconsistencies in the system are glaring when it comes to fintechs, cryptocurrencies and other digitally-based companies. Federal and state laws scrupulously control who can own as little as 10 percent of a commercial bank’s equity simply because such investors might influence its decisions.

Such concerns appear to be irrelevant in the fintech world. No authority regulates or limits those that mine more than $250 billion of cryptocurrencies around the globe, notwithstanding reports indicating that almost 50 percent of some are mined in China.

Banks are subject to stringent capital, liquidity and reserve requirements overseen by multiple federal and state regulators. Non-bank companies can register or license similar financial services with little or no such prudential oversight.

If financial regulation has a purpose, and I believe that it does, it needs to be responsive to the state of financial markets. When only a portion of the financial risks in the economy are being regulated, events like the 2008 financial crisis are easily understood. Such approaches incentivize the most severe financial risks to migrate to unregulated sectors of the economy where regulators are less likely to be watching.

As long as the country maintains such an illogical and ineffective system of financial oversight, it will continue to experience catastrophic collapses of the economy. Indeed, large financial players are increasingly appreciating that the greater the risks taken, the more successful they will be in the short term, while the government will bail the economy and them out in any long-term financial meltdown.

Politics, administrative bureaucracies, money and inertia all play a role in maintaining this status quo. But the advancement of fintech and new technologies such as artificial intelligence, Cloud computing and eventually quantum computing are shoving fundamental questions directly into our faces and challenging us to develop more effective and equitable forms or financial regulation. We ignore this opportunity at our peril. 

I have been an advocate of financial advancements through technology for more than 40 years. Fintech has indeed created dynamic ways to deliver financial services, many of which are now peer-to-peer verification systems that do not require trusted intermediaries such as banks. But they are not necessarily less systemically threatening. A smart rebalancing of all financial regulation would both turbo charge innovation by putting competitors on a leveler playing field and ensure greater economic stability. We should tip our hats to technology for underscoring how much the regulation of financial services is in need of renovation. 

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