Fintech Wave Could Flood “Too Big to Fail”

Fintech companies may become victims of their own successes as they increasingly come into regulatory crosshairs, but substandard economic growth rates and increasing banking sector concentration make a strong case for shifting in the direction toward laissez-faire.

GDP growth limped along at 1.5 percent in the Obama years. President Trump’s budget envisions getting to 3 percent. By comparison, policies advocated by JFK resulted in a real GDP increase of 6.6 percent in 1966.

With many frustrated by the Obama years’ new normal, creative destruction as explained by Joseph Schumpeter should be allowed to play out. Fintech — financial technologies — is already performing creative destruction in making banking easier and more democratic. More competition in banking may subtly bury the idea of “too big to fail” and lessen risks to the financial system. Competition has waned in recent years with the Dodd-Frank Act further tilting the field toward big banks.

In explaining Schumpeter’s insight and contrasting it with the neoclassical economics of Alfred Marshall, Herbert Hovenkamp wrote in a 2008 posting on Competition Policy International’s website: “This endless process displaced older technologies to make room for new ones, but led to economic growth far greater than more stable, conservative alternatives.… Neoclassical competition is a little like watching the ocean when it is calm while Schumpeterian competition is like watching a raging storm or perhaps even a tidal wave.”

Fintech is a tidal wave, but whether you find the water refreshing may depend on where you work. Big bank Citigroup is forecasting a loss of another 1.7 million jobs in the banking sector over 10 years, according to a 2016 story in the Financial Times. But the share of the losses will fall disproportionately on traditional banks. Lending and payments are two important areas where fintech companies are making advances against traditional banks, Citigroup said in a 108-page report.

The fintech sector is expanding impressively, with global investment tripling to $12.2 billion in 2014 from $4.05 billion a year earlier, according to an Accenture study published in 2015 through the consulting company’s subsidiary FinTech Innovation Lab London. The United States has been drawing the largest share of investment in fintech (close to $600 million in 2014), although Europe had the highest growth rate (215 percent) in 2014, the study found.

After 2014, 2015 was another bang-up year, with global fintech investment growing 75 percent to $22.5 billion, Accenture said. More than $50 billion has been put into 2,500 companies since 2010 with rainmaking venture capitalists, private equity firms, corporations, and other players trying to create the next big wave of change in how people store, save, borrow, move, spend, and protect money, the consultancy said.

“Fintech touches not just the financial services sector, but every business the financial services industry deals with (which is to say, all of them),” Bernard Marr wrote in a February column for Forbes.com. “Fintech startups are small and agile, able to disrupt the lumbering behemoths that are traditional financial institutions and innovate quickly – and your business can use that to your advantage.”

Alibaba, Amazon, Apple, Facebook, and Google are among the companies refining customer experiences and “increasingly playing around the periphery of financial services” as fintech reaches for its next level of maturity and further penetrates the mainstream, Accenture surmised.

PayPal, founded in 1998, is probably the best-known major fintech player with abilities that include delivering money to customers in more than 100 currencies. Annual revenue in 2016 at the San Jose, Calif.–based company rose 21 percent to $10.84 billion from a year earlier, with mobile-payment volume rising 55 percent to $102 billion.

Such a swarm of players and accompanying industry growth draws the eyes of regulators with their own ideas about the pace of change and proper management. As a study by another major fintech-sector observer, Deloitte, noted, “Federal regulations are not new but direct federal supervision would be.”

The study, published in January 2017, was produced by the tax-and-advisory company’s Washington-based Center for Regulatory Strategy Americas and is titled “The Evolving Fintech Regulatory Environment: Preparing for the Inevitable.”

The Securities and Exchange Commission and the Federal Reserve Board have held workshops and forums “focused on maintaining a secure financial system while encouraging innovation,” Deloitte said. The Consumer Financial Protection Board has leveled enforcement actions on fintech-marketplace lenders and payment firms, and is now accepting complaints on consumer loans from marketplace lenders.

The largest regulatory iceberg was set in motion by the Office of the Comptroller of the Currency. In December 2016, the agency issued the third of its fintech “white papers,” in which it proposed creating a special-purpose national bank charter available to fintech companies that offer non-deposit-banking products and services. The paper sought public comments that were due by January 15 of this year.

The OCC effort provoked pushback from state regulators. As detailed in the Deloitte report, New York State Department of Financial Services Superintendent Maria Vullo opposed “any effort to federalize what the states have been doing – and doing well – for over a century.” Echoing Vullo’s statements that state regulators are “best positioned” to give the most benefit to fintech companies as well as consumers, the Conference of State Bank Supervisors called the OCC’s plan “fatally flawed.”

Fintech companies, including marketplace lenders and payment companies, are subject to certain federal regulations, the Deloitte report noted. Besides the CFPB, the Federal Trade Commission and the Department of Justice enforce certain consumer-protection laws and regulations, and all can bring actions against fintech companies for noncompliance.

The CFPB has also raised issues dealing with consumer data and privacy. Satisfying these concerns means fintech companies must protect consumer information with “robust” data-security measures and controls that are thoroughly tested on a regular basis to ensure they work as promised, Deloitte said.

Certain fintech companies, especially those that qualify as money-service businesses, are subject to the same anti-money-laundering provisions under the Bank Secrecy Act as other financial institutions, with enforcement carried out by the Financial Crimes Enforcement Network and the Department of the Treasury’s Office of Foreign Assets Control. In addition, relationships with banks may make all fintech firms liable to safety and soundness requirements included in the BSA and other laws, Deloitte said.

“Regulators are asking banks to ‘know your customer’ (KYC) and, in turn, bank management is asking the same question of fintech firms, which banks underwrite, take deposits from, and transact with as customers,” the report states.

Addressing the question of whether federal or state regulation is best, Deloitte said, “It depends.”

“Each fintech organization has unique goals, products, opportunities, and challenges. The OCC is now in the process of identifying the standards for obtaining and maintaining a charter. States may also collaborate to rationalize the licensing processes to encourage fintech oversight at the state level. While there are many unknowns, the regulatory standards are expected to be rigorous, and companies should increasingly expect to be held to the same standards as applied to the banking industry.”