The Rise of Fintech Highlights the Need for an Innovative Regulatory Framework

While sensible regulatory oversight of fintech is necessary, over-regulation can have a chilling effect on innovation and pose significant barriers to entry to new market participants—all of which would increase costs to consumers, limit choice, and reduce the quality of service.

Fintech is a relatively recent term for a centuries-old concept: the use of technology to facilitate delivery of financial services. Financial innovation dates back to the first transfer of signatures by telegraph in the 1860s, but it took a lengthy pause—as noted by Paul Volcker ,who once quipped that the ATM was the most important financial innovation he had seen in the past 20 years. Innovation resurged after the 2008 financial crisis with the introduction of cryptocurrency and other alternatives to traditional financial services delivery models. 

Further fueling the revival of financial innovation was the ubiquity of smartphones and the widespread introduction of mobile apps which helped expand the scope and reach of financial services—giving rise to the concept of Banking-as-a-Service (BaaS). 

This paradigm shift paved the way for new market participants and ultimately a redefinition of the concept of banking. By the time Angela Strange of Andreesen Horowitz declared that “every company will be a fintech company,” consumers had already shown a willingness to use non-bank companies such as Apple and Google to conduct financial transactions.

The need for innovation in fintech regulation

From debates over chartering authority to crackdowns on new forms of currency, regulators have tried to rein in some aspects of fintech while encouraging others. As an emerging industry, Fintech occupies a new space, much of which falls outside of the scope of existing regulations that were designed for traditional banking models. The most clear example of this is cryptocurrency which, as a newer technology, presents not only its own set of unique regulatory risks but also new challenges related to existing regulatory risks, such as money laundering risk in the context of a decentralized medium of exchange.

Fintech startups argue that increased regulations will raise costs and discourage innovation, while proponents of traditional banking models have raised concerns regarding inequities in regulatory burden, such as exemptions from Bank Holding Company Act and Community Reinvestment Act requirements. Some have argued that the traditional regulatory framework, which may be described as “entity-based,” should be rethought in light of the rise of fintech, advocating for a transition to an “activity-based” framework.

Among federal banking regulators, the OCC has taken the lead in advancing financial innovation by establishing the fintech charter and authorizing national banks and federal savings institutions to use innovative technologies, including independent node verification networks (INVNs) and stablecoins (cryptocurrencies designed to minimize price volatility) for payment activities. While it remains to be seen whether the OCC will continue to embrace fintech to the same degree the agency did under the previous administration, a significant change in course is not expected.

Implications for traditional banking

Growing customer expectations for on-demand delivery of financial services, which became critical during the pandemic, have accelerated the need for financial services innovation. While consumer expectations may have grown beyond traditional delivery systems, existing financial service providers that embrace fintech innovation are better positioned to retain customers and leverage expanded service offerings to grow their existing customer base.

Johnston Clem Gifford has an experienced team of lawyers dedicated to understanding the complexities of the financial services industry. We have become trusted advisors to our clients and thought leaders in the financial services legal market. Contact us online or by calling (214) 974-8000.