Why It’s Critical to Get Fintech Regulation Right

A so-called regulatory sandbox proposed by U.S. lawmakers could pave the way for sensible fintech regulation.


Preventing future financial crises is a matter of creating better financial instruments, Nobel-winning economist Robert Shiller wrote in his 2012 book Finance and the Good Society. To that end, the right fintech tools would go a long way toward encouraging innovative and healthy development in the finance sector. While a so-called regulatory sandbox to play in is probably not the structure Shiller had in mind to create these better financial instruments, American lawmakers are proposing such a solution, following in the footsteps of the United Kingdom, which unveiled a similar initiative earlier this year.

This sandbox, part of a bill that was introduced in the House of Representatives on September 22, is meant to facilitate the growth of finance technology in the U.S. by giving fintech companies special exemption from certain regulations (namely, permitting them to roll out products to consumers on a trial basis without having to put them through the full regulatory wringer before launch). “We have this wide variety of prudential regulators, and their responsibility traditionally is to kill it before it grows,” Representative Patrick McHenry (R-NC), who introduced the bill, told the Wall Street Journal . “We want to have a mind-set shift in how regulators function, and we want them to be responsive in order to enable financial innovation and . . . to drive it forward.”

McHenry’s bill is coming at a critical time in the life of the fintech industry, as interest in finance technology has increased and companies are starting to deliver. There’s no question that fintech businesses are going to make significant changes to the financial services sector worldwide. For an example, look at blockchain technology , which even central banks are considering adopting. And given that financial services is a highly regulated industry, the growth of fintech disruptors and innovators is of much interest to Washington and other political capitals around the globe.

Of course that means the fintech industry is already on the radar of regulators and lawmakers, as insiders know. (This is perhaps because American finance technology infrastructure trails that of other developed nations — for instance, in the U.K. bank customers can send money to customers at any other bank in a matter of minutes; such a transaction would take far longer in the U.S.) Earlier in September the House passed legislation that is its first fintech-related resolution, according to American Banker . This resolution, known as HB 835 , was rather innocuous, calling for “a national policy” to foster technology development that “maximizes the promise customized, connected devices hold to empower consumers, foster future economic growth and create new commerce markets.”

Meanwhile, the Office of the Comptroller of the Currency — which regulates all federal and some state-chartered savings banks — is in the process of developing a so-called fintech charter. In a speech at the Marketplace Lending Policy Summit last month, Comptroller of the Currency Thomas Curry laid out his plan.

“If we at the OCC do decide to grant limited-purpose charters in this area, the institutions who receive the charters will be held to the same strict standards of safety, soundness and fairness that other federally chartered institutions must meet,” he said at the summit, later adding, “We want a framework that encourages and promotes advances in products, services and processes that serve consumers, communities and businesses better and more fairly.”


But how does financial regulation affect the economy? The answer is difficult to quantify. A 2014 study said that banks spent $35.5 billion more on regulatory costs in 2013 than they had in 2007, a whopping $70.2 billion in total. But this figure, the amount banks spent on compliance, lacks context and does not factor in any positive or negative effects from the implementation of these rules. On a larger scale, Dodd-Frank is only six years old, and not all of the legislation has even been implemented at this point; a true accounting of its benefits and costs is years away. (Regarding Dodd-Frank, it is also important to point out that the legislation has had the unintended consequence of solidifying incumbent firms and raising the barrier of entry; a sandbox, therefore, may help remedy this, as compliance costs can be a huge burden for start-up companies.)

Some argue that regulations stifle growth; others say they are critical to it. To me, regulation — specifically, sensible, nonobstructive regulation — is crucial to the success of the free market system; nonetheless, as Raghuram Rajan and Luigi Zingales wrote in their 2003 book Saving Capitalism from the Capitalists , the key to maintaining the free market system is not a question of more or less regulation but a matter of getting the regulations right. For Rajan and Zingales, both finance professors at the University of Chicago’s Booth School of Business, that means government rules that provide a level playing field.

“Markets need political support, yet their very function undermines the support,” they noted. “As a result the market is a fragile institution, charting a narrow path between the Scylla of overweening government interference and the Charybdis of too little government support.”

Regulations specifically targeting fintech should seek to reduce the asymmetry of financial information between those on Wall Street and those on Main. They should also strive to make human interactions with the technologies safe. Fintech is too important to the future of the American and global economies to get wrong.