View from the District: Fintech: Balancing the Promise and Risks of Innovation
by Teresa Curran, Executive Vice President and Director, Financial Institution Supervision and Credit, Federal Reserve Bank of San Francisco
One of the hottest topics I am often asked about today is financial technology or fintech, as it is widely known. Fintech is a broad term, but at its core, it refers to the use of technology to better deliver banking products and services. These services could be in the form of lending platforms, payment processes, investments and savings, blockchains, digital currencies, or a host of other areas. In all of these sectors, fintech has the potential to transform financial products and services for consumers and small businesses.
Think about it. Consumers can now use their smartphones and other mobile devices to manage their money, transfer funds, or obtain a loan. This type of accessibility has altered their expectations and demands about when and how they should be able to conduct financial transactions. In my view, the expectation for an on-demand experience is just one of the permanent changes driving today’s innovation.
At the San Francisco Fed, with its proximity to Silicon Valley and the many new fintech firms nearby, the emergence of innovative technology has captured our attention. Some of the latest innovations offer consumers convenience, speed, and reliability, and provide banks the ability to access and analyze big data quicker and sometimes cheaper than ever before. Other innovations can address some of the financial system’s long-standing challenges, including the ability to facilitate direct payments between buyers and sellers and to direct households’ and businesses’ savings to their most productive uses, such as building homes, expanding businesses, or obtaining an education.1
But our excitement is tempered by our resolve to balance these promises by understanding and mitigating the risks of innovation. In certain terms, our goal is simple: to ensure that consumers are protected and that the safety and soundness of banks is maintained. Toward that end, the Federal Reserve System is fully analyzing fintech innovations and their impacts in different areas, including supervision, community development, financial stability, and payments. This effort aligns directly with our role in maintaining the stability of the financial system and containing systemic risk that may arise in financial markets.
In this article, I talk about these efforts and offer some thoughts about why bankers and supervisors should care about fintech.
Why Should Bankers Care About Fintech?
The emergence of fintech has changed consumer expectations around the delivery and types of financial services. Consumers now expect to be able to complete a streamlined loan application online and receive a quick, if not almost immediate, response. They also appear to be embracing new ways to quickly transfer funds to other people, automatically move money to savings, and better manage their finances. As a result of these trends, banks are now feeling increased pressure to update and diversify their delivery mechanisms to stay competitive, particularly in the consumer and small business lending and payments channels.
A recent article in Consumer Compliance Outlook provides a good overview of four fintech market segments: credit; digital payments; savings, investments, and personal financial management; and distributed ledger technology.2 These segments do not encompass the entire fintech landscape, but they are among the areas most likely to impact current banking practices.
In April 2016, I addressed a group of West Coast bankers and discussed many of the trends that we’re seeing in fintech and why bankers should take notice.3 One rising trend is greater collaboration between banks and fintech firms, which can occur through investments, funding, or partnerships that range from loan originations to loan purchases to referral arrangements. We are also seeing bankers create fintech solutions or directly acquire fintech companies to complement their strategic goals.
We don’t yet know which of the various efforts — acquisition, investment, or partnership models — will ultimately survive. But we do know that financial institutions and bankers collaborating with fintech firms must ensure they control for the risks associated with these new products, services, and third-party relationships. While incorporating innovation that is consistent with a bank’s goals and risk tolerance, bankers will need to consider which model of engagement makes the most sense in light of their business model and risk management infrastructure, manage any outsourced relationships consistent with supervisory expectations,4 and have strong fallback plans in place to limit the risks associated with products and partners that may not survive in this dynamic market.
Also, bankers should carefully consider timing issues when deciding to enter the fintech market. For example, early adoption carries the risk of committing to products and partners that may not survive, while waiting too long could mean losing customers and new business opportunities.
Why Do Bank Supervisors Care About Fintech?
The discussions that I’ve had with my supervision colleagues across the Federal Reserve System reveal a strong interest in gaining a better understanding of fintech’s potential and its related risks. For example, we see the opportunity to expand access to financial services, reach underserved customers, reduce transaction costs, provide greater transparency with simpler products and clear cost disclosures, provide greater convenience and efficiency, and enable better control over spending and budgeting.
At the same time, we are concerned about the risks fintech may introduce to both financial institutions and their customers. Fintech has the ability to be a disruptive force, creating competitive pressures for banks in terms of speed, convenience, price, and maintaining customers. Also, fintech lending models raise several questions. How will the models perform over a full credit cycle? How are the requirements for the Bank Secrecy Act, information security, and customer privacy and data security managed, and by whom? And importantly, how is consumer protection ensured? It’s conceivable that innovative algorithms, unintentionally or not, could enable new forms of discrimination or other unfair credit practices.
In the fintech speech I presented in April 2016, I told the bankers that our job, as supervisors, is to find an appropriate balance of oversight.5 For example, as we develop relevant and applicable supervisory policies for fintech, we have to consider which existing regulations and guidance may be either appropriate or ill-suited to capture the set of risks that fintech poses to banks.
Bankers and supervisors alike need to learn more about fintech and develop appropriate strategies to capitalize on its benefits and mitigate its risks. Understanding and taking steps to ensure that a proper balance exists between the promise of innovation and the associated risks are key roles of bank supervisors, and we are committed to getting it right.
What Are Bank Supervisors Doing About Fintech?
Most bank supervisors are taking a measured approach to consider the effect of supervision on fintech. Notable steps taken by other agencies to date include:
- The Consumer Financial Protection Bureau (CFPB) created Project Catalyst to facilitate consumer-friendly innovation;6 it includes a “No-Action Letters” policy, finalized on February 18, 2016, to reduce regulatory uncertainty for a new product or service that offers the potential for significant consumer-friendly innovation.7
- The Office of the Comptroller of the Currency (OCC) released the white paper "Recommendations and Decisions for Implementing a Responsible Innovation Framework" on October 26, 2016.8
- Editor’s note — On December 2, 2016, the OCC announced a further step in its initiative to foster innovation by proposing to allow fintech companies to become chartered as special purpose national banks; see OCC, “OCC to Consider Fintech Charter Applications, Seeks Comment,” December 2, 2016, available at tinyurl.com/ktd3huv.
- The U.S. Department of the Treasury published the white paper "Opportunities and Challenges in Online Marketplace Lending" on May 10, 2016.9
- The U.S. Federal Trade Commission released the report Big Data: A Tool for Inclusion or Exclusion? Understanding the Issues on January 6, 2016.10
- The State of California’s Department of Business Oversight implemented the practice of offering prefiling meetings with its Money Transmitter Division staff to answer applicant questions with the goal of timely application processing.11
- The State of New York’s Department of Financial Services (NYDFS) created BitLicense for companies conducting virtual currency activities in June 2015.12 The NYDFS has since issued four licenses.13
The Federal Reserve System is no different, and it has undertaken extensive efforts to study various technologies and their impact on financial services. Within the System, we have convened several high-level working groups that bring together the best thinkers across the Fed, including economists, payments specialists, supervisors, attorneys, and community development experts. These groups are tasked with understanding potential concerns and proposing solutions that support beneficial innovation.
The System is not alone in pursuing the goal of better understanding the implications of innovation in financial services. Supervisory agencies in other countries are grappling with the same issues, and we are monitoring developments abroad and considering potential best practices. Similarly, we are coordinating efforts with other domestic regulatory agencies to achieve consistency in our approaches.
Ultimately, our goal is to adopt an appropriate balance of oversight that acknowledges both the promise of innovation as well as its potential risks.
The System intends to maintain an active dialogue with innovators, bankers, and other stakeholders to stay informed of developments in order to best fulfill its role of ensuring the safety and soundness of the nation’s banking and financial system and protecting the rights of consumers. Part of that role is considering how to best mitigate risks to financial institutions’ safety and soundness and ensure consumer protection. Since the stakes are generally higher in the area of financial services than in other areas of technological innovation, the System is working diligently to ensure transparency, create a strong compliance culture, and provide safeguards for consumers.
John Williams, the San Francisco Fed’s president, expressed similar ideas in an April 2016 speech. He noted that “well-designed regulation that protects consumers, fosters inclusionary rather than exclusionary practices, and enhances the fairness and resilience of the financial system should help, rather than hinder fintech’s contribution to creating a better financial system and economy.”14
Given some of the lessons learned from the financial crisis about the importance of articulating a clear risk tolerance and the need for exercising sound management to limit risk, it is critical that financial institutions and fintech firms consider the long-term sustainability of the products and services they offer. This will come through continuous, thoughtful conversation on the right use of technology, its value to customers, and the relationships that are built along the way.
Speaking of relationships, I am reminded about an article I wrote for Community Banking Connections in 2013,15 in which I mention that community banks are most successful when they establish deep connections with their customers. The continued viability of the community banking model is in large measure dependent on these connections and the extraordinary service that community banks can offer their customers. Innovative use of technology to offer expanded and improved services is a natural development that we hope to see benefit both community bankers and their customers. It will be up to all of us — regulators and financial institutions alike — to do our respective parts to ensure that happens.
- Federal Reserve Bank of San Francisco 2015 Annual Report video, Transforming Financial Services, www.frbsf.org/our-district/about/annual-report/annual-report-2015/transforming-financial-services.
The author would like to thank Tracy Basinger, Cynthia Course, Tim Marder, and Desmond Rice of the Federal Reserve Bank of San Francisco for their contributions to this article.
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Teresa Curran, the author of this article, passed away in November after a heroic battle with a long illness. She served as executive vice president and director of the Financial Institution Supervision and Credit Division at the Federal Reserve Bank of San Francisco. Teresa was a highly respected leader who made significant contributions to the Federal Reserve System and its banking supervision function. She was passionate about the Federal Reserve's critical role in the economy, held strong regard for the importance of community banks, and was an expert on issues important to banking in Asia. Teresa is greatly missed by her many friends and colleagues throughout the Twelfth District and the Federal Reserve System.
- 1 John C. Williams, “Fintech: The Power of the Possible and Potential Pitfalls,” speech delivered at the LendIt USA 2016 conference, April 12, 2016, available at tinyurl.com/j6roh7j.
- 2 Tim Marder, “Fintech for the Consumer Market: An Overview,” Consumer Compliance Outlook, Third Issue 2016, available at
- 3 Teresa Curran, “Tailoring, Fintech, and Risk Culture: The Talk of the (Community Banking) Town,” speech delivered to the Western Independent Bankers Annual Conference for Bank Presidents, Senior Officers & Directors, April 4, 2016, available at tinyurl.com/zt4ve7g.
- 4 See Supervision and Regulation letter 13-19/Consumer Affairs letter 13-21, “Guidance on Managing Outsourcing Risk,” available at www.federalreserve.gov/bankinforeg/srletters/sr1319.htm.
- 5 See Curran, “Tailoring, Fintech, and Risk Culture: The Talk of the (Community Banking) Town.”
- 6 Consumer Financial Protection Bureau, Project Catalyst, available at www.consumerfinance.gov/about-us/project-catalyst.
- 7 Consumer Financial Protection Bureau, “CFPB Finalizes Policy to Facilitate Consumer-Friendly Innovation,” February 18, 2016, available at tinyurl.com/zkd8px3.
- 8 Office of the Comptroller of the Currency, “Recommendations and Decisions for Implementing a Responsible Innovation Framework,” October 2016, available at tinyurl.com/gwq8ck5.
- 9 U.S. Department of the Treasury, “Opportunities and Challenges in Online Marketplace Lending,” May 10, 2016, available at tinyurl.com/jezxwdn.
- 10 U.S. Federal Trade Commission, Big Data: A Tool for Inclusion or Exclusion? Understanding the Issues, January 2016, available at tinyurl.com/zmjs3dg.
- 11 California Department of Business Oversight, Money Transmitter Division, Money Transmission Act, available at www.dbo.ca.gov/licensees/money_transmitters/default.asp.
- 12 New York Department of Financial Services (NYDFS), Final BitLicense Regulatory Framework, available at www.dfs.ny.gov/legal/regulations/bitlicense_reg_framework.htm.
- 13 NYDFS, “DFS Grants Virtual Currency License to XRP II, LLC, an Affiliate of Ripple” (press release), June 13, 2016, available at www.dfs.ny.gov/about/press/pr1606131.htm.
- 14 See Williams, “Fintech.”
- 15 Teresa Curran, “Considerations When Introducing a New Product or Service at a Community Bank,” Community Banking Connections, First Quarter (2013), pp. 1, 8–11, available at www.cbcfrs.org/articles/2013/Q1/Considerations-When-Introducing-A-New-Product.