FinTechs & Banks – Balancing Innovation and Competition

This week The US Treasury issued a report, Assessing the Impact of New Entrant Non-bank Firms on Competition in Consumer Finance Markets. The report examines the current state of innovation and competition between banks and non-bank financial service providers and makes several recommendations. John and Elliot discuss key aspects of the report and the recommendations. They also talk about how the recent collapse of the cryptocurrency exchange FTX may influence the approach of legislators and regulators going forward.  

FinTechs & Banks – Balancing Innovation and Competition TRANSCRIPT

Elliot Berman: Hi, John. How are you this week? 

John Byrne: Good, Elliot. How are things going? 

Elliot Berman: Good. The weather's turned more wintery here. We haven't had much snow, but it's gotten quite cold. But that's not unusual for just before Thanksgiving here in Wisconsin. I assume you're still having sort of that nice glide path fall that you have in Northern Virginia.

John Byrne: Yep. So far, so good. I think it's gonna be this way for a few days, so at least through the next three or four 50 degrees, and I can't complain. So, hey, a bunch of things have happened. Obviously, we had the elections in the United States, so there'll be some changes, legislative seats, as they say, coming in 2023.

But for our purposes, having done this for many, many years, typically money laundering and related topics, even including what we're gonna talk about today, tend to be fairly bipartisan. So I don't really see changes. Even though the changes are aren't gonna be major, the Senate stays the same, and the house is only gonna be slightly Republican.

I don't think it's gonna change the focus on digital assets, cryptocurrency, and then obviously, as we've talked about in many of our conversations, money laundering sanctions and terrorist financing. But a lot in the past couple of days, we thought it made sense to mention, and obviously, one of the big things happens to do with what occurred with FTX. So without going through it in detail, here are a couple of things that are outcomes of that collapse. One is the house, in early December, is going to hold a hearing on the financial services committee on the collapse of FTX and broader consequences for the ecosystem of digital assets.

And then the Secretary of Treasury, Janet Yellen, just released a statement earlier this afternoon. We're recording this on Wednesday, and she says, I'm quoting, "the recent failure of a major cryptocurrency exchange and the unfortunate impact that has resulted for holders and investors in crypto assets demonstrate the need for more effective oversight of cryptocurrency markets." And she references the president's working group on financial markets and the executive order on digital assets. And a study we're gonna mention in a moment, but I think all this means is that there's gonna be a lot of focus on whether or not current regulations and current oversight are sufficient.

You know, given how relatively new this part of the financial industry is. And so based on those two things, the Yellen statement and the announcement by the house, there was also a report released by Treasury earlier this week from the White House Competition Council. And it's got a lengthy title, but assessing the impact of new entrant non-bank firms on competition in consumer finance markets.

What were some of the big takeaways from that report? 

Elliot Berman: It's interesting. The report's been in the works for the better part of a year. Secondly, as that lengthy title talks about, a lot of the report is about how non-banks and non-bank relationships with traditional banks are insured and depository.

How that's affecting competition. But there are some, and there are several recommendations which we can talk about in a moment. But I think for me as, you know, a bank regulatory lawyer for many years, I think some of the conversation or text in the report, the impact of regulation and the purpose of regulation is an important place to start, particularly in light of both the House Financial Services Committee plan for a hearing and Secretary Yellen's comments.

And that is that when you really get down to it, the bank regulatory structure in the United States is about the safety, soundness, and stability of the financial system coupled with consumer protection. So we're certainly seeing that many people who were holding their crypto assets at FTX have been hurt.

And it's not clear what the result will be for the organizations in bankruptcy. So that process will grind away. But which consumer protection regimes might apply needs to be clarified. And there are many other FinTech financial service providers other than exchanges. Certainly, many of the peer-to-peer payment mechanisms and others like that.

There are Neobanks that are operating totally online with a broad range of financial services, including taking deposits. But since they're not insured depository institutions, they're doing it under some kind of a shared arrangement where those deposits are really being held at traditional banks.

So coming back to your question, what are the big takeaways? I think one of the takeaways is that the Treasury's very interested in figuring out how to balance innovation, competition, and protection. And that is a tough three-legged stool, to be honest. Because innovators will generally say, just get out of my way, we can make it better. Competitors will say, I want a fair, competitive landscape. But everybody then argues about what fair means, and protection and stability tend to be governors of rapid innovation. And they talk about all of that in the report, but again what we saw with FTX, which was something that, you know, so very rapid disintegration of a huge pile of assets that now with a lot of people being stuck. That's going to get regulators and legislators saying, well, we have to look at this now.

There are some people who are big innovation supporters who will say it'll all work out. Let's give it a chance. They probably didn't have a lot of money tied up at FTX. But we'll have to see. Did you take a look at the recommendations in the report? 

John Byrne: Yeah, but I also wanted to highlight the section on the risk because one of the things from our world, you know, they talked about sort of toward the end of the report, reliability, and fraud, and they said a few things that I thought were particularly compelling, and they say that issues with that reliability are widely cited concerns with the provision of digital financial services and, they say consumers may not recognize that they're not transacting directly with a depository institution when they use what they're calling a non-bank Neobank, which is a relatively new term that I wasn't aware of.

And they also mention that this goes back to the whole issue of you could access and de-risking. Additionally, they said that the CFPB had received a number of complaints related to certain Neobanks, but consumers reported sudden account closures, unexpected loss of access to their funds, and alleged cases of fraudulent transactions in which consumers reported major challenges in seeking remediation. So we have enough fraud going on. They said one study said nearly 18 million Americans were defrauded through P2P or digital wallets in 2020. So fighting crime, as they mentioned, is a major expense. The total amount projected of compliance in this report for 2021 was 49.9 billion across financial institutions only in the US.

So that's also, I think, an area of focus for our community in terms of that. You know, there's going to be more studies, but it all comes down to what I mentioned earlier, and that is will there be additional regulation, federal level, state level, both, you know, that sort of thing.

And so I think that's pretty important. But on the recommendation side, they talk mainly about how federal banking regulators can use their existing authority to make sure there's competition, make sure there's proper oversight, that is commensurate with the risks, of course, as they're doing with traditional banks.

And they had five categories of recommendations, including competition, as I mentioned. Enabling competition in responsible consumer credit, underwriting, effective oversight of a bank, FinTech relationships, and competition again with small-dollar lending. And one of the areas they spend a lot of time on is secure data sharing.

So they talk about privacy and data sharing quite a bit in this study as well. 

Elliot Berman: Yes. And that's an ongoing challenge. And, of course, in other parts of the world, the UK and Europe. In the European Union, where our company operates, consumer privacy protections at the country level are substantially higher than they are in the US.

We have some protections here and in some states, California initially, but more states now. Are enacting stronger data protection and privacy regimes. But, it is a growing risk and a growing concern. I think the thing that I scratched my head about just a little bit in reading the Treasury report was their recommendation about bank regulators using their existing authority. That works to the extent that they're going to modify existing regulations and, even without doing that, change their examination procedures to look at how banks are partnering with non-banks. How are those relationships being managed, and is there adequate risk assessment?

But without probable change, you know, new legislation or amendments to existing legislation, I'm not sure how far they can truly get to reaching some of the non-banks who, at the moment, sit outside their regulatory schemes. We know that, for example, they have the regulators mean, in this case, FinCEN has extended a good share of the Bank Secrecy Act regulations to crypto exchanges coming back to that through definitions by defining them as MSBs. But I don't know how that works up and down the regulatory schemes. 

John Byrne: Right. So a lot more to come on this. Elliot, do you wanna mention that next week we'll be pulling This Week in AML out of our archives since it's Thanksgiving week?

Elliot Berman: Yeah. So last year, we set a precedent, and for Thanksgiving, it was the first time we hadn't been live for one. And so we took Thanksgiving week and Christmas week off last year. We're gonna do that again. We're gonna be running an archive edition. It's something that we did earlier in the year on elder financial abuse, which we think is an important topic.

That should stay on everybody's list. It seems to be more prevalent at this time of the year and with all of the other activities going on online and things like that. So we'll be doing that, and then we'll be back the week after that, which will be the first Friday in December, with a live event.

John, you wanna mention the December webinar? 

John Byrne: Well, the December webinar, broadly based, is on corruption. We will have a couple of investigative journalists that are, as we speak, working on several projects that they believe will be completed by the time of the December 15th event. So more to come on that, but obviously, corruption is a major issue in our community, and they will cover that as, as good journalists always do, making sure everybody's aware that it's a broad-based problem.

I would just say that as you hear this, we'll already have had the November event Counter-terrorism Financing Across the Globe. And what we'll be able to do with you in the future is share excerpts of that going forward. So that's always an important topic for our community.

Elliot Berman: Right. And when you hear this edition on Friday, you will be able to register for the December webinar at our website, amlrightsource.com. John, good to talk to you. We had some technical difficulties, but we finally got to the finish line.

John Byrne: Hopefully, we'll fix them going forward. But yes, enjoy the rest of your week and Thanksgiving, and we will talk soon.

Elliot Berman: Sounds great. Bye-bye.