The Consumer Financial Protection Bureau is joining a slew of regulatory agencies across the globe to create a fintech regulatory sandbox, and so far the bureau has offered scant details about the effort.
Having conceived the bureau’s sandbox idea two years ago as head of the agency’s Project Catalyst innovation initiative, and having created the blueprint during my last few months at the bureau before leaving in July, I would like to share my personal views on the problems the sandbox should address and the tools that should be deployed.
The bureau’s sandbox should aspire to more than the mere articulation of a pro-innovation stance. There is no question that a sandbox should facilitate innovation and competition, but the bureau ought to clearly spell out how it intends to accomplish these goals. Rather than rushing out specific policy tools on a piecemeal basis, the bureau should first lay out to the public the problems that the sandbox is meant to address.
The bureau’s sandbox should simply reduce two things: regulatory uncertainty and fear.
Regulatory uncertainty results from the tension between rapid-evolving technologies and perennial lagging regulations. A sandbox can offer meaningful learning opportunities to help regulators develop sound policies and rules in the long run.
In my experience, true regulatory uncertainty only accounts for a small fraction of the issues that beset fintech firms and incumbent financial institutions. However, regulatory uncertainty is almost always associated with the most disruptive technologies that have the most potential to serve consumers better. Regulatory uncertainty is also the most challenging, often leaving a firm with two undesirable options: exiting the market entirely or operating in a gray area.
Regulatory fear is an irrationally rational behavior. A firm may not be willing to offer a new product because it fears that its regulator(s) would view the novelty of the product negatively, even though the product may be fully compliant. This is a very sad reality.
A driver should feel confident to operate a vehicle as long as he has proper insurance and a valid driver’s license. He does not need to seek pre-approval from the DMV every time he gets on the road — that would be absurd. Similarly regulators should, to the extent possible and permissible by law, clearly prescribe and enforce the rules that everyone must abide by. The market will take care of everything else. To get to this ideal stage, regulators need to take more initiative to reduce regulatory fear. A sandbox can be used to allow such novel and compliant products a chance to be tested in a live market.
What, then, should the bureau’s sandbox look like? Naturally, many would focus on revising the
Both policies are designed to reduce regulatory uncertainty and should be updated and strengthened. The no-action letter policy is broad in scope but the non-binding nature has made it unattractive to many. The trial disclosure policy is binding but only applicable to federal disclosure testings. Although the bureau can theoretically extend most waivers indefinitely, in my experience, the lack of assurance or commitment from the bureau to update the disclosure rules to accommodate the new form being tested has made the policy really unattractive. More importantly, while there are legitimate complaints that certain disclosure rules are too burdensome or ineffective, I have rarely heard anyone citing disclosure as an obstacle to product innovation.
The bureau can do better, and Congress has already given it the tools to do so. Three major statutes — the Truth in Lending Act, Equal Credit Opportunity Act, and Electronic Fund Transfer Act — contain safe harbor provisions where the bureau can grant “approvals” to a specific product or service or an entire category of products or services. These provisions give the bureau the power to provide more certainty for new financial products that encounter regulatory uncertainty. And unlike no-action letters, which are staff recommendations, approvals are agency actions that are binding in nature and would provide complete immunity from liability. Approvals can be used to relieve both statutory and regulatory requirements. Not only can approvals be issued in cases where genuine regulatory uncertainty exists, but they can also be available for products and services that are not in compliance with applicable laws or regulations — cases where the regulations are outdated and the benefits far outweigh the technical violations.
The approval authority is a very powerful one, and the bureau should use it with great caution. In every application of such authority, the bureau needs to demonstrate to the public its objective and how it intends to ensure consumer protection is not compromised.
The bureau can and should also develop tools to reduce regulatory fear. Simultaneously working to expand its existing research pilot program into a beta testing program and forming meaningful and strong working relations with its sister agencies is essential. Without being overly prescriptive, the bureau should encourage firms to take appropriate risks and pilot more new products and services. To make the beta testing program effective, the bureau must ensure that all relevant agencies are consulted with and fully on board. In particular, the bureau should collaborate with other agencies to revisit third-party vendor risk management guidance to promote more bank-fintech partnerships.
One should bear in mind that approvals, no-action letters, disclosure waivers and beta testing should primarily be intended as short-term measures. The bureau should not be obsessed with these sexy sandbox tools. The real work is the unsexy long term policymaking and rulemaking. Ultimately, the bureau needs to learn from those experiments to modernize the outdated rules that are impeding consumer-friendly innovation. The bureau must usher in a new compliance culture that balances consumer protection and innovation.
These are truly exciting times. Technology is profoundly transforming financial services, from how they are created, delivered, and consumed. Yet we still see much inefficiency in the banking system and a large number of underserved consumers. Regulatory hurdles are often hampering technology to realize its full potential. The bureau has a real opportunity to truly promote innovation and marketplace competition. The new leadership has declared that
