Regulatory Uncertainty Is Stifling Innovation in Payments

Those of us with gray hair may remember how, in its heyday, IBM could freeze markets and competitors with a simple announcement about new product developments or changes to a product road map. Buyers would stop, wait and often abandon purchases from IBM competitors based on these communications. The industry acronym for that effect was "FUD": fear, uncertainty and doubt.

FUD results from unclear market communications, intentional or otherwise. Although unintentional, missteps in communications by regulators can engender a similar effect on banks and technology companies engaged in developing financial innovations. Some recent examples:

The Federal Deposit Insurance Corp. had to withdraw its list of high-risk merchants because the list, created to provide guidance, became conflated with the Justice Department's Operation Choke Point. But rather than settle the issue, the withdrawal has left bankers and technology companies that play in these market segments ill at ease and waiting to see what happens next. For example, payment innovators depend on banks for back-end processing. There is effectively a moratorium on new third-party processing relationships, especially for startups with nontraditional offerings. The next Simple may die on the vine looking for a bank partner.

Recently, technology companies have been looking at extending Check 21 to fully electronify checks, that is to create, deposit, and clear checks virtually (known as electronically created items, or ECIs). The industry pursued this with support from the Federal Reserve's Retail Payments Office. When the Fed discontinued these efforts in June, companies participating in the project were left in the lurch. One reason given was that with declining check use, there was no need to pursue it. But the Fed missed the point: ECIs are not about paper truncation but rather a competitive method of payment leveraging the ubiquity of Check 21 processing. Worse yet, the ECI concept is now tainted; while companies such as VerifyValid and Global Standard Financial have spent considerable effort developing and promoting ECI solutions, banks considering these offerings cannot be sure if the Fed is simply focused elsewhere or actively discouraging the use of ECIs.

Meanwhile, the ongoing dispute between the Federal Trade Commission and the Federal Reserve Board over remotely created checks leave innovators frozen in their tracks. In response to the FTC’s proposal to ban such checks, the Fed's Marie Gooding stated that doing so could "stifle innovation that includes the legitimate use of electronically issued payments. ... " ECCHO president David Walker writes that the changes may signal to consumers, merchants, and banks that RCCs are "inherently 'flawed' " and that the rule's halo effect could discourage other "market-driven payment innovations." These overlaps are getting worse, and banks—especially small institutions—may simply opt out of innovation when faced with potentially getting caught in a regulatory crossfire.

These and other instances stifle innovation in payments and other areas, and the U.S. could be left behind as a result.

For comparison, the U.K. government is aggressively partnering with industry, looking to turn the country into a hub for Bitcoin, among other innovations. Chancellor George Osborne (the U.K.'s equivalent of Treasury secretary) remarked at a recent industry event, "I'm here today because I want the U.K. to lead the world in developing fintech. That's my ambition -- short and sweet." While the U.S. financial system is different from the U.K.'s in many ways, we must take all necessary steps to cultivate innovation and eliminate obstacles wherever possible.

Regulators can adapt in the following ways:

Communicate better. Communications must be precise, telling bankers what's in and what's out. In this new environment, over-communicating what is not circumscribed by regulatory changes helps to create running room for innovators and gives banks assurance they will not run afoul of regulatory constraints.

Let innovators innovate, let the market delineate. Regulators play a critical role in the ongoing development of the nation's payment system. But they should refrain from steering on specific technologies and avoid communications that appear to prejudge potential innovations; "good" approaches will win out over "bad" ones when market forces are applied—as they always do.

Stay in touch. The regulatory process is and must be deliberate. But banks and technology companies fill in the gray space created by pending changes with assumptions, extrapolations, and outright rumors. Industry liaisons should provide a clearinghouse function—aggressively—to eliminate confusion and provide early guidance to technology innovators and their bank partners.

By recognizing banks' heightened sensitivity to regulations and taking steps to improve communications, regulators can broaden the involvement of banks in bringing financial innovations to market. Greater involvement by more institutions would accelerate innovation, improve the efficiency of the payment system, and yield dividends for both bankers and consumers.

Glen Fossella is a technology industry executive with a background in payments and branch automation.