Government Accountability Office Annual Report Weighs Benefits and Risks of Fintech Consumer Products | Hudson Cook, LLP

Fintech is increasingly prevalent in the financial services market, allowing providers to offer countless innovative products and services that dramatically change how consumers interact with financial service providers and access financial services. The Government Accountability Office’s (GAO) annual report on financial services regulation, released in March, addressed topics related to the growth of fintech. The foreword to the report acknowledged fintech’s potential to help consumers underserved by traditional financial institutions access financial services, but also found that it is “unclear how many underserved consumers use [fintech] products, what risks they may pose, and the extent to which existing financial services laws address those risks.” The report, titled “Financial Technology – Products Have Benefits and Risks to Underserved Consumers, and Regulatory Clarity is Needed,” focused its review on four fintech products that, according to the GAO, “appeared to address barriers to financial access for consumers not served by traditional banks”: (1) digital deposit accounts, (2) credit-building products, (3) small-dollar fintech loans (defined as unsecured personal loan installments of $2,500 or less) and (4) earned income access.The report examined the benefits, risks, and limitations of the selected fintech products for underserved consumers and what is known about the extent to which underserved consumers have used them , and the steps federal and state regulators are taking to assess the selected fintech products.

In measuring the benefits of the subject of fintech products, the GAO compared the costs of the fintech products to the costs associated with what the GAO considered “comparable traditional or alternative financial products.” GAO also analyzed data obtained from fintech companies and empirical studies from federal agencies and researchers to determine the extent to which underserved consumers used the selected fintech products. GAO’s research into the risks associated with the selected products, and the steps regulators are taking to evaluate the products, included a review of the regulators’ investigation procedures, regulatory guidance, investigation reports, enforcement actions, and interviews with regulators.

The report concluded that fintech products can actually offer benefits to underserved consumers, especially those without bank accounts or credit scores. The report noted cases where fintech products resulted in lower costs for consumers than other comparable products, and where the fintech products allowed increased access to credit for consumers with limited credit files and no credit scores. The report noted that data from fintech vendors surveyed indicated that their products were mainly used by lower-income consumers. However, the report also identified potential barriers for underserved consumers in accessing fintech products, such as the consumer lacking internet access or preferring “the individualized or personal assistance of traditional banks” and ultimately stated that “[d]assess the extent to which fintech products serve underserved consumers [is] limited.”

While much, but not all, of the price analysis in the report appeared to reflect relatively lower costs for consumers using the fintech products considered, the GAO concluded that there was also a risk to consumers that the costs and other terms of fintech products could not be sufficiently transparent. For example, earned salary access providers sometimes give consumers the option to leave the company with a “tip” after using the service. Apparently, the tip is voluntary (in most programs) and does not affect the decision to grant access to earned wages or the amount of the advance. The GAO noted concerns from consumer groups, however, that consumers may be unaware that the tip is truly optional and may feel forced to pay the additional cost, which would provide no additional benefit to the consumer. Regarding digital deposit accounts, the GAO noted that consumers may not be fully aware that the fintech company was not a bank and that their deposits were held by a separate institution. The report also noted that consumers may not be aware of the level of FDIC insurance coverage protecting a digital deposit account.

In addition to potential risks to consumers, the GAO identified certain risks to banks that work with fintech companies. Arguably, such risks would be largely applicable to any third-party arrangement, and not specific to a fintech partnership, such as concerns regarding the fintech’s compliance with laws governing the bank or liquidity issues if a bank was overly dependent on the fintech relationship. However, the GAO also noted that banks could face credit risk if the alternative credit guarantee models used by fintech partners lead to large losses for the bank. The GAO also raised concerns that alternative collateral data, such as cash flow data, utility or rent payments, employment history, and educational attainment, “may have fair lending implications if the data correlates with groups of individuals protected under antidiscrimination laws and use of the data disproportionately adversely affects those groups.” However, the report also pointed to research that found that cash flow information (the alternative data most commonly used by the fintech lenders interviewed for the report) was predictive of performance and did not correlate with race, ethnicity or gender. Furthermore, the GAO acknowledged that using “alternative data in the underwriting process can expand access to credit to consumers with poor, thin, or no credit files by including data that credit reports do not typically capture.” This will of course potentially increase access to credit for underserved consumers.

In concluding the report, GAO made only a single recommendation for enforcement action. The GAO urged the Consumer Financial Protection Bureau (CFPB) to provide additional clarification on when an earned income access product would be considered an extension of credit subject to the Truth in Lending Act (“TILA”). In 2020, the CFPB issued an advisory opinion ruling that payday access products with certain characteristics would not be considered an extension of credit. Specifically, the statement limits its application to an earned income access product offered through an employer, with no fees imposed on the employee whatsoever (voluntary or otherwise), and where the advance amount will be recovered through an employer-facilitated payroll deduction, among other claims. The advisory opinion did not explicitly address whether other earned wage access models would or would not be considered credit under TILA, leading to some confusion in the industry. The GAO report recommended that the CFPB clarify the application of TILA’s definition of “credit” to earned income access products not covered by its 2020 advisory opinion. The GAO report included in its appendix a letter from CFPB Director Rohit Chopra concurring with its recommendation to provide further clarification on the application of TILA to products for earned salary access. We note that, depending on the scope of the forthcoming guidance, there may be implications for other seemingly non-credit products that also face recharacterization challenges.

While the report reiterated a number of common concerns about fintech products, it largely refrained from weighing potential harms against potential benefits to consumers from the availability of fintech products. The report would have benefited from further analysis of which of the concerns identified as creating a risk of harm were likely to be inherent to the fintech product, which of the concerns were likely to be equally prevalent in a non-fintech product, and which of the concerns were speculative pending further research. For example, the report does not address whether the liquidity risk banks may face when overly reliant on a relationship with a fintech will also be prevalent in other non-fintech service provider relationships or strategic partnerships. Similarly, the potential fair lending risks of a fintech using alternative data in underwriting are hypothetical in that they largely reflect the lack of fair lending data available for any new underwriting method. The report did not provide substantial evidence to support the position that alternative insurance methods would adversely affect groups of individuals protected under anti-discrimination laws. On the other hand, concerns that consumers of digital deposit accounts are confused about the party holding their account, and the federal protections available for their accounts, are arguably specific to the nature of the product. In such cases, balancing risks and benefits and the realistic measures to reduce the risk will be of increased concern.

Another limitation of the GAO’s report is that each selected product was analyzed in a vacuum, separate from other fintech products and services. Fintech companies often offer the products and services that the report assesses in combination with each other. For example, a digital deposit account can be simultaneously created for a consumer who has registered for a credit building product and can also be offered in connection with a small dollar loan. Although the report outlines the benefits and risks of such products individually, GAO does not consider whether additional benefits or risks arise when these products are offered in combination with each other.

A copy of the GAO report is available here: United States Government Accountability Office Report to Congressional Committees, “Financial Technology – Products Have Benefits and Risks to Underserved Consumers, and Regulatory Clarity is Needed.” March 2023.