US regulators are wary of FinTech innovation
If there was at least one consensus that came out of last week’s DC FinTech Week confab, it’s that banks and the regulators who oversee them must tread a fine line between innovation and risk.
And the line may not be easy to define.
As noted in addresses by Michael S. Barr, the Federal Reserve’s deputy chairman for oversight, and Michael Hsu, acting comptroller of the currency, there are no easy answers in the mix when it comes to striving for that balance.
Barr’s comments noted that there must be “balance” — and the problems inherent in finding that balance have existed for, well, centuries.
He pointed, for example, to the 17th century, when Dutch merchants and bankers were “otherwise busy creating global finance” and “where a series of destabilizing bank runs also prompted them to establish a ban on short selling. Many of the problems we struggle with today are not as new as we think… We have seen throughout history that excitement over innovative financial products can lead to a pace of adoption that overwhelms our ability to assess and address underlying vulnerabilities.”
And with particular reference to crypto, he stated that crypto assets had grown rapidly in recent years, both in market capitalization and in reach.
“However, recent cracks in these markets have shown that some crypto assets are fraught with risks, including fraud,” he warned. Central banks, he said later in the comments, “are and always will be the most important source of trust behind money. Stablecoins borrow that trust, so we have a continuing interest in a strong federal prudential framework for their use.”
As mentioned earlier, there are still risks of bank runs and the threats of instability in the overall financial system: When a bank’s deposits are concentrated in deposits from the crypto-asset industry or from crypto-asset companies that are highly interconnected or share similar risk profiles, banks can experience deposit fluctuations that are correlated and closely linked to broader developments in the crypto-asset markets, Barr said.
Congressional frameworks will be needed to help oversee stablecoins, and as for CBDCs, Barr said, “The Federal Reserve has not made any decisions on whether to issue a CBDC and if we think it makes sense to do so , we want the support of Congress and the administration.”
During the Q&A session, following his comments, it was noted that many FinTech companies are small and experimental in nature. And when asked by Chris Brummer, professor at Georgetown University Law Center and founder of DC FinTech Week how to measure the risk associated with the smaller companies, Barr noted that it is important, by and large, to have capital and liquidity buffers and to consider ” what are the chances of these firms doing the same thing … if you have thousands of these firms, each of which is small, doing exactly the same thing, they will correlate the risk in the economy.”
And an important difference in risk that is significantly different today is the speed of change. Given the technologies that are in place today, and the network effect, Barr said, “you can go from being a very small firm to being a very large firm very quickly … you can get to ubiquity much faster than ever before. “
During his own remarks, OCC’s Hsu said, and as noted last week, that “skeuomorphism,” — where new concepts are promoted to the public by comparing them to familiar ones that don’t mean the same thing in banking — can have its limitations as new, digital financial products enter the market. The key question lies in whether these companies’ representations fulfill the purpose of enabling the trust necessary for wider adoption.
During the Q&A session with Hsu, Brummer noted that if FinTechs don’t strive to simplify what’s being offered, “people won’t understand what that technology or that product is.” But there is a tension between skewomorphism and the inherent complexity of some of these newer financial products or infrastructures that, in Hsu’s words, “is not easily resolved.”
