FinTech: Overview, Payments, and Regulation

Perspectives on Regulation

Natasha Sarin, Assistant Professor of Law, Assistant Professor of Finance

Overview

• Theoretical Criticisms of Regulation

• Concerns and Innovations in Financial Regulation
• What FinTech is
• Growth of FinTech
• Approaches to Regulating of FinTech
• USA | Australia | UK | China | Singapore
• Looking Forward
“ Regulation may be actively sought by an industry, or it may be
thrust upon it...as a rule, regulation is acquired by the industry
and is designed and operated primarily for its benefit. At worst,
regulation hinders growth and innovation through
bureaucracy.”

— GEORGE STIGLER, ECONOMIST AND AUTHOR OF “THE THEORY OF

ECONOMIC REGULATION”
“ Corruption is government intrusion into market
efficiencies in the form of regulations.”
— MILTON FRIEDMAN, NOBEL LAUREATE (ECONOMICS)
“ Regulation is necessary, particularly in a sector,
like the banking sector, which exposes countries
and people to a risk.”
— CHRISTINE LAGARDE, MD, IMF
“ Cars, toys, aspirin, meat, toasters, water – nearly every
product sold has passed basic safety regulations well in
advance of being marketed and sold. But consumer
credit is a kind of buyer-beware, wild west.”

— SENATOR ELIZABETH WARREN (MA)

“Good regulation should be conducive to
business and to customer protection.”

— JAMIE DIMON, CEO, JP MORGAN

“Markets are imperfect. So you do need
regulation, knowing that the regulators are
also human.”

— GEORGE SOROS, MD, SOROS FUND MANAGEMENT

FinTech: Overview, Payments, and Regulation
The Regulation Innovation Tradeoff

Natasha Sarin, Assistant Professor of Law, Assistant Professor of Finance

The Regulation-Innovation Tradeoff

Regulation Innovation
AT Regulation ensures Companies create new
BEST consumer safety and products in a safe and
reduces market/societal responsible way
risks

AT Regulation hinders Fast-paced innovation

WORST growth/innovation through fails to address security
bureaucracy and cybercrime risks

It may also benefit

incumbent companies and
transfer risk from more to
less regulated sectors
The Regulation-Innovation Tradeoff
The Regulation-Innovation Tradeoff

Regulation:
• Involves the restriction of industry’s ability to engage in certain practices to
hopefully best serve consumers
• Is meant to help consumers, by protecting them against risks that emerge
in different markets
• Can ill-serve consumers by making certain markets less competitive and
providing incumbents advantage in those spaces

Sources: Northwestern Institute For Policy Research; CoreLogic; Federal Reserve Bank of St. Louis; Federal Reserve History
Case Study of Over Regulation: Licensing

• The percent of occupations

requiring a State license has
increased from less than 5%
of workers in the early
1950s to 25% in 2015
• Jobs that require such
licenses range from
physicians and lawyers to
barbers and manicurists

Source: The Council of State Governments (1952); Greene

(1969); Kleiner (1990); Kleiner (2006); and Kleiner and Krueger
(2013), Westat data; CEA Calculations.
Case Study of Over Regulation: Licensing

• An excess of these licensing

requirements has been
found to reduce worker
mobility and increase
inequality

Source: Census Bureau, American Community Survey 2010-

2013; CEA Calculations.
FinTech: Overview, Payments, and Regulation
The Great Recession

Natasha Sarin, Assistant Professor of Law, Assistant Professor of Finance

The Great Recession

The losses of the Great Recession were large and widespread:

• 8+ million Americans lost their jobs
• 7.8 million homes were foreclosed
• 2.5 million businesses were shuttered
• 12.1% decline in median real family income
• 40.1% decline in median real net worth
• 4.3% decline in real GDP

Sources: Northwestern Institute For Policy Research; CoreLogic; Federal Reserve Bank of St. Louis; Federal Reserve History
Post-Great Recession Financial Regulation

• Dodd–Frank Wall Street Reform and Consumer Protection Act

• Consumer Financial Protection Bureau (CFPB)
• Capital reserve requirements
• Stress-testing
• Expanded regulation of the shadow banking system and derivatives
“ To the extent that regulation played a role in the [big] banks’
reluctance to re-enter the small-business market once the crisis had
subsided, our findings reinforce the view that one of the
consequences of heightened bank regulation may be to drive
activity to the less-regulated, nonbank sector.”

— CHEN ET AL. (2017), THE DECLINE OF BIG-BANK LENDING TO SMALL

BUSINESS: DYNAMIC IMPACTS ON LOCAL CREDIT AND LABOR MARKETS
FinTech: Overview, Payments, and Regulation
Emergence of FinTech

Natasha Sarin, Assistant Professor of Law, Assistant Professor of Finance

Emergence of FinTech

In the years after the crash, entrepreneurs saw needs for new types of
financial businesses including:
• Low-cost ways to invest household saving
• Platforms to borrow money without a commercial bank
• Faster payment methods
• Mediums to crowdfund projects and startups
• Low-fee ways to transfer money abroad
Emergence of FinTech

What is considered “FinTech”?

• An app that deposits cheques via a photo?
• A new peer-to-peer lending platform?
• A website that make international transfers cheaper?
• A new medium of exchanging value like Bitcoin?
• Payments through Facebook Messenger?
Emergence of FinTech

• FinTech covers a spectrum from totally new ideas and kinds of businesses,
to traditional businesses taking advantage of new technologies
• Useful to think of financial technologies as involving “business practices”
and “financial institutions”
• The relative “newness” varies depending on the particular product
• Ex. Bank of America’s mobile platform
• Ex. Facebook payments
• Ex. Lending Club
• The kind of regulatory framework we will want to adopt will be a byproduct
of the existing regulation that already exists in that space
Emergence of FinTech

• FinTech is the contraction of ‘financial’ and ‘technology’.

• At first, FinTech referred to technology that improved back-end systems at
traditional financial institutions
• With the emergence of new technologies in money transfer, lending,
investing, crowdfunding, payments, and more, this definition has been
broadened
Emergence of FinTech

• The breadth of FinTech makes regulation challenging because, while

FinTech is typically considered one group of technologies, they include:
• Well-established, regulated firms doing new things (e.g. JP Morgan
launching its own cryptocurrency)
• Startups doing existing finance differently (e.g. no-fee peer-to-peer
payments)
• Startups reconsidering the financial system (e.g. decentralized,
blockchain-based marketplaces)
FinTech: Overview, Payments, and Regulation
FinTech Growth & Benefits

Natasha Sarin, Assistant Professor of Law, Assistant Professor of Finance

Growth of FinTech
• The number of FinTech
companies founded annually
has grown significantly from
178 in 2008 to 668 in 2014
• In 2016 there were over
1,000 FinTech companies
globally

Strong growth in the number of FinTech companies founded in banking/capital markets, investment
management, insurance, and real estate.
Growth of FinTech
• Total investment in FinTech
companies - across M&A,
PE and VC - grew from
$18.9 billion in 2013 to
$111.8 billion in 2018
• The number of investment
deals more than doubled
from 1,132 in 2013 to 2,196
in 2018

Strong global growth in funding for FinTech companies

Growth of FinTech

Growing public interest in FinTech.

Note: The graph is standardized with 100 being the peak of online search volume for ‘fintech’.
Growth of FinTech
Benefits of FinTech

• Access
• Mobile banking, tech-driven microfinance, crowdfunding, etc.
• In the United States, about 20% of consumers are reportedly
underbanked and about 7% are unbanked
• Efficiency
• Ease-of-payment, low-cost international transfers, etc.
FinTech: Overview, Payments, and Regulation
Issues with FinTech

Natasha Sarin, Assistant Professor of Law, Assistant Professor of Finance

Issues with FinTech

• New challenges for regulators:

• Data Breaches/Cybercrime
Data Breaches/Cybercrime

• According to the FBI’s

Internet Crime report,
cybercrime cost the U.S.
over $1.4 billion in 2017

Source: FBI
Data Breaches/Cybercrime
Data Breaches/Cybercrime

• Company: Equifax
• Problem: Data breach by hackers through a single
Internet-facing web server with out-of-date software
• Result: Breach of personally identifiable information of
over 143 million people
• Regulatory Response: Sen. Elizabeth Warren co-
sponsored a bill that would give the Federal Trade
Commission more direct supervisory power over credit-
reporting agencies like Equifax, and impose the ability to
levy fines
Data Breaches/Cybercrime

Source: Information is Beautiful

Issues with FinTech

• New challenges for regulators:

• Data Breaches/Cybercrime
• Unanticipated, or “Weird” Problems
Issues with FinTech
Issues with FinTech
Data Breaches/Cybercrime

• Company: Bitcoin
• Problem: Purported anonymity fueled illegal activity,
for instance, on Silk Road
• Result: In March 2013, Silk Road had 10,000 products
for sale via bitcoin by vendors, 70% of which were
drugs
• Regulatory Response: The FBI seized 26,000
bitcoins and shut down Silk Road in 2014
FinTech: Overview, Payments, and Regulation
Issues Regulating FinTech

Natasha Sarin, Assistant Professor of Law, Assistant Professor of Finance

Issues Regulating FinTech

• FinTech is hard to define

Issues Regulating FinTech
Issues Regulating FinTech

• FinTech is hard to define

• The technologies are fast-moving
• Unclear cross-country regulatory jurisdiction
• Unclear within-country regulatory jurisdiction
Issues Regulating FinTech
FinTech: Overview, Payments, and Regulation
U.S. FinTech Regulation

Natasha Sarin, Assistant Professor of Law, Assistant Professor of Finance

Various Approaches to Regulating FinTech

Source: Australian Centre for Financial Studies

Approach to Regulating FinTech (USA)

• OCC vs. States

• In 2018, the Office of the Comptroller of Currency (OCC) at the U.S.
Department of the Treasury (DoT) announced it would begin accepting
applications from FinTechs for special bank charters (which would
allow FinTechs to operate nationally)
• Eligibility is defined as FinTech companies that do not take deposits but
are otherwise engaged in “the business of banking” — paying checks or
lending money
Approach to Regulating FinTech (USA)

• OCC vs. States

• In the 2017 lawsuit Conference of State Bank Supervisors (CSBS) v.
OCC, the CSBS alleged that the OCC lacked statutory authority to
charter nondepository FinTech companies
• The case was dismissed on jurisdictional grounds but, nevertheless, the
CSBS declared that the charter is ‘a regulatory train wreck in the
making’
• No Single Framework
FinTech: Overview, Payments, and Regulation
Global FinTech Regulation

Natasha Sarin, Assistant Professor of Law, Assistant Professor of Finance

Proposals for “FinTech Sandboxes”

• “[A regulatory sandbox is] a framework set up by a financial sector

regulator to allow small-scale, live testing of innovations by private firms in
a controlled environment (operating under a special exemption, allowance,
or other limited, time-bound exception) under the regulator’s supervision.”

Source: CGAP (Consultative Group to Assist the Poor)

Approach to Regulating FinTech (Australia)

• Centralized regulation for FinTechs

• The Australian Securities and Investment
Commission (ASIC) helps FinTech companies work
out which licenses and regulations apply to them
and make sure consumers and investors are
protected when dealing with FinTechs
• The ASIC created a FinTech “regulatory sandbox”,
which is designed to help FinTechs maintain their
flexibility to test new products and services for up to
12 months without an Australian financial services
or credit license
Approach to Regulating FinTech (UK)

• Attempting to create a global FinTech “sandbox”

• The UK Financial Conduct Authority (FCA) is
working on a global sandbox for FinTech
companies to help the growth of companies with
cross-border ambitions
• In the meantime, the UK has established FinTech
bridges with Canada, China, Hong Kong, Japan
and South Korea
Approach to Regulating FinTech (Singapore)

• Created a regulatory sandbox in 2016

• “The regulatory sandbox will enable FIs as well as
FinTech players to experiment with innovative
financial products or services in the production
environment but within a well-defined space and
duration. It shall also include appropriate
safeguards to contain the consequences of failure
and maintain the overall safety and soundness of
the financial system.” - Monetary Authority of
Singapore (MAS)
Approach to Regulating FinTech (China)

• Loose regulatory oversight over FinTechs

• According Dexter Hsu, an analyst at Macquarie,
“The whole of China is a regulatory sandbox, a safe
zone for startups to test new applications and
ideas”
• However, some regulation has been implemented:
the ministry of industry and information technology
will start to produce ratings for blockchain products
and Beijing banned initial coin offerings (ICOs),
blocking websites that offered cryptocurrency
trading services
Approach to Regulating FinTech: Takeaways

• Clearly defining internal regulatory authority is a necessary step for

coherent FinTech regulation (USA)
• Regulatory sandboxes have been found to increase value and capabilities
of participating firms (UK)
• While absent regulation can spark a boom, it also gives rise to a market full
of scams and high-risk financial models (China)
• Active and collaborative regulation can be encouraged through innovation
hubs that help FinTechs navigate the regulatory landscape (Australia,
Singapore)
FinTech: Overview, Payments, and Regulation
RegTech and Looking Forward

Natasha Sarin, Assistant Professor of Law, Assistant Professor of Finance

Looking Forward: RegTech

Using the methods/tools of FinTech to comply with regulation

Looking Forward: RegTech

• A software platform that allows financial institutions to process

large volumes of granular data and output the required regulatory
data, calculations, risks and reports (i.e. compliance)

• Provides ID verification for companies - such as Paypal, Stripe,

and Amazon - to comply with know-your-customer (KYC) and anti-
money laundering rules
Looking Forward: Key Questions

• Is it appropriate to regulate FinTech as one thing?

• Should FinTech be regulated with one global framework?
FinTech: Overview, Payments, and Regulation
Thank You

Natasha Sarin, Assistant Professor of Law, Assistant Professor of Finance