Should Fintech Be Regulated?

If you want to see a rowdy debate, try gathering a group of colleagues and posing the question of whether or not fintech companies should be regulated. In posing this question to several groups of payments professionals, I have observed that the same arguments, pro and con, keep coming up. Here are a few:

What is and what isn’t a fintech? Definitions of fintech include technology companies independent from banks that provide transactions or loans using new technologies. The definition can also include units of bank holding companies that innovate and implement new versions of a bank’s services using new technologies. And some see it as the technology itself, not the company.

Should they be regulated? One might be tempted to apply the “duck rule:” If it walks like a financial institution and talks like a financial institution, it should be regulated as a financial institution. No sooner is this said than a volley comes back about squelching innovation. There is some truth in both assertions. Some of the most successful entrepreneurs warn that regulation inherently interferes with early-stage innovation, whether it is in pharmaceuticals, rocketry, or financial services. But we have few pure examples of innovation dying simply from being regulated, and also few where the absence of regulation by itself spawned innovation.

Playing the Airbnb card Someone is sure to point out that, if zoning and hotel regulations had been enforced, we’d never have innovated the short-stay, home-rental industry. Or that, if regulations get applied, we won’t see self-driving cars. A counter to this view is that fintech should be regulated because, if it goes wrong, people could lose their life savings or have their insurance canceled over a mishandled payment. The pro-regulation groups point out that a self-driving car can take your actual life, not just your life savings, and short-stay rentals exacerbate housing shortages. In other words, maybe regulation of new ways of doing anything is always needed and fintech is just another case.

Does the financial industry have a unique or special characteristic that requires regulation? Academics and economists have argued that financial organizations of all types need to be regulated. This claim seems well-founded when it comes to making loans. Bad loans have an absolute capacity to cause more damage than the value of the loan that goes bad. That’s due to the leveraged economics of the business. Loans are packaged and sold to investors, who in turn use the mortgage-backed securities to leverage more and riskier economic activity. It’s something we seem to re-learn every generation after a financial crash.

But is the same true for payments? Are payments leveraged in such a way that a few payment failures could bring the system down? At first, it might seem that they aren’t. But whatever the case is now, we will soon see risk increase as faster payments take away the time buffer that banks (and fintechs) use to block the domino effect of one payment going unconsummated and leading to a chain reaction. When we take the time lags out of the payments process, we remove the opportunity to assess problems in a payment, a payor, or a payee.

By this logic, payments will become as prone to runaway crises as lending can become. With unregulated companies making up more and more of total payments, this type of risk would only increase.

Innovation in other industries can provide some guidelines for applying regulation to fintech. Three proven principles are:

When could people get hurt? To reprise the self-driving car example, regulating self-driving technology being used on a closed course during development would only suppress innovation. But not regulating self-driving vehicles’ use of public streets would be irresponsible.

Courses for horses (to reverse the British aphorism). We need to thoroughly understand the nature of an innovation before we can assess the need for regulation. What might go wrong? What is the impact if it does? What is the best way to counter it?

Social inclusion Innovators can get trapped in the cul-de-sac of overserving people already served by an industry and underserving those who may most need the help innovation can bring. Here, regulation can step in where the market fails.

It’s a discussion that can get heated, but one we need to start having.