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December 3, 2018
Building Blocks for the Sandbox
I just returned from a leave of absence to welcome my third child to this world. As I catch up on payments news, one theme emerging is the large number of state and federal regulatory bodies launching their own fintech sandboxes. Typically, these testing grounds allow businesses to experiment with various "building blocks" while they innovate. Some businesses are even allowed regulatory relief as they work out the kinks. As I've researched, I've found myself daydreaming about how my new little human also needs to work with the right building blocks, or core principles, to ensure he develops properly and "plays nice" in the sandbox.
But—back to work. What guidance do fintechs have available to them to grow and prosper?.
On July 31 of this year, the U.S. Department of the Treasury released a report suggesting regulatory reform to promote financial technology and innovation among both traditional financial institutions and nonbanks. The report in its entirety is worth a review, but I'll highlight some of it here.
The blueprint for a unified regulatory sandbox is still up for discussion, but the Treasury suggests a hierarchical structure, either overseen by a single regulator or by an entirely new regulator. The Treasury suggests that Congress will likely have to assist by passing legislation with the necessary preemptions to grant authority to the newly created agency or a newly named authoritative agency.
The report outlines these core principles of a unified regulatory sandbox:
- Promote the adoption and growth of innovation and technological transformation in financial services.
- Provide equal access to companies in various stages of the business lifecycle (e.g., startups and incumbents). [The regulator should define when a business could or should participate.]
- Delineate clear and public processes and procedures, including a process by which firms enter and exit.
- Provide targeted relief across multiple regulatory frameworks.
- Offer the ability to achieve international regulatory cooperation or appropriate deference where applicable.
- Maintain financial integrity, consumer protections, and investor protections commensurate with the scope of the project, not be based on the organization type (whether it's a bank or nonbank).
- Increase the timeliness of regulator feedback offered throughout the product or service development lifecycle. [Slow regulator feedback is typically a deterrent for start-up participation.]
Clearly, the overarching intent of these principles is to help align guidance, standards, and regulation to meet the needs of a diverse group of participants. Should entities offering the same financial services be regulated similarly? More importantly, is such a mission readily achievable?
People have long recognized the fragmentation of the U.S. financial regulatory system. The number of agencies at the federal and state levels with a hand in financial services oversight creates inconsistencies and overlaps of powers. Fintech innovations even sometimes invite attention from regulators outside of the financial umbrella, regulators like the Federal Communications Commission or the Federal Trade Commission.
In the domain of financial services are kingdoms of industry. Take the payments kingdom, for example. Payments are interstate, global, and multi-schemed (each scheme with its own rules framework). And let's be honest, in the big picture of financial services innovations and in the minds of fintechs, payments are an afterthought, and they aren't front and center in business plans. Consumers want products or services; payments connect the dots. (In fact, the concept of invisible payments is only growing stronger.)
What is more, a fintech, even though it may have a payments component in its technology, might not identify itself as a fintech. And a business that doesn't see itself as a fintech is not going to get in line for a unified financial services regulator sandbox (though it might want to play in a payments regulator sandbox).
When regulatory restructuring takes place, I hope it will build a dedicated infrastructure to nurture the payments piece of fintech, so that all can play nice in the payments sandbox. (Insert crying baby.)
By Jessica Washington, AAP, payments risk expert in the Retail Payments Risk Forum at the Atlanta Fed
September 10, 2018
The Case of the Disappearing ATM
The longtime distribution goal of a major soft drink company is to have their product "within an arm's reach of desire." This goal might also be applied to ATMs—the United States has one of the highest concentration of ATMs per adult. In a recent post, I highlighted some of the findings from an ATM locational study conducted by a team of economics professors from the University of North Florida. Among their findings, for example, was that of the approximately 470,000 ATMs and cash dispensers in the United States, about 59 percent have been placed and are operated by independent entrepreneurs. Further, these independently owned ATMs "tend to be located in areas with less population, lower population density, lower median and average income (household and disposable), lower labor force participation rate, less college-educated population, higher unemployment rate, and lower home values."
This finding directly relates to the issue of financial inclusion, an issue that is a concern of the Federal Reserve's. A 2016 study by Accenture pointed "to the ATM as one of the most important channels, which can be leveraged for the provision of basic financial services to the underserved." I think most would agree that the majority of the unbanked and underbanked population is likely to reside in the demographic areas described above. One could conclude that the independent ATM operators are fulfilling a demand of people in these areas for access to cash, their primary method of payment.
Unfortunately for these communities, a number of independent operators are having to shut down and remove their ATMs because their banking relationships are being terminated. These closures started in late 2014, but a larger wave of account closures has been occurring over the last several months. In many cases, the operators are given no reason for the sudden termination. Some operators believe their settlement bank views them as a high-risk business related to money laundering, since the primary product of the ATM is cash. Financial institutions may incorrectly group these operators with money service businesses (MSB), even though state regulators do not consider them to be MSBs. Earlier this year, the U.S. House Financial Services Subcommittee on Financial Institutions and Consumer Credit held a hearing over concerns that this de-risking could be blocking consumers' (and small businesses') access to financial products and services. You can watch the hearing on video (the hearing actually begins at 16:40).
While a financial institution should certainly monitor its customer accounts to ensure compliance with its risk tolerance and compliance policies, we have to ask if the independent ATM operators are being painted with a risk brush that is too broad. The reality is that it is extremely difficult for an ATM operator to funnel "dirty money" through an ATM. First, to gain access to the various ATM networks, the operator has to be sponsored by a financial institution (FI). In the sponsorship process, the FI rigorously reviews the operator's financial stability and other business operations as well as compliance with BSA/AML because the FI sponsor is ultimately responsible for any network violations. Second, the networks handling the transaction are completely independent from the ATM owners. They produce financial reports that show the amount of funds that an ATM dispenses in any given period and generate the settlement transactions. These networks maintain controls that clearly document the funds flowing through the ATM, and a review of the settlement account activity would quickly identify any suspicious activity.
The industry groups representing the independent ATM operators appear to have gained a sympathetic ear from legislators and, to some degree, regulators. But the sympathy hasn't extended to those financial institutions that are accelerating account closures in some areas. We will continue to monitor this issue and report any major developments. Please let us know your thoughts.
By David Lott, a payments risk expert in the Retail Payments Risk Forum at the Atlanta Fed
December 4, 2017
What Will the Fintech Regulatory Environment Look Like in 2018?
As we prepare to put a bow on 2017 and begin to look forward to 2018, I can’t help but observe that fintech was one of the bigger topics in the banking and payments communities this year. (Be sure to sign up for our December 14 Talk About Payments webinar to see if fintech made our top 10 newsworthy list for 2017.) Many industry observers would likely agree that it will continue to garner a lot of attention in the upcoming year, as financial institutions (FI) will continue to partner with fintech companies to deliver client-friendly solutions.
No doubt, fintech solutions are making our daily lives easier, whether they are helping us deposit a check with our mobile phones or activating fund transfers with a voice command in a mobile banking application. But at what cost to consumers? To date, the direct costs, such as fees, have been minimal. However, are there hidden costs such as the loss of data privacy that could potentially have negative consequences for not only consumers but also FIs? And what, from a regulatory perspective, is being done to mitigate these potential negative consequences?
Early in the year, there was a splash in the regulatory environment for fintechs. The Office of the Comptroller of the Currency (OCC) began offering limited-purpose bank charters to fintech companies. This charter became the subject of heated debates and discussions—and even lawsuits, by the Conference of State Bank Supervisors and the New York Department of Financial Services. To date, the OCC has not formally begun accepting applications for this charter.
So where will the fintech regulatory environment take us in 2018?
Will it continue to be up to the FIs to perform due diligence on fintech companies, much as they do for third-party service providers? Will regulatory agencies offer FIs additional guidance or due diligence frameworks for fintechs, over and above what they do for traditional third-party service providers? Will one of the regulatory agencies decide that the role of fintech companies in financial services is becoming so important that the companies should be subject to examinations like financial institutions get? Finally, will U.S. regulatory agencies create sandboxes to allow fintechs and FIs to launch products on a limited scale, such as has taken place in the United Kingdom and Australia?
The Risk Forum will continue to closely monitor the fintech industry in 2018. We would enjoy hearing from our readers about how they see the regulatory environment for fintechs evolving.
By Douglas A. King, payments risk expert in the Retail Payments Risk Forum at the Atlanta Fed
September 18, 2017
The Rising Cost of Remittances to Mexico Bucks a Trend
From time to time, I like to look back at previous Risk Forum activities and see what payment topics we've covered and consider whether we should revisit any. In September 2012, the Risk Forum hosted the Symposium on 1073: Exploring the Final Remittance Transfer Rule and Path Forward. Seeing that almost five years have passed since that event, I decided I'd take another, deeper look to better understand some of the effects that Section 1073 of the Dodd-Frank Act has had on remittances since then. I wrote about some of my findings in a paper.
As a result of my deeper look, I found an industry that has been rife with change since the implementation of Section 1073 rules, from both a regulatory and technology perspective. Emerging companies have entered the landscape, new digital products have appeared, and several traditional financial institutions have exited the remittance industry. In the midst of this change, consumers' average cost to send remittances has declined.
Conversely, the cost to send remittances within the largest corridor, United States–Mexico, is rising. The rising cost is not attributable to the direct remittance fee paid to an agent or digital provider but rather to the exchange rate margin, which is the exchange rate markup applied to the consumer's remittance over the interbank exchange rate. As remittances become more digitalized and the role of in-person agents diminishes, I expect the exchange rate margin portion of the total cost of remittance to continue to grow.
Even though the average cost of sending remittances to Mexico is on the rise, I found that consumers have access to a number of low-cost options. The spread between the highest-cost remittance options and the lowest-cost options is significant.
With greater transparency than ever before in the remittance industry, consumers now have the ability to find and use low-cost remittance options across a wide variety of provider types and product options. To read more about the cost and availability of remittances from the United States to Mexico and beyond in a post-1073-rule world, you can find the paper here.
By Douglas A. King, payments risk expert in the Retail Payments Risk Forum at the Atlanta Fed
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