Innovation during a wave of regulation
American financial institutions are already facing an incredibly challenging regulatory environment. What’s to come will only complicate the situation.
Why? The convergence of new political priorities in Washington creates many new compliance risks. This trend may have an increasingly negative impact on industry innovation, diverting time and resources that could instead be devoted to improving product development or customer service.
Institutions that hope to stay ahead of the regulatory curve will need to revitalize their compliance operations with a technology-driven approach and engage compliance early in any product or service development effort. This saves time and money, and helps maintain a culture of continuous innovation during the ebb and flow of regulatory tides.
The Future of Open Banking Regulation
At the recent Money 20/20 conference, Consumer Financial Protection Bureau (CFPB) director Rohit Chopra announced a process for developing regulations under section 1033 of the Dodd-Frank Act that would “increase consumer access to more than that, their financial data.”
This is an important step towards “open banking” and “open finance” and will have significant implications for financial institutions offering deposit accounts, credit cards, digital wallets and other transactional accounts.
Under this rule (due to be finalized in 2024), covered firms will be required to provide consumers with their financial information or provide it to a third party at the consumer’s direction. Other proposals will also be considered, such as efforts to simplify the process of transferring accounts between companies and new requirements regarding the confidentiality of personal financial data.
Undermining the US financial sector
The overarching goal is to increase competition in the market by making it easier for consumers to transition from a financial service provider, forcing companies to innovate and compete to retain customers. The regulatory impact will be related to major new requirements related to customer data: data portability, data sharing, data security, data storage and more.
Banks and other companies that process personal financial data will need to make changes to their internal processes and digital infrastructure, such as implementing secure data exchange methods such as APIs, to comply with these rules. Some companies will even have to adjust their business models.
Chopra called the initiative one of the “most important rules the CFPB is working on or will ever work on in its history,” foreshadowing the wide implications the rule could have on the US financial sector.
New disclosure requirements
Another regulation to monitor is the proposed SEC rule requiring registrants to disclose reliable amounts of information about climate risks and greenhouse gas emissions, which should be finalized in the coming months. Disclosure will require extensive reporting and sharing of company environmental practices and strategies, especially with regard to emission reductions, which creates new barriers to compliance.
In addition to Section 1033 by Dodd Frank and the ESG, financial institutions must prepare for new compliance requirements related to digital assets (especially cryptocurrencies after the FTX crash), data privacy, cybersecurity, and more. In the coming era of divided government, President Biden is likely to rely more on presidential decrees to advance his regulatory agenda.
Compliance costs for banks have already increased by about 60% since the economic crisis in 2008, and the fact that these regulatory problems can arise during a recession makes matters worse.
New Solutions for a New Era
During economic downturns, companies are forced to increase budgets and make tough decisions about their workforce, growth strategy, and product development. Rising compliance costs don’t help. Any additional dollars spent on compliance with CFPB, SEC, or Treasury regulations cut innovation budgets, impacting individual companies, US economic competitiveness, and the financial industry as a whole.
Compliance will stifle innovation if business leaders do not innovate their compliance systems and processes to maximize efficiency and minimize costs.
Additional training and workforce are likely part of the solution, but the main challenge for compliance teams is to implement new technologies that allow new or relevant regulatory requirements to be identified faster and better coordinate enterprise operations.
Adopting and implementing enterprise software solutions based on artificial intelligence (AI), machine learning (ML) and cloud computing is the most cost-effective and efficient way to mitigate the effects of an increasingly complex and costly regulatory environment.
Compliance is part of the “innovative engine”
However, having the latest technology is not a silver bullet. Forward-thinking fintech innovators are also changing the way they operate in compliance to maintain their pace of innovation.. Compliance teams should be involved early in the development of a product or service—even during ideation.
Incorporating compliance feedback and expertise during development can greatly reduce delays caused by compliance issues. Compliance should not be seen as a “gateway” at the final stage of product development, but as part of the innovation engine that drives companies forward.
It is impossible to fully predict the future regulatory landscape. But with the right tools and workflows, financial institutions and FinTech innovators can work smart to minimize risk and maximize innovation.
Kevin Jacques and Ben Malka are partners with Cota Capital, a technology investment company based in San Francisco.
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