Hummingbird

As someone who spends my time on high-level ideas and trends in financial innovation and regulatory strategy, I took an important step last year:  I cofounded a startup.  It’s called Hummingbird Regtech, and it aims to transform compliance through cutting edge technology, starting with anti-money laundering.

For me this is learning by doing, and the practical, concrete process of designing a next-generation compliance tool has already brought me insights I never would have found by doing policy work at 30,000 feet. The breakthrough moments have come from brainstorming with my colleague Matt Van Buskirk, who is a regulatory expert. Matt likes to say that when you tell fintech engineers about regulatory requirements, their first reaction is usually disbelief, as in, “you have to be kidding -- why would we need to do that?” The next is that they set out to design an efficient, effective way to get it done. If you tackle that task with no preconceptions and no legacy tools, and instead just apply new technology to a blank slate, you can create tools that are faster, cheaper and more effective in reaching public policy goals, all at once.

The Hummingbird work is giving us more than ideas for compliance solutions. I’ve predicted that 2017 will be the year of “regtech,” a term that has two meanings. One is using updated technology to comply with regulations. The other refers to use of new technology by regulators, themselves, to enhance their own work. Regulators around the world are innovating, using big data, machine learning, API data feeds, and other new strategies to rethink everything from bank regulatory reporting to detecting patterns of insider trading.

As I spend time with tech people on these problems, we are finding ourselves evolving a whole new vision for how regulations could be designed in the digital age. The core shift should be from creating regulations as linear processes -- rules, policy, procedure, and the like -- to framing them as technology “systems” that can be flexible, easily updated, and constantly improving. I’m convening a cross-section of regulatory experts, engineers and designers to flesh out the concept and will expand and share this further in the coming months.

This is an exciting time, stay tuned as I will also be sharing more on Hummingbird as it launches live pilots this month! 

In addition to discussing fintech and regtech with global senior supervisors at the New York Federal Reserve Bank in early March, I am also very much looking forward to what's up next: 

• April 10th, London - I’ll speak on regtech at Innovate Finance, and later that week I’ll  join in the regulatory forum of the Financial Conduct Authority

• April 26th, New York - FINXTECH Annual Summit - Panel on Key Regulatory Perspectives

• June 15th, Austin, TX - Center for Financial Services Innovation (CFSI Emerge), FInancial Health Summit.

Technology is transforming finance. It can transform regulation too! Exciting times ahead!

RegTech and the Trump Disruption

2017 will be the year of “regtech.”

That’s partly because this new technology is growing exponentially, and also because it can find fertile soil in the turmoil of Donald Trump’s Washington, where everything is suddenly open to change.

Most of the U.S. financial world has not even heard the term yet (again, that will change this year). It has two meanings. There is regtech for regulators -- applying new technology to the regulatory process itself. There is also regtech for industry, as innovators create new-generation compliance tools that simultaneously slash costs and strengthen public policy outcomes.

Worldwide, these trends are moving fast. Countries from the UK to Singapore have established regtech learning labs, and the developing world is a hotbed of experimentation as regulators rush to keep pace with the financial transformation driven by smartphones. Meanwhile, capital is pouring into startups inventing new tools for financial companies. Innovators are realizing that the same technologies behind fintech -- big data, AI, blockchains, and more -- will also revolutionize regulation.

The trend is slower in the United States, partly because our fragmented agency structure impedes change. However, regtech is the single best path to regulatory streamlining, a top priority of the new administration.

I myself have cofounded a regtech firm to automate AML compliance, which I’ll tell you about soon!

Meanwhile, please enjoy the latest podcasts featuring Theo Cosmora of the OneDollarSmartphone); LendUp CEO Sasha Orloff, and the formidable former SBA Administrator and Harvard Business School Fellow, Karen Mills, on fintech for small business.

 Karen Mills, Harvard Business School senior fellow and former SBA Administrator, says, “The industry needs regulatory policy.”

And here’s what’s coming up :

• March 6th, New York - LendIt USA hosts its huge annual conference on lending fintech. (I’ll join a lively panel there on the OCC’s fintech charter concept.)

• April 10, London - I’ll speak on regtech at Innovate Finance, and later that week I’ll  join in the regulatory forum of the Financial Conduct Authority

• April 26th, New York - FINXTECH Annual Summit - Panel on Key Regulatory Perspectives

• June 15h, Austin, TX - Center for Financial Services Innovation (CFSI Emerge), FInancial Health Summit.

Disrupting Regulation in 2017

Friends,

As the year turns, we sweep out debris and start clean, focused on goals, fixed upon hope.

2016 was the year of disruption. In December I was in Europe, where I found nearly every financial executive, startup founder, regulator, and taxi driver wanting to discuss the U.S. election. The whole world feels shock waves from our seismic event.

Disruption, always, destroys and creates. Old assumptions crack or collapse. Hardened ground softens. Change takes root. The change, always, is both bad and good. The balance of positive and negative outcomes depends, ultimately, on how people use the forces released.  

Financial regulation is ripe for change -- especially as technology disrupts the industry and with it, inevitably, the rigid regulatory framework we’ve built around it. Our regulatory system has important strengths to preserve and serious weaknesses to fix.

My 2017 resolution is to pursue regulatory disruption, to help shape new, better policy for finance. We should foster market innovation through fintech. We should foster regulatory innovation through regtech. We should build new channels of dialogue. We should use disruption to do better, together. I’ll look forward to working with all of you to try to make that happen.

Last month I spoke in Geneva at a global UN regulatory forum on how fintech can build financial inclusion. Two days earlier, I spoke in London at FINTECH CONNECT LIVE, where people from around the world explored disruptive forces ranging from Brexit to blockchains. The world is alive with new ideas.

Let’s learn and think about them, and channel them to good use.

I wish all of you the best of progress, and the blessings of peace, in the new year!

Guest Blogger : Katherine J. Flocken on Not Forgetting those Most Desperate

For the holiday season, here is a moving and thought-provoking post by guest-blogger Kate Flocken, about the the need to make it possible for people of every background, in every corner of the world, to lead healthy financial lives.

I wish you all peace and joy in the new year. Jo Ann

---

As the Holiday Season Arrives Remember Those Most Vulnerable

Snow dusts the ground in the woods just outside of Freeport, Maine. It’s 32 °F when Jack and his two dogs emerge from their tent. Jack’s breath makes clouds in the chilly air while he heats his camp stove and prepares for the day. First he will sneak to a nearby RV campground to use the shower facilities, before looking for work, and someone willing to pay in cash.

Jack is not camping — he is running from his debt. When he moved out of his parents’ house to start college he received offers from credit card companies offering him accounts. The sign-up was easy and he started to rack up debt which spiraled out of control. Eventually he became so overwhelmed by his situation that he left his home to move someplace without an address and where his creditors could not find him. He does not see a way out of his present situation. He does not see any way to pay off his debts or rebuild his credit and he is not interested in opening a bank account because he is trying to live an invisible existence — no address. Cash only.

Over 8,000 miles away in a six-person community in southern India, Akshat and Lavanya are gathered with other members of their small community for a meeting. They are arguing with a woman, Padma, with long dark hair and glasses. The people living in the community are all victims of leprosy and the woman is the representative of a charity that is interested in working with them on a micro-lending program. The people in this community live in one building which is made up of small, 5’x4’ concrete rooms. In these rooms they have a mat on the floor to sleep on and a pail of water for both drinking and hygiene. Lavanya has a flower pot outside of her door. There is no electricity or plumbing.

The participants in the meeting are telling Padma that they do not want to be part of the micro-lending program because they do not want to risk losing eligibility for a monthly shipment of rice and beans. Padma is trying to convince them that by participating in the program they will not need the shipment because they will have a better, and self-sufficient, living.

These two situations have far more in common than it appears on the surface. In both cases the individuals involved are struggling financially and are trapped by a sense of hopelessness. They are afraid to seek help for fear of losing what little they have. They also completely lack access to or desire for any sort of financial services.

These situations highlight the immense difficulty of reaching the most underserved. Even if Jack, Akshat and Lavanya had access to a bank branch or any sort of technology, they have spiraled to a point where it is unlikely they would utilize available tools. This underscores the challenge that must be met in order to enable even the most underserved and desperate consumers to improve their financial health.

The financial services industry is experiencing tremendous change driven by startups and other organizations aiming at the un- and underbanked populations all over the world. This revolution of global fintech technology presents a tremendous opportunity to reach the underserved — but it is important to remember those who have fallen so far out of the system that they have given up.

As the temperatures drop and we celebrate the holiday season it is worth taking time to think about those who are most vulnerable and in need of help.People like Jack, Akshat and Lavanya are in need of thoughtful and considered effort to help them build their financial health and regain their pride and self-sufficiency. The first step is understanding that these consumers exist and recognizing the difficulty of reaching them. While we budget for gift buying and strategize how to navigate family dynamics it is important to consider how we can help those who must focus all of their resources on day-to-day survival. Though reaching these consumers is immensely challenging, it is crucial that innovators do not forget the most desperate members of our population — that they consider the possibilities of how their products can meet people where they are — and how new solutions can effectively engage even the most underserved.

Kate Flocken works for a nonprofit dedicated to promoting consumer financial health. She is a former U.S. Senate staff member.

Please note - the opinions expressed herein are my own and are not related to any organization.

Fireside chat with Richard Cordray at Money 2020

Last night I had a fireside chat with CFPB Director Richard Cordray on the main stage at Money 2020.  It was the first time a federal agency head has addressed the world's largest financial conference (11,000 people this year), and he did not disappoint.

Director Cordray explained how the CFPB will play its leading role in regulating financial innovation. Not surprisingly, he called on the thousands of innovators in the audience to design products that help, not harm, consumers. He said startups should have compliance in their DNA, from birth.  He promised to make enforcement tough but fair.  He announced the first-ever report on the Bureau's Project Catalyst, its regulatory "sandbox"-type program that tests innovative concepts that raise regulatory questions.

And then he said two things that are making news today.

First, he said the CFPB is going to assure that consumers can control their own financial data, including to let third parties help them manage their finances. Today's personal financial management (PFM) tools increasingly work by having the customer allow access to bank account information for analysis of income and spending flows.  Examples are Mint and Digit (see my podcast with Digit CEO Ethan Bloch about making saving easy, automatic, and even fun).  In recent months, banks have voiced concern that such solutions may not be reliably safe, and some institutions have cut off access or made these new tools much harder to get. While consumer safeguards may be needed, the core principle of customers' right to their data is fundamental to achieving the promise of fintech. It's also enshrined in the law, in Section 1033 of the Dodd-Frank Act which empowers the CFPB to write rules on the issue. Director Cordray last night announced a priority to move forward in securing these rights.

Second, the Director also said the Bureau will take on the thorny issue of how lenders can use nontraditional data in evaluating credit risk. Many people (including me) believe that new kinds of data are a key to widening financial inclusion (especially when paired with low-cost mobile services). Tens of millions of Americans have thin or no credit files, or complex situations that prevent accurate underwriting under traditional scoring. Today's big data and machine learning make it possible to fine-tune risk assessment of these people and find the many who are actually creditworthy.  That effort collides, however, with the equally powerful policy goal of fair lending. Use of alternative data is so novel that lenders can't tell what factors can be considered without potentially violating the laws against discrimination through "disparate impact." Some data types will undoubtedly have disproportionate adverse effects on one group versus enough in terms of race, gender, ethnicity, and other borrower characteristics. When such effects occur, the burden shifts to the lender to demonstrate not only that the data accurately predicts credit performance, but also that there are no alternatives with less discriminatory results. Precisely how to do so is unclear.

This uncertainty inadvertently undermines the policy goal of encouraging lending to creditworthy consumers who have moderate incomes. Most such loans are not highly profitable anyway, when done responsibly.  When they also carry extremely high regulatory risk, many lenders simply avoid the market. In other words, the goals of consumer protection and inclusion can work against each other.

Today, new technology makes it possible to have both -- if regulators provide ground rules on using non-traditional data that are clear enough to follow without enforcement fear. The CFPB has embarked on a path to provide it.

In our fireside chat last night, I said data is the circulatory system for innovative finance, the life's blood. If it can't readily flow and be used - within appropriate safeguards - finance will develop heart disease. The system will be weakened by blocked arteries and loss of oxygen, and some parts - with high potential to help consumers -- will die. Last night, the CFPB took on not one, but two, of the policy challenges most crucial to building a healthier financial system for everyone. Good for them.


Director Cordray's speech             

New report on Project Catalyst  

New CFSI report on principles for data aggregation  

My Helpers

I just got my first robot.

It’s a vacuum cleaner, a Roomba from iRobot. Okay I know that’s not exactly cutting edge. My son’s floors have been cleaner than mine for years because he was an early adopter, but I’ve been holding out until the technology got good at rug tassels.

Needless to say, it did. The newer Roomba knows tassels when it touches them – it turns neatly to run its sweeper along them. It’s also more efficient than its predecessor thanks to intelligence that lets it perceive the contours of the space and plan a strategy to minimize time and motion. And of course, my version has a phone app, so I can control it from the other side of the world. I like it.

The only problem is that it doesn’t listen to me when I talk to it.
All my other helpers do. The one that’s the best company is Alexa – the Amazon Echo. She sits on my kitchen counter in her sleek black cylinder and, in her gorgeous voice, tells me the weather, and cracks jokes, and reads me the morning newspaper and answers fact questions and Googles things for me. She can adjust my lights and thermostat. And if I was a Capital One customer, she would do my banking. 

Cortana, too, listens and talks. She’s (yes, I’ve decided to think of these beings as “she” rather than “it”) has been simplifying my computer work for over a year. This month, she has also inhabited my Xbox. A while back, I made a little video demonstrating how I use my Xbox to simplify media entertainment, because I can just give voice commands to change channels or watch Netflix or BlueRay or find a movie on Bing. Or to exercise, or call someone on Skype and see them on my big screen. I thought that was pretty cool, but now Microsoft has brought Cortana into the Xbox. She’s has a smarter language brain than the “old” Xbox did – more natural.

And of course, I have my Iphone. It not only contains Siri, which most people seem to use now, but also a newer extra-super-smart voice app -- Hound. It was created by the founder of the music-recognition app SoundHound. Unlike Alexa, Hound has a flat robotic voice but wow, can she think. I can say, “Hound, find me an electronics store near the Boston airport that is open Sunday evening.” And she will.

I’ve gotten so spoiled commanding my smart devices by voice that it’s hard not to try to converse with, say, dumb TV’s in hotels. But of course, they will soon get smart. And so will Roomba’s listening skills --I have no doubt.

Natural voice technology, combined with artificial intelligence, will bring a huge leap in financial services. It is a simplifier.  It de-layers information. Alexa has absolutely no interface except voice -- no screen to touch, no keyboard. She just listens, talks, and controls physical items in the Internet of Things that are smart enough to interact with her.  For financial services customers, the ability to do tasks and answer questions simply by talking with a robot “coach” will close the last mile of access for people who don’t thrive on the way we present products today.

This Wired magazine article changed my whole way of thinking about voice.

Fintech is more tech than fin, in that it is driven mostly by the technology change, not financial product invention. The tech change, in turn, is remaking everything we do, leveraging changes that are that are converging, In finance the driving trends are mobile technology, artificial intelligence, block chains, and yes, voice tools. But those are only a few of the army of transformations heading toward us. Along with them come robots, drones, 3-D printers, CRISPR genetics and so much more. 

Even my limited experience with my primitive new helpers makes it easy for me to picture living in a completely different way. Among other impacts will be a transformation of the labor market.  3D printers can make buildings. Uber will pick us up in driverless cars – in fact, they’re testing these this month in Pittsburgh. My TaskRabbit errand or pizza delivery will come by robot or drone. Jobs that got outsourced to the developing world in recent decades are going to change again – going now to machines.

I recently spent an evening hanging out with some young MIT PhD candidates in genetic science. Most of the time I had no idea what they were talking about, but I caught enough to get a glimpse of technology that will change the very nature of life. Not surprisingly, it’s very advanced in China.

Scary, yes. Exciting, yes again. Also unstoppable.

All innovation brings mixed impacts, good and bad. Technology will spread high quality of life to nearly everyone by making amazing things universally available. Already more people globally have access to cell phones than to toilets. It will also bring profound dislocations.

Specific predictions are usually wrong, but it’s safe to say that profound transformations are upon us. They are catching us by surprise because they are growing exponentially, and partly because they’re converging. Talking to my Xbox seemed pretty cool last year. Now, a few months later, my old Xbox conversations seem, well, kind of quaint.

Allowing the good and mitigating the bad is the most important challenge facing government, including financial policymakers. That’s why, for financial services, I’m working on finding new ideas for how to do it.

If you want more food for thought, buy fintech guru Brett King’s book Augmented.

Meanwhile, much as I love my high-tech helpers, they’re nothing compared to my human ones. My work relies on an amazing team of young people who support it part-time. Here they are:

Harvard research assistant on my book:                      Amrita Vir
Podcast show notes:                                                    Jane Hencrickson and Rachel Cossar
Social media strategy:                                                  Rachel Cossar
Tech support, strategy and podcast/video editing:    Matt Van Buskirk
Making it all work:                                                         Katherine Foote        

They are the greatest.

Second Teaser to my New Video Series : The Five Tech Trends

Regulation Innovation / Briefing 1: The Five Tech Trends

The first thing to understand about fintech is that it is far more about “tech” than “fin.” Financial people tend to underestimate the size and speed of the coming change, simply because the forces driving it are mostly developing outside their field of vision -- in the technology world, not in finance. These massive innovations are essentially traveling through the financial realm, creating and altering financial products and channels in the process. Like all technology change, moreover, these shifts are global.

Their technology roots have many implications, including that regulatory responses will be shaped heavily by regulators other than the ones overseeing banking and finance.

The second thing to understand about these trends is that each is an enormous force in itself, but still looks deceptively small because the technologies are also converging. Most innovators are already leveraging several of them (which is one reason some fintech is radically breaking old molds). As they continue to merge, they will spark explosive change.

Regulation Innovation, accordingly, starts with examining the Five Tech Trends.

Trend 1: Big Data

Big data is the proliferating information being generated by our modern digitized lives. For consumers, it includes information gleaned about our buying habits, entertainment preferences, and social media activities. It also includes geolocation data gathered by location-aware devices like our phones and cars.

Another source is information gathered by the expanding use of cameras, large and small that use facial recognition technology. These can identify who and where we are and can assess our reaction to what we’re hearing or seeing – such as whether we frown or smile as we look at merchandise in a store. Here’s more on facial recognition.

Another enormous category is the burgeoning Internet of Things, or IOT – the interconnections between all the little computers embedded in devices surrounding us. These range from smart thermostats and baby monitors to electronic keys and cameras, to electronic scales and fitness trackers. We will soon have smart refrigerators and washing machines that automatically order resupplies when, say, the milk or detergent is running low. These devices have the ability to map intricate and voluminous data about our tastes, movements, associations and lifestyles.

In addition, government is contributing to the big data revolution by digitizing records. In finance, examples are the CFPB’s databases on consumer complaints and the Home Mortgage Disclosure Act. These have been designed to use “application program interface”, or API, capability, to make it easy for third parties to acquire and work with the data. While data like HMDA information is old, it can now be combined with other proliferating and detailed big data, boosting the power of all of it. The same trend is underway at all levels of government, from accessibility of property titles to records of birth, death, marriage and divorce. The Obama Administration views federal records as a national resource that should be available for public use to the extent consistent with protecting privacy. Such steps are creating explosive growth in the amounts and types of available data.

As discussed below, big data is driving toward financial inclusion by making it possible to know more about individual consumers and thereby fine-tune risk assessment and underwriting.

Still, big data is problematic simply because it’s so big. That brings us to the second trend.

Trend 2: Artificial Intelligence

Big data differs fundamentally from the information traditionally collected by financial companies. Unlike credit scores, verified customer information, or a bank’s own information on its customers, big data sources are massive and messy. Information is often inaccurate – it’s typically collected for reasons that don’t require accuracy at the individual level. Furthermore, the information is lodged in databases that don’t easily connect.

However, we are learning to put this new data to work through artificial intelligence, or AI. The terms“machine learning,” “deep learning,” and “neural networks” all refer to the ability of computers not only to amass and process information efficiently, but actually to learn -- to think. Today’s machines solve complex problems through rapid, powerful trial and error and pattern recognition. Some have the capacity to search, quickly, all the digitized information in the world (which, as noted above, is skyrocketing in volume).  Here is an excellent Wired Magazine article on how machine learning is changing our lives.

For example, we now have computers that not only can diagnose cancer by accurately reading radiology reports, but that have also noticed attributes of tissue outside the malignancies they were analyzing and pointed out important patterns that scientists had not even asked them to look for. In finance, an example is Goldman Sachs’ Kensho, which can answer thousands of complex “what if?” questions from investors and brokers, in simple text, in seconds (for instance, what would happen to homebuilding stocks if a category 5 hurricane hit the U.S. mainland?).

For a quick, fascinating look at AI, see these images of Google’s photo-search computers “dreaming.” After the engineers stopped feeding information to them, they continued to “think” about what they had “seen,” and this is what was on their minds….

The use of new data analysis in financial services raises complex public policy challenges. Again, these trends are a massive force driving toward more financial inclusion, because alternative data and analytics can assess the risk profiles of consumers who have thin or no credit files or complex credit situations. These applicants are typically rejected in today’s systems, but may in fact be creditworthy. In some ways, new technology offers a 21st century, high-tech version of the kind of traditional banking where the banker personally knows a customer well enough to make a sound loan despite problematic circumstances. That system works well on a small scale and for borrowers fortunate enough to have such a banking relationship -- which, of course, many people do not. More data and better data analysis can open up a semblance of such nuanced evaluation on a larger scale.

On the other hand, regulators of course worry about new models that have not yet been tested through an economic downturn, especially given the failure of credit risk modeling in the financial crisis. Policymakers also have concerns about fair lending issues arising from new data uses, including disparate impact risk. In addition, new collection and uses of data raise concerns about privacy and cybersecurity.

Most banks do not yet employ these techniques, partly due to the regulatory uncertainties around them. However, many fintech companies do. As new data methods become refined, they may tend to give a competitive edge to innovators using them over companies that don’t, simply by enabling more sound and profitable lending decisions. For community banks seeking to grow, alternative data could make broader markets reachable. We may also reach a point where financial companies will be penalized for not using big data analytics, if it in fact proves to be both highly inclusive and predictive. Future videos and briefings will explore all these issues at the intersection of regulation and innovation.

 AI carries profound questions for the future. Many dramatic predictions about it have not yet proven out, but it seems clear that big change is coming and accelerating, and could profoundly change the human experience. One scenario is depicted in the movie Her, about a human-like, voice-only operating system -- with its startling final plot twist. This year Microsoft withdrew a new AI-basedchatbot (talk robot) named Tay after one day, because she had “learned” abhorrent views through her online conversations. People also worry about (or hope for) the evolution of trans-human technology like enhanced eyesight (watch for author Brett King’s upcoming book, Augmented). The growth of AI could reach a point that Vernor Vinge in 1993 called the singularity, in which computers with superhuman intelligence could create change as significant as the rise of human life itself. Ray Kurzweil, who received the National Medal of Technology and Innovation in 1999, has written The Singularity Is Near, predicting that humans will eventually transcend the limitations imposed by our physical bodies and brains.

Here is one of my favorite Ted Talks, by Jeremy Howard, on “the wonderful and terrible implications of computers that can learn.” He shows how computers can “see” and “listen;” can learn to recognize pictures and words; can “write;” and can collaborate with humans. He gives insights into how Google search can find information for us so instantly and accurately. He also addresses the daunting implications of all this for society. It’s my top background link for this briefing.

Natural Voice Technology

I believe voice technology will close the last mile of financial access for millions of people who have difficulty using today’s standard product forms and channels. Many people don’t understand (or are frankly bored by) financial information as normally presented. Voice tools can change that.

We already have sophisticated voice technology. Products like Dragon Dictation can instantly translate voice to text and vice versa, while other tools can translate one language to another, even mimicking the voice of each speaker. If you didn’t watch the Jeremy Howard TedTalk above, watch it now. At about 4:30, he demonstrates machine learning translating his own talk into Chinese. And watch this wonderful demonstration of schoolchildren using Microsoft Translator to communicate.

Many of us already use Siri, Apple’s voice assistant on our IPhones, to dial phone calls, make restaurant reservations, report the weather, or set up reminders and shopping lists. You can ask Siri fact questions. If you ask, “who is Bill Gates?” she’ll send a Wikipedia article to your phone and ask if you want her to read it to you. You can say, “Find pictures of polar bears,” and she’ll find them.

The same is true of Microsoft’s Cortana. I was in a hotel room last fall and she suddenly activated on my laptop. I said, “Cortana, what are you doing?” She said, “I’m working out the mechanics of a virtual fist bump.”

Here’s a blog post I wrote about my wonky week of getting Cortana, Google Photo, and an Apple Watch all within a few days, and being amazed as they all began doing things for me, often at their own initiative (technology taking the initiative is another theme we’ll explore, as is fintech’s playful use of humor). It was especially impressive that they sometimes cooperated – even though they come from three different companies.

And now, we have the Echo – Alexa -- Amazon’s new voice-only personal assistant. As I write this, she is sitting on my kitchen island where she does things like reports the weather, adjusts the lights or thermostat, and reads me the news. I’m going to say, now, “Alexa, tell me a joke.”

Here’s her answer: “What did one flag say to the other? Nothing, it just waved.”

An important thing about Alexa is that it has no way to interface with us, except voice. There’s no keyboard, no screen to touch. This Wired Magazine article is thought-provoking about the importance of this. It discusses the potential for voice interface to mirror the power that Steve Jobs recognized when he first saw the graphical user interface, or GUI, and knew that touchscreens would be the future of computers. The article predicts that the voice interface will bring technology to millions of people currently at or outside the margins of access (including the twenty million people in the U.S. who cannot see).

Importantly, voice technology “unlayers” information and brings it instantly to the top. Suppose you need your bank routing number. Instead of looking it up, you can have your voice assistant simply read it to you. Alexa is new, but Capital One has already created a banking app for it.

For a mindboggling demonstration of what voice interaction can already do, watch this demonstration of Soundhound’s Hound (be sure to stay for the financial questions near the end).

The power of voice will magnify as it converges with big data, AI and, as discussed below in Trend 5, mobile. It will put a personalized, smart, interactive, helpful financial coach, equipped with a supercomputer, in all of our phones.

Trend 4: Digital Currency and Blockchain

The blockchain was created by the anonymous inventor of Bitcoin. Also called “distributed ledger technology,” or DLT, it is a record of a chain of transactions, posted on the internet in a manner that’s transparent, unbreakable, and unfakeable. Because it’s on the internet, the information moves almost instantly and at nearly no cost.

The initial driver for its creation was a desire to make Bitcoin an alternative currency. Given Bitcoin’s colorful early scandals involving drug trafficking and fraud, the mainstream financial world originally tended to dismiss it. However, the ingenious design of the distributed ledger is now inspiring a profusion of innovation aimed at using it to transform many systems and to change our lives.

Given its roots in Bitcoin, blockchain technology has focused initially on changing finance. Innovators are applying it to models that range from being a “currency” -- “digital currency” or “crypto-currency” -- to an investment, to a new or enhanced payments infrastructure. Hundreds of innovators are putting it to use in payments -- seeking to wring nearly all the expense and delay out of them and essentially do for money what the internet did for information by making it instant, free, and shareable with anyone. (We’ll discuss some of these emerging models in the next briefing, Meet the Innovators.)

In addition, central banks in the U.S. and throughout the world are exploring the possible benefits, and risks, of creating government-issued digital currency. Governments and payments clearinghouse systems are also evaluating ways to streamline and accelerate central payments systems.

Beyond finance, blockchain solutions for other use cases arise almost daily – thousands of companies are working on them. These include recording legal titles and contracts, redesigning stock markets, and organizing complex flows of operations to strip out complexity, cost and delay from activities like large bank information and processing systems.

The U.K. Office for Science has produced an especially interesting report on the potential for distributed ledgers and the regulatory opportunities and issues arising from them. It begins by saying:

The progress of mankind is marked by the rise of new technologies and the human ingenuity they unlock…(We may be) witnessing one of those potential explosions of creative potential that catalyse exceptional levels of innovation. The technology could prove to have the capacity to deliver a new kind of trust to a wide range of services. As we have seen open data revolutionise the citizen’s relationship with the state, so may the visibility in these technologies reform our financial markets, supply chains, consumer and business-to-business services, and publicly-held registers.

The same report says, “(Distributed ledger technologies) have the potential to disrupt the whole economy, and society.”

The report’s reference to trust is critical, as blockchains make it possible to engage confidently in transactions with people we don’t know, without the help of mutually trusted intermediaries and without traditional contracts. The trust is built, efficiently, into the technology itself.

The blockchain is yet another technology that drives toward financial inclusion. Digital financial access is rising worldwide, especially in the developing world where (as discussed below) cell phones will soon be ubiquitous. The low cost of executing financial transactions on the internet is likely to disrupt the remittance industry. This efficiency, combined with the fact that digital currencies are almost infinitely divisible, will also make it economically viable to process micro-payments. People will be able to send and receive a few cents, opening up enterprise in the developing world and generating whole new business models everywhere.

In addition, real-time settlement of financial transactions can remove one of the factors that drives consumers into high-priced cash and payday lending services, namely the inability, today, to know when a check or electronic payment will clear.

Here is my blog post on the consumer benefits of Bitcoin.

This area, like the others, will raise enormous regulatory challenges that we’ll explore in later briefings.

Trend 5: Online & Mobile

Financial services have been online for years – a majority of banking is now done there. What’s new, today, is the successful advent of innovative business models delivering services entirely or mostly online, capturing enormous efficiencies compared with traditional branch-based infrastructure. Many also use very sophisticated data analytics and offer a markedly superior online user experience, or UX -- typically because they’ve been designed by technology people, rather than financial people. Some of these companies hope to change finance in the same way Amazon changed bookstores and retailing.

Among the online players, there is particular interest in “marketplace” lending (formerly called peer-to-peer lending) that matches borrowers and investors online. We’ll explore more about this in the next briefing on “Meet the Innovators.”

Even more innovative than online services, though, is mobile technology – it may, in fact, be the most revolutionary of all the five trends.

Financial people tend to think of mobile as being about payments, but finance is a tiny fraction of the change underway. We are seeing a fundamental reshaping of how we live, a shift potentially on the scale of the invention of money itself, or agriculture, or electricity or the internal combustion engine.

The smart phone has become a layer, an interface, between the individual and nearly everything in the world. It mediates what comes in to us, and what goes out. It is reshaping communication, relationships, social norms, information, education, entertainment, work, commerce, shopping, buying, selling, creativity, health and fitness, time-management and nearly everything else. People use the phone for self-expression, to share music, to share humor. They use it to seek advice. They use it to compare prices. They use it to track calories and monitor exercise. There is almost no realm of human life not being altered by it – people even use it to guide prayer. When the phone is converted to a watch or other wearable, it takes on additional capabilities.

This has huge implication for finance. One is mobile payments -- a topic we’ll explore extensively in the series. Beyond that, the phone will leverage all the five technology trends to become a single, powerful financial tool. It will consolidate all our financial information in one place; use that automatically and painlessly to build budgets; organize and handle payments; use behavioral economics to nudge us toward goals and away from financially damaging temptation; enable effortless saving and reinforce it by entertaining us with amusing text messages; block out dangerous products; and become our financial coach – eventually by voice.

Again, all the new technologies are converging in the phone. Since it knows where we are, it can alert us as we walk toward Starbucks if our budget can’t afford a latte today. It can remind a hurried mom with fidgety children to hold spending at the grocery story to hold to the $75 she can afford. If we overspend, it can recalculate and help us monitor a reduced daily budget. It can find the best choice of a credit card or car loan or mortgage and explain why. It also take the initiative to help – for instance, offering to talk about a retirement plan, for someone who doesn’t know how to start or where to turn.

It will also address the widespread failure of financial literacy education. Josh Reich, founder of Simple, points that when the automobile was invented, people couldn’t drive without understanding how it worked. Then we got automatic transmissions, and now most people can operate a car with no idea of what’s under the hood. (And now we’re even going to have driverless cars). Finance will go through the same transformation. After a century of U.S. federal policy fostering “financial literacy,” only a tiny percentage of people understand finance. Today’s technology, though, can help people build healthy financial lives without sophisticated knowledge, by using tools that deliver helpful information, right when it’s needed. The phone education can be customized, and can be made interesting and even enjoyable.

Smart phones will also put financial comparison tools in everyone’s pockets. These have already emerged, but big data and AI will massively enhance them and build them conveniently into the phone, synthesizing fast-growing data on consumer reviews and complaint scores, as with Yelp, Open Table or Trip Advisor. (Amazon already lets customers rate its credit card on the product page, just like a TV or a pair of socks.)

Even more profoundly, the financial coach in the phone can eventually flat-out prevent poor decisions by screening out products with hidden adverse terms, whether the person fully understands them, or not. This mimics the medical concept of a “smart membrane,” letting in the good and blocking out the bad.

Think about it this way: the new technology means that businesses will know everything about us, and we will also know everything about them.

Most importantly, cell phones are the most democratizing force in the history of finance. They can deliver services to almost everyone, everywhere, at very low cost. In the United States, they are disproportionately highly used by lower-income and minority consumers, including for financial tasks (partly because many of these households never adopted more expensive PC-based banking.) A 2015 Federal Reserve study found:

Mobile phones are prevalent among unbanked and underbanked consumers. —The share of consumers who are unbanked is 13 percent, and the share who are underbanked is 14 percent. —Sixty-seven percent of the unbanked have access to a mobile phone, 65 percent of which are smartphones. —Ninety percent of the underbanked have access to a mobile phone, 73 percent of which are smartphones. —Forty-eight percent of underbanked consumers had used mobile banking in the 12 months prior to the survey.

People have phones. They know how to use them. They already use them for financial tasks. As more financial tools come into the phone, people’s lives will be transformed.

Outside the United States, cell phones are even more ubiquitous, because many parts of the world never had landlines and so adopted mobile earlier. More people in the world have access to cell phones than to toilets. Governments, NGO’s and businesses worldwide are rapidly building a global population that has full access to digital financial services. The relative American slowness on mobile is creating disadvantages for the U.S. in ways we will explore in the series.

One more note on demographics. Millennials are now the largest generation in the history of the world, in the U.S. and worldwide. In 2015 they surpassed the Baby Boomers, who will henceforth decline sharply as a percentage of population. Just as the boomers did when their numbers surged, the millennials are already exerting an outsized influence on the culture and the economy. Their preferences, including for mobile services and fast, easy transactions, will reshape finance.

Those are the five tech trends driving financial innovation: 1) big data, 2) artificial intelligence, 3) natural voice technology, 4) the blockchain, and 5) online and, especially, mobile. Again, each is huge, but they are also converging. (Check out my bonus video, Why Does Jo Ann Barefoot Have An Xbox (since she’s never played a videogame in her entire life?  It explains that four of the five tech trends have already converged in my own living room, in my Xbox.)

Nodes of innovation in each of these trends will increasingly connect with the others. Most innovators are already leveraging several of these technologies at once, and will add more. When big data combines with machine learning, and creates services delivered through voice-based consumer help, modernized by the blockchain, and delivered through the smart phone, everything changes.

Each of these trends, and all of them in combination, will raise enormous regulatory challenges – most of which will cause permanent uncertainty about regulatory standards and expectations. We will examine these in Video 3, Meet the Regulators and discuss how to integrate them into a strategy for regulation innovation.

Suggested Action Steps:

• Have your innovation team assess your company’s use of alternative data and analytics
• Have it assess your company’s strategy for mobile services, and especially how it rates with millennial customers (hint: ask your young employees)
• Register innovation team members for a tech-focused conference like Emerge, Money 20/20, LendIt, Finnovate, or SXSW – SouthBySouthwest(I’ll be speaking at many of them)
• Subscribe to Barefoot Innovation, my free podcasts
• Watch for the next video and briefing, where we will Meet the Innovators who are leveraging all this technology to transform finance

And of course - SUBSCRIBE HERE

First Teaser to my New Video Series

Welcome to my video briefing series, Regulation Innovation -- Thriving on disruption.

Each video comes with a fuller written briefing that includes background resources. The series is designed to build over time, as a journey. You can start anywhere, but watch them all. 

Please share the videos in meetings, and circulate the briefings throughout your organization. And I hope you enjoy the little bonus videos offering my light-hearted take on some of these issues.

Here is my briefing on the introduction to the series.

Why fintech matters:  What is it, and why is it so disruptive?

Before exploring precisely why regulation and innovation are two sides of the same challenge, let’s look quickly at what’s happening (later briefings will go in depth on these topics).

Fintech is innovation that applies new technologies to financial services and channels to make them faster, cheaper, clearer, more manageable, more user-friendly and/or more engaging and fun (yes, fun). It includes online and marketplace lending; digital currencyand real-time payments; efforts to “uberbize” payments by making them disappear into the consumer experience; “robo-investing;” emerging “insure-tech;” and a vast array of personal financial management, or “PFM” solutions (usually mobile apps). The latter do things like smooth out financial volatility, make savings easy, organize bill-paying, and enable bill-sharing. The term sometimes also includes “reg-tech” that seeks to simplify compliance. 

They all leverage some combination of emerging technologies (usually several at once), including big data, powerful data analytics, natural voice technology, the blockchain, and the smart mobile phone, all of which we’ll explore in the series.

Broadly speaking, fintech innovators are trying to do these things:

• Identify everything that bothers people about traditional finance, and fix it
• Find additional things people don’t even realize bother them about today’s financial markets, and fix those too (just as Uber has solved problems we didn’t know we had until Uber removed them, like having to pay at the end of a taxi ride)
• Wring every possible cost out of delivering financial services, through mobile channels, new uses of data, blockchain technology, and leveraging the newcomers’ clean-slate edge over banks’ old legacy IT systems.
• Find broader markets and make financial services more inclusive, again, using mobile delivery and alternative data.
• Usually, make products simpler and more transparent
• Help consumers manage their own financial lives better, with easier and more powerful tools and by more actively engaging consumers through use of behavioral science and nontraditional methods like playfulness.

Their thinking reflects “blue ocean strategy” – growing not by competing with incumbents in a zero-sum “red ocean” game, but rather creating whole new markets through innovation that will simultaneously raise value to customers and cut costs for providers.

The new technologies, themselves, are neither “good” nor “bad.” They’re just powerful -- often mold-breaking. Similarly, innovators’ motives may or may not be “good” – they range from idealism to straightforward profit goals. In general, though, the innovators believe they can sharply improve on traditional financial offerings. Some hope to do so by replacing parts of today’s financial industries. Some hope to sell to today’s incumbents. Many hope to partner with them.

These changes are highly disruptive. The Financial Times reports the Bank of England’s Andrew Haldane as saying (“astonishingly”) that the unit cost of US financial intermediation seems to be unaltered over a century. Innovators plan to change that, and a great deal more, through technology, in the same pattern seen in so many other sectors.

More than any other sector, however, financial services are pervasively regulated. This means inevitably that the impacts will disrupt not only the industry, but its regulatory framework as well.

As a result, the technology changes ahead will create enormous regulatory shifts. The industry will have to create entirely new ways to manage both the innovation and the regulation, together.

How are regulation and innovation intertwined?

The top two existential challenges facing nearly every financial company today are, first, regulation, and second, disruptive innovation. Most people view regulation and innovation as very different topics – like oil and water – but they actually are intricately intertwined. Neither can be gotten right unless they are addressed together. Here’s why.

First, regulators and disruptive innovators are often attacking the same things about traditional consumer finance. They’re both finding every place where the industry’s current business models benefit (knowingly or not) from customer confusion or inertia about complex products and pricing, and where old delivery channels and legacy IT create high costs, errors, or lack of access. Obviously regulators and innovators have different motives and tools, but they have locked in on the same vulnerabilities. For traditional companies, it’s a pincer attack. 

An example is bank overdraft protection fees. Most banks know the CFPB plans to issue new rules on these.  Many don’t realize, though, that innovators are meanwhile inventing products to keep consumers from needing to overdraw. Attracted by the revenue potential in the estimated $30 billion consumers pay in annual overdraft fees, they are aiming to create affordable and convenient alternatives (watch for Briefing 2 in our series, Meet the Innovators.) Similar dual assaults target payday lending and many other areas.

Second, regulation and innovation have both pushed financial services into a state of permanent uncertainty, impossible to manage with traditional tools. 
 

For innovation, the permanent uncertainty arises from the fast pace of change and the mold-breaking nature of new technology (which we’ll explore extensively in the series).
For consumer protection regulation, the uncertainty is fueled by a huge shift from rules-based to principles-based oversight. Most financial companies sense this but have not grasped its profound ramifications, maybe because the regulators have not formally articulated it.

One driver for the regulatory transition is that the financial crisis revealed massive failures in our traditional federal policy of using prescriptive rules and disclosures to protect consumers. While detailed rules will still loom large, they are already a shrinking share of regulatory risk, overshadowed by a rapidly rising focus on broad principles. Regulators have massive discretionary powers to punish unfair, deceptive and abusive practices (UDAAP), and credit discrimination, including unintentional patterns of statistical “disparate impact.” These are the tools they will increasingly rely upon, as innovation undermines policymakers’ ability to keep technical rules up to date. 
 
Principles-based regulation is inherently subjective, and therefore uncertain. While the post-crisis industry has established compliance programs for UDAAP, few have infused all decision-making with robust thinking about the emerging principles dominating regulatory risk. Companies must move beyond compliance models geared to reactive implementation of rules, and create new ones that work proactively in the absence of clear regulatory guidance. 

This means financial companies must learn to think for themselves about these principles, in order to predict and plan for unknowable regulatory reactions as technology changes the industry. They must also learn to predict coming innovation trends, and build compliance systems able to accommodate them efficiently and effectively. 

Rapid change will make this difficult. Here are “9 Dangerous Words” reflecting the challenge.

Third, regulation and innovation continuously reshape each other. Innovators introduce new products and channels; regulators respond with rules and principles and with oversight and enforcement; then innovators respond to those; and the spiral goes on – ever-accelerating and permanently interlocked.

Fourth, the high costs of regulation and innovation can only be optimized together.Companies that don’t invest enough in either area face enormous risks. Banks are spending 70-80% of their IT budgets on compliance, leaving scant resources for technology innovation. Fortunately, though, approaching the two challenges holistically can cut their combined costs. Updating legacy IT systems will solve tremendous problems in both realms, as will using new and better data and data analytics. Similarly, “reg-tech” solutions are emerging to make regulation easier, but again, only for institutions that connect both sets of challenges. Future videos in the series will explore how to do so.

Fifth, the path to innovation will be easier for companies that win regulators’ “trust.”Again, disruption of the industry will disrupt the regulatory system too. Agencies will face rapid and unmanageable change and critical decisions about what innovations to permit, and by whom.

Those decisions will be difficult, since the innovation underway will inevitably create risks to both consumers and the financial system, even as it generates benefits. Regulatory challenges will include protecting privacy and data security, assuring “fairness” in new uses of data, and updating disclosures for mobile and voice-based services. Consumers will be exposed to harm from well-meant but unfamiliar technology. And while most innovators are trying to create pro-consumer options, some will channels these new technologies into manipulative or predatory uses. Our fractured and bank-centric regulatory framework will also be mismatched with the industry’s changing competitive structure, especially regarding nonbanks. 

All these issues will be discussed in Video 3: Meet the Regulators. Their combined impact will be to give an edge to companies that regulators can trust to have both compliance strength and committed innovation strategies aligned with the regulatory principles of customer fairness and business soundness. The banks that are best at this will have an advantage in pursuing new ways to both partner and compete with innovators. Banks with weak and rules-based compliance systems will discover these have become a strategic barrier to competitiveness.

Here’s the good news: the interconnectedness of regulation and innovation will enablecompanies to reduce risks in both realms together. For most banks, vulnerabilities on regulation and innovation are lodged in the very same places – in legacy IT systems, old ways of using data, and outdated profit and compensation models and cultures. This means that fixing one, can help fix the other -- equipping companies to thrive on disruption.

Exponential change

Tackling the twin challenges of regulation and innovation is urgent, because the industry is evolving so fast. Accenture reports that global investment in fintech increased 75% in 2015, reaching $22.3 billion. After a late-year lull, it surged 67% in the first quarter of 2016. The U.S. saw 667 fintech investment deals in 2015, up 16%, while North American investment rose 44%, to $14.8 billion. A McKinsey study finds over 12,000 fintech firms invading every aspect of bank activity and predicts that the innovators could win up to 60% of traditional bank revenues in the next decade.

The change underway is exponential, driven by the phenomenon that Gordon Moore accurately predicted in the 1970’s, called “Moore’s Law” --  that computing power will double every two years. 

By its nature, exponential change masks the magnitude of what’s ahead because the transformation will hit quickly. Imagine, for example, that someone has a pond on which lily pads start to spread at a rate that doubles every day. Suppose that, on day 30, the owner realizes the water is half covered and starts pondering how to respond. 

The next day, this owner will find the pond completely covered. What took 30 days to reach fifty percent, takes only one day to reach one hundred.

Moore’s Law means that in five years, computing power will be 32 times more advanced. In ten years, it will be a thousand times more advanced. In twenty years, a million times. In fifty years, a quadrillion times. As computing power grows, technology change will accelerate with it, transforming every aspect of life. Here’s just one example:  imagine a world in which computing capacity is not finite and costly, but rather limitless and cheap – for everyone. The possibilities are breathtaking.
  
We’re living now on the steep part of this curve, using brains and institutions wired for linear change. The challenges we feel today will only intensify.

I highly recommend reading this thought-provoking post by Niv Dror on exponential change.

Reading before the next video:

• Here’s an article I wrote for Forbes on how fintech will disrupt finance and financial regulation.
• Here is a Q&A discussion I developed for Women in Housing & Finance’s 2016 fintech symposium, which teases out many of the keys to understanding it. 

Suggested Action Steps:

• Share this article with your team
• Form an innovation task force that deeply integrates innovation and regulation (include & empower young employees as part of it)
• Begin to educate the team on fintech innovation and assess the challenges likely to arise
• Come back next time for Briefing 1: “The Five Tech Trends,” to understand the five huge, converging technologies that are driving disruption.

 
Which is not like the others? 
Legislation, litigation, regulation…innovation

FOR ACCESS TO FUTURE CONTENT PLEASE SUBSCRIBE HERE and visit www.regulationinnovation.com