Guest Blogger: Amrita Vir on Millennials and Privacy

This is our first post by a guest blogger, and a very special one. Most of our readers know I’m at Harvard this year as a Senior Fellow in the Kennedy School’s Center for Business & Government, working on a book on financial innovation and regulation. I’ve been extremely fortunate to have a very talented graduate student, Amrita Vir, as my research assistant. Amrita is a candidate for dual MBA and Master of Public Policy degrees here at Harvard. She’s from Texas, a graduate of Southern Methodist University, and former consultant who has traveled extensively throughout the world.

One day last fall we were brainstorming about the book, and she told me a story illustrating how millennials think about privacy. I asked her to write it up and, even though our Boston springtime has now made her account slightly out of date, I’m sharing it with you as food for thought.

-- Jo Ann

Boots Anecdote, by Amrita Vir
 

I recently moved to the Northeast from Texas, and the weather is a little different here. By that, I mean it snows here, and I am inadequately prepared. Last week, I was browsing through Amazon to try to find a pair of boots that were both impervious to snow and aesthetically pleasing. This was a difficult task, but I finally settled on a pair of maroon Sorel’s that looked pretty acceptable.

And then I got distracted doing schoolwork and completely forgot about the boots. I blame the over-consumption of information for my ADD.

Anyway. A couple of days later, I picked up my boot-shopping task. I spent a good thirty minutes digging through Amazon trying to find those boots, but they were nowhere to be found. How on earth was I going to find these boots again?

And then I thought to myself – who knew that I lingered too long on that Amazon page? Who would know that I really wanted to buy those boots? Who knew that I got distracted and unintentionally lost the page in the Internet cosmos?

…FACEBOOK!  

So I popped open a new tab, typed in facebook.com, and scrolled down until I reached the ads. Alas, there they were. My maroon Sorel’s were right there, ready to be ordered and delivered with my Prime delivery service two days later.

You see what just happened there? Apparently, I have so much faith in the magical powers of the Internet that his was the most logical course of action for me. I don’t think twice about the fact that not only did Amazon collect data on my movements on their site, but that Facebook somehow got ahold of it and used it to push ads in my direction. There is probably some price discrimination that comes with knowing my online shopping habits and history (if you saw my Amazon account, you would know that I’m a sucker for shoes, and this is also an example of me being a very easy target).

What does it say about me and my generation that not only am I completely desensitized to the fact that these companies are collecting my data and using it to manipulate my consumption? What does it mean that I not only anticipated it, but sought the outcome of this behavior in the form of a Facebook ad? Is this representative of a broader outlook on privacy and the ways in which we choose to engage with our technology?

In talking to Jo Ann, I realized that this is perhaps a generational viewpoint. Quite naively, I asked her exactly *why* people get so bent out of shape over privacy on the Internet. I guess I don’t see what the big deal is about the government or the private sector looking at my information, so long as they’re not using it against me. Don’t get me wrong, I want transparency about who is taking what information, but I don’t really mind anyone using it – especially in aggregate form and especially if it is ultimately helping me out – like helping me find my snow boots.

Maybe I’m shameless or desensitized or jaded. Or maybe I’m just a product of a generation that does not know how to define privacy anymore, or at least does not place the same value on it as generations past.

Fintech Q&A in Washington

I spoke this month at the annual Symposium of Women in Housing & Finance in Washington, DC. This year’s topic was fintech and was well-timed, since the OCC had just issued its White Paper on Responsible Innovation. In my session, I talked with OCC Chief Counsel Amy Friend, who has chaired the innovation task force, about their plans.

Before the conference, WHF asked me to help them create a Q&A document for the program. I’d agreed, thinking I could dash off a few quick sentences on each item.  As I worked on them, though, I found the questions (prepared by the OCC) to be exceptionally thought-provoking. The more I wrote, the more they clarified my own thinking -- even though I’m speaking and writing on these subjects every day.

So, I’m sharing them with you. 

Meanwhile, if you’re in the DC area, join WHF for great events and networking!
 

"A Q&A with FinTech Expert Jo Ann Barefoot"

Ahead of the 2016 Symposium, WHF interviewed Jo Ann Barefoot, CEO of the Jo Ann Barefoot Group, LLC which advises on financial technology and regulation. Jo Ann previously served as Deputy Comptroller of the Currency and served for three years on the Consumer Advisory Board of the Consumer Financial Protection Bureau.

WHF: How would you define FinTech and what are some emerging products/services in the FinTech industry?

Barefoot: FinTech is innovation that applies new technologies to financial services and channels with the goal of making them faster, cheaper, clearer, more manageable and/or more user-friendly. In my view, they are more “tech” than “fin.” For that reason, the financial world is tending to underestimate the scale and speed of the coming change, because most of the change is happening in the technology world rather than in finance. It’s developing outside the field of vision of most financial people.

Emerging products and services take many forms. They include online lending; “marketplace” or peer-to-peer lending that matches borrowers and lenders online; payments innovations like digital currency and the “blockchain” and efforts to “uberize” payments by making them disappear into the consumer experience; “robo-investing” that automates investment management; and a vast array of mobile solutions that aim to solve a spectrum of consumer problems, from providing short-term cash, to making savings easy, to helping people manage their finances in new, engaging ways through personal financial managementtools, or “PFM.”

The five main technologies being leveraged are big data; artificial intelligence and “machine learning;” natural voice technology; digital currency and the blockchain; and online and especially mobile. Importantly, most FinTech innovators are applying more than one of these. Just as Uber disrupted both the taxi industry and traditional payment processes, FinTech companies are trying to break category walls by combining, say, sophisticated new data analytics with mobile delivery channels.

WHF: Why are regulators turning their attention to the FinTech industry now?

Barefoot: The regulators are recognizing that these technologies are rapidly disrupting financial services and call for updated regulatory thinking. Financial services are by far the most pervasively regulated sector to undergo disruption, which inevitably means that the changes ahead will disrupt the regulatory framework too. The agencies face a range of challenges. One is the sheer speed of change, which is dramatically mismatched with the normal pace of regulatory action. A related issue is that traditional regulatory processes don’t easily lend themselves to ongoing collaborative dialogue, which will probably be needed to foster the “rapid learning” regulators will need to keep up with new developments. These forces are likely to push the regulators toward more use of principles-based, rather than rules-based strategies, because the market will change too fast for rules to stay current.

In terms of consumer impacts, the agencies are increasingly recognizing that regulatory actions could inadvertently undermine desirable innovation. For instance, Federal Reserve research has shown that lower-income and minority consumers are disproportionately high users of smart phones.  Mobile fintech creates an unprecedented opportunity to reach millions of consumers with more affordable products than has ever been possible before. Similarly, alternative Big Data and analytics are making it possible to make finance more inclusive by reaching more customers with “thin” or no credit files or complex credit histories. Robo-investing, too, expands the affordability of investment advice. Digital currency, meanwhile, is speeding up payments, which can reduce the difficulty of paying bills for consumers who have no financial cushion and currently rely heavily on cash to be sure their payments are credited on time.

On the other hand, the agencies also see fast-emerging new consumer risks from FinTech. These range from loss of privacy and cybersecurity, to likely increases in branch closings, to fairness and discrimination questions arising from use of alternative big data to evaluate credit worthiness.

Beyond these issues, regulators are concerned about the impacts of FinTech on the overall financial system. They are looking at risks to banks from adopting new technologies that have not been tested by time and the business cycle. They are working on how best to allow banks to partner with innovators, while assuring protection of the bank and its customers. They need to worry about whether regulatory burdens on banks will cause them to lose ground to nonbanks. They are also grappling with how to regulate a fast-growing and diverse nonbank industry that will include players ranging from “big tech” firms like Facebook and Amazon to legions of small startups. At the federal level, we have a bank-centric financial regulatory system, confronting an increasingly diverse nonbank marketplace. At the state level, regulators are working on equipping themselves to evaluate license applications and to oversee novel kinds of companies and to consider the challenges involved in enabling nonbank innovators to reach scale.

Regulators are also exploring how best to work together.  These issues impact our five federal agencies that directly supervise financial institutions, as well as agencies ranging from the FTC (which generally leads in privacy matters) to FINRA to the SEC. Coordination will be important.

WHF: You have used the term “Regulation Innovation” in the past. What does this mean and don’t the two words oppose each other?

Barefoot: I use the phrase “Regulation Innovation” partly because, as you say, it seems incongruent – it startles people! I think the most important thing for banks to recognize is that they are facing two overwhelming strategic challenges. One is regulation. The other is innovation. Today, banks manage these as separate issues, with different people and tools. In reality, though, the two are deeply intertwined, because the same weakness cause vulnerability in both realms.

A critical point is that consumer protection regulators and disruptive innovators are targeting the same aspects of traditional consumer finance. They are both identifying places where the provider benefits – knowingly or not -- from the customer’s confusion, inertia, or lack of financial education, or where pricing is high due to legacy structures and compensation arrangements. It’s like a pincer attack, from two directions at once. Examples include overdraft protection by banks and payday lending. The industry knows that regulators are reviewing these, but may not realize that innovators are attacking them too.  The more profitable a product or practice is, the more likely it is that innovators are aiming to compete with it.

Regulation and innovation are also connected in that both have entered a stage of permanent uncertainty. This may be obvious regarding innovation, but it’s also true of regulation. Change is coming so fast the regulatory clarity will lag behind. The traditional compliance model of waiting for regulators to provide rules and then implementing them will need to be remade. We’ll still have many rules, of course, but increasingly banks will have to use their own judgment about regulatory risk, in the absence of clear prescriptive regulations. The solution to this will be to build ever-improving consumer benefit and pricing into every product. Doing this will, simultaneously, defend against FinTech competition.

Another trait linking the two areas is that they both are, increasingly, all about data, and especially understanding the overall patterns that data reveal. Most banks’ IT systems have evolved over decades and are weak in connecting data to gain a holistic picture. Today, regulators are analyzing data, such as CFPB complaint numbers, and finding patterns that raise concerns about unfair and deceptive practices (UDAAP) or discrimination. Most banks are blind to these because their compliance systems look mainly at technical regulations, while greater risks are arising “in the cracks” where compliance never looks, such as in unintended impacts of operating systems or in disconnects between what is marketed and what some customers receive. Principles-based regulation, especially UDAAP, has become the top risk in consumer protection, and it is often detected initially by looking at data.

The good news is that the interconnection of regulation and innovation means that fixing one, helps fix the other. The more banks assure that products and practices are transparent and well-priced, the more they will be well-positioned to prevent both regulatory and FinTech competitive risk.

Finally, banks (and policymakers) should focus on burgeoning innovation in “Reg-Tech” – new technologies that can make regulation simpler and more automatic, leveraging the same strengths that are driving FinTech solutions.

WHF: What are some of the biggest changes that have taken place within the financial services industry as a result of FinTech?

Barefoot: The industry is in the early stages of responding. Most large banks have created innovation teams or labs and are actively inventing, buying, and/or investing in new ideas. Some of this is explicitly designed to be a learning experience, while other efforts aim at practical problem-solving for customers or operations issues. Large banks are also exploring how to use the blockchain – the “distributed ledger” invented by Bitcoin – as a new approach to managing complex internal operations that involve chains of activity or transactions.  (The blockchain is a transparent way of tracking a chain of transactions or records, such as payments or, say, legal titles, on the internet. This makes the information move instantly, at very low cost, and in ways that can be viewed and verified by all interested parties and therefore, cannot be duplicated or faked).

For smaller banks and credit unions, most have taken steps to create more mobile apps. Some have begun partnering with innovators in areas like online lending – for instance, Lending Club has a partnership with BancAlliance for working with community banks. Most small banks will not be able to invent their own innovation. They will need to get good at working with innovators while still satisfying regulatory standards about third-party risk management. It’s a tough challenge.

One thing most banks are not doing is upgrading their IT and data systems enough to compete well in this fast-changing market. I believe it will be necessary to do so. Banks underestimate the degree to which innovators have an advantage, simply because they are working with clean, powerful data.

WHF: You were a financial regulator and now you advise financial institutions. What regulatory challenges does the FinTech industry face?  What are some of the compliance concerns?

Barefoot: The FinTech industry faces enormous regulatory challenges. One is the sheer cost of compliance – most startups can’t afford the expertise and systems needed to be sure to get everything right, although the smart ones are finding ways to do so and are building a compliance focus into their businesses early. A related challenge is the difficulty of assuring cybersecurity and getting anti-money laundering compliance right, on a small budget.

Another issue is that regulators often don’t understand these enterprises. For instance, digital currency companies need state money transfer licenses, and some states today are not yet familiar with these new technologies. Also FinTech tools are usually mobile – often mobile-only. This makes it complicated to manage disclosures even electronically, not to mention the ones requiring paper mailings.

Some innovations are breaking regulatory molds. Is digital currency a currency, an investment, or a payment system?  Marketplace lending is being affected by a court case invoking usury laws written long before this form of lending existed, and also faces the question of whether its investors, including individuals, could be subject to fair lending laws if they select loans to fund using criteria that could create disparate impact.

Another challenge is that innovators often use alternative data to evaluate creditworthiness.

Again, this can help drive toward more inclusive but sound lending, but raises many unresolved issues about fair lending disparate impact. It is not clear what data standards and algorithms will survive regulatory scrutiny over time.

WHF: Are traditional banks and FinTech firms’ natural competitors or can they co-exist?

Barefoot: They can definitely co-exist! However, both face big challenges and a great deal of change. I believe traditional banks will have to embrace innovation fully and will not survive if they don’t. Similarly, many FinTech firms will fail. Over time, I think some FinTech firms will probably emerge as top-tier financial providers. I think many will be bought by banks. Many will become banking vendors and partners.

I also believe large nonbank technology firms will become major financial players – candidates would include Facebook, Google, Amazon and Apple. All of these already offer some form of consumer financial services, have huge customer bases and data, and are liked and even loved by many customers. They are also young companies with strong innovation cultures. Telecom and internet providers will increasingly enter the market as well (and already dominate in some parts of the world), although they have less natural strength in innovation and customer popularity.

Ultimately, the new technologies will permeate the whole market, creating business and market models that are cheaper, faster, more inclusive, and much more transparent to customers (including through Yelp-type customer reviews). We’ll still have banks, and nonbanks, both serving customers directly and working in partnership with others to provide financial solutions.

WHF: What, if any, traditional consumer financial services are at risk of becoming obsolete because of technological innovations?    

Barefoot: As noted above, the most vulnerable areas are the ones being targeted simultaneously by innovators and regulators based on a perception that customers don’t really understand the product and pricing. Examples include deposit overdrafts, payday lending, and compensation models that may incent higher rather than lower pricing. Also vulnerable are any products and processes that are lengthy and burdensome for customers and anything that has high built-in costs due to high personnel or infrastructure needs.

The more profitable a product or channel is, the more likely it is that innovators will target it to remove costs, delays, and customer frustrations.

Beyond specific products, banks have broad vulnerability due to their “full-service” strategies and the fact that they often bundle services together with cross-subsidized pricing. Innovators are trying to pick off each product one by one, with simple solutions and minimized pricing.

While many customers do want the convenience of one banking relationship, the smart phone is increasingly making it easy to manage one’s finances with tools other than a consolidated banking arrangement.

Branches are also very vulnerable. Branches will not disappear overall, but many will close and others will be repurposed. Most banking transactions are already done online and as online and mobile services grow, banks will face challenges with how best to manage and streamline costly branch systems. (These will include Community Reinvestment Act issues.)

A vulnerability that banks tend to underestimate is that many innovations offer a better “user experience,” or UX. This is mainly because innovators are designing them from scratch and are fully integrating all elements – human-centered design, the latest technology, and compliance – in a seamless whole. This is different from taking an existing bank product and putting it into a new channel, like mobile. Banks are well-advised to hire people from technology backgrounds outside of banking, and also to listen to their own younger employees, who tend to be users of innovative solutions.

Finally, all bank products are vulnerable to the potential of disappointing millennials. This is the largest generation in world history and the first to be “digital natives.” Already their tastes and habits are reshaping the larger culture, just as the huge Baby Boomer generation did. Their preferred technologies are rapidly spreading to older customers, in the same way email and cell phones started with young people and expanded to everyone. Millennials expect technology to get constantly better, faster and cheaper, and they think of financial services in terms of technology tools.

Also, millennials expect high engagement, and innovators are giving it to them. Many FinTech companies have strong personalities and are funny. This raises the customer’s active interest and builds lasting relationships. Banks are, sad to say, vulnerable of seeming boring by comparison.

WHF: What advice can you give to someone interested in starting a FinTech startup company?

Barefoot: My top recommendation, other than generic advice for any entrepreneur, is to focus from the start both on “compliance” and, more deeply, on consumer benefit.

On compliance, build or buy clean new compliance tools that use technology to assure and document compliance, rather than doing it the traditional ways.

On consumer benefit, be ready to make the case for why the product will be good for consumers. Think through how it might be harmful, and design those vulnerabilities out of it. Strive for very high transparency. Strive for simplicity. Strive to be trustworthy, as trust is the factor that will make or break most of these companies over time. Also invest in strong data protection, AML compliance, and in winning the confidence of banks, as a customer or partner.

Finally, commit to continuous innovation. Even high-tech companies lose their edge today if they stagnate. The technology is changing constantly. The products should keep getting better and better.

Regulating FinTech: Fostering innovation while preventing harm

Guess where the following statement appears on the web:

“We promote competition through disruptive innovation— innovation that offers new services to customers and challenges existing business models.”

A fintech company? A bank vendor? A consulting firm? A think tank? A trade association?

None of the above. Actually, it’s a regulator. Can you guess which regulator?

Hints: It's not the Comptroller’s Office. Not the Federal Reserve Board. Not FDIC. Not even the Consumer Financial Protection Bureau.

It's the Financial Conduct Authority, in the UK.

“We promote … disruptive innovation … that challenges existing business models.”

Disruptive innovation—by a regulator?

Will fintech change regulatory philosophy?

The UK has a national strategy aimed at being the fintech capital of the world. To that end, it is actively working to attract and nurture innovative financial companies, using a range of tools that include regulatory policy.

This proactive stance contrasts sharply with traditional regulatory approaches worldwide, including those used in the U.S. (thus far). Normally, policymakers focus on addressing emerging risks as markets change. While many regulators may try to minimize interference with industry practices, it’s rare that regulatory strategy seeks, affirmatively, to embrace the upside potential of innovation.

Increasingly, however, innovative technology is forcing this kind of balanced thinking into the regulatory arena. In the UK, this is partly conceived as a national strategy for economic competition, but is also explicitly designed to capture the massive potential benefits that innovation is creating for consumers.

Regulators are striving to balance on the knife-edge of preventing new risks—which will undoubtedly develop—while still allowing pro-consumer fintech to flourish.

Upside of philosophical shift

The potential consumer benefits are enormous. Fintech innovation is driving the whole sector toward:

• Sharply reduced costs, especially through mobile delivery channels.

• High transparency to consumers.

• More inclusiveness through, again, lower-cost channels and also use of alternative data that can fine-tune risk evaluation of people with limited or complex credit histories.

• Consumer empowerment through easy personal financial management tools and simplified savings and investment.

• Faster payments that reduce uncertainty about when payments will clear, thereby helping consumers who have timing problems covering their bills.

Regulators throughout the world are starting to realize that their own actions could inadvertently undermine such upside potential, as they pursue legitimate efforts to address downside risk.

Finding the right mix of policies is not a simple task.

UK’s regulatory innovation

The FCA has created a “Project Innovate” initiative and an “Innovation Hub.” Though a regulatory body, it is pursuing strategies that range from directly nurturing promising start-ups to adopting policies that foster innovation. [Read Jo Ann Barefoot’s earlier “Lessons from London? ‘Fair banking’—with English on it”]  

For example, the FCA has sought public comment on two questions. One, is what regulations are impeding innovation? The other is whether there is a need for new regulations to foster innovation. These reflect fundamental strategic thinking about the role of financial regulation.

Another example is the FCA's exploration of whether to create a formal “regulatory sandbox” to enable innovators to test new ideas that might raise regulatory concerns or that do not fit squarely into the structure of current rules.

Click the image to view a video from FCA. (Scroll to bottom of page you land on.)

I had the chance to participate last year in FCA’s roundtable discussion of the sandbox proposal and was struck by the far-ranging new thinking underway.

For example, the agency invited input on whether to create a “virtual sandbox” in which consumer data could be collected and centralized so that innovators could test ideas without having to use real customers as “guinea pigs.”

Another idea is to permit industry associations to play an “umbrella” role, streamlining access to the sandbox approval process for small innovators.

Numerous other challenges are under discussion, from how to define and measure consumer benefit, to how to protect providers’ intellectual property and competitive positioning, to how to make a sandbox permission process simple enough that it would help, rather than hinder, fast-moving innovation.

UK regulators describe their efforts as experimental. (I notice that both public and private sector leaders often use the word “journey.”) No one I know, in government, banks, or startups, thinks they have figured out all the answers.

As a former bank regulator myself, what I find fascinating is that they are trying to move toward a different way of operating as they navigate the extreme uncertainties and rapid change ahead. There is an effort to be more flexible, more collaborative, and more nimble—faster.

While no one seems actually comfortable with this, there is palpable excitement about its potential.

Bear in mind, too, that innovators in the UK have the opportunity to “passport” their operations throughout the European Union. That, combined with this innovative regulatory strategy, makes the UK an excellent place for innovative companies to do business.

Principles versus rules

The UK contrasts with the US in another aspect of regulatory policy:  It relies much more heavily on “principles-based,” rather than rules-based, regulation for consumer financial protection.

The UK does have extensive technical rules governing consumer financial products and practices, but the regulators moved, years ago, toward emphasizing broad standards for “treating customers fairly.”

UK regulators also require senior executives to attest that their institutions have done so.

Here again, one hears people use the word “journey” to describe the difficulties of regulating “conduct,” as opposed to straightforward (if complex) compliance with procedural rules. Conduct and fairness are subjective concepts, difficult to apply.

Personal accountability standards can have unintended consequences, sometimes driving providers out of market sectors where regulatory risks are high and/or hard to predict.

Still, these regulatory strategies emerged in the UK before the US agencies began to emphasize similar approaches regarding unfair, deceptive and abusive practices (UDAAP). As a result, the UK has arguably moved further in clarifying broad principles and building consensus about what their regulators  mean.

The regulators have even taken steps toward trying to measure consumer outcomes, rather than compliance inputs, as the primary way to judge banks’ performance toward consumer protection goals.

Can US adopt this model?

None of this means that the UK is a fully apt model for the US.

As always with regulators and the regulated, there are many contentious issues between the financial industry and the FCA. Also, the UK’s challenges are simpler than ours in many ways. The country has a much more concentrated banking system, unlike the U.S. with our thousands of institutions.

The UK also has a vastly simpler regulatory structure, with two primary agencies—the FCA addressing “conduct” issues (and containing the semi-independent Payments Systems Regulator) and the Prudential Regulation Authority in the Bank of England overseeing prudential risk.

This contrasts sharply with our U.S. structure, in which we have five federal agencies directly overseeing financial institutions in addition to performing other critical missions, plus 50 states also chartering and regulating banks and also licensing and overseeing thousands of nonbank financial firms, especially lenders and money transmitters.

Nevertheless, the US can learn from observing the UK’s “journey.”

This side of the pond

Here in America, the regulators are moving in directions that parallel the UK’s efforts.

On principles-based regulation, they have already vigorously shifted to a proactive stance.

Coming out of the financial crisis, CFPB and also the prudential agencies have all emphasized UDAAP and fair lending as critical priorities. While technical rules continue to proliferate, the highest consumer regulatory risks for US banks today concentrate overwhelmingly in areas where product terms and practices are viewed by regulators as deceptive, unfair, or discriminatory.

Furthermore, this trend will only intensify as the sheer speed of technology change forces regulators to rely more on principles than rules, simply because detailed rules will increasingly lag behind market and product transformation.

On the innovation front, too, U.S. regulators are also starting to shift gears.

• Comptroller of the Currency Thomas Curry appointed a task force last year on Responsible Innovation, addressing both consumer protection and prudential regulation. In announcing the initiative, Curry noted that regulators have a cultural “tendency to say no,” and that the OCC needs to build a deep understanding of technology change, along with an ability to be “nimble.” The agency may issue a report this spring.

• Similarly, the Federal Reserve Bank of San Francisco held a first-ever conference last year on innovation and regulation, with participants drawn from industry, Silicon Valley, consumer advocates, and think tanks.

• The Treasury Department, too, held a conference on financial inclusion with a strong innovation focus late last year.

• CFPB has continued to evolve its Project Catalyst program, which seeks to identify pro-consumer fintech. Recently CFPB issued in final form its policy to facilitate consumer-friendly innovation.   

• At the state level, the Conference of State Bank Supervisors has been exploring the same kinds of challenges.

• Meanwhile the Federal Trade Commission is doing extensive work on privacy and fair usage of “big data,” including the Internet of Things (IoT).

Questions all should be asking

There is no shortage of meaty and critical topics:

1. How should fintech startups be able to access and partner with the banking system, under what sets of rules and standards?

2. How should we address rising concerns about data security and privacy?

3. How should we address the opportunities and risks involved with use of alternative and “big” data and data analytics in risk evaluation and fair lending?

4. What are the implications of digital currencies, the blockchain, and real-time payments?

5. Do we need regulatory standards regarding data aggregation practices? Should consumers’ banking data be portable, as in the UK, and who should actually “own” it? 

6. How can our bank-centric regulatory system cope with burgeoning innovation by nonbanks, from tiny startups with a cool new phone app, to some future Uber of finance, to, say, mold-breaking services from “Big Tech” firms like Facebook, Amazon, Apple, and Google—all of which have consumer financial services in some form, already?

The technology forces disrupting finance will also disrupt our regulatory framework, because this industry is subject to such pervasive rules and supervision.

All players are living through an epic shift. The story’s outcome will depend on how well regulators, industry, innovators, and consumer advocates work together to embrace and shape innovation.

This article also appeared on BankingExchange.com. You can find it here.

Launching My Video Series

Eighteen months ago, someone made a suggestion to me. Why not take the consulting advice I give to my advisory clients and package it in a form that's affordable and widely accessible - as videos? Instead of reaching the few clients that can pay to fly me around and meet in person, why not use technology to share my thinking with everyone who's interested?

I loved the idea. It turned out to take a lot of work, but I'm excited to say that I'm finally, today, launching the series.

I'm calling it Regulation Innovation.

Is that an odd name?

Here's a question:  Which of these is not like the others?

Regulation, legislation, litigation, innovation....

Obviously innovation doesn't belong on that list.

Except...it does.
 

These two drivers - regulation and technology innovation -- are the two transformative forces that are disrupting consumer finance.  They are the top challenges facing virtually every company, both in cost and risk.

The industry handles them as if they are unconnected - even opposite, incompatible, like oil and water. In reality, they are tightly linked:

They have the same targets. Regulators and disruptive innovators are attacking the same consumer problems -- especially lack of product clarity and high product costs.

Both therefore threaten the same profit centers -- it's a pincer assault.
 

They mostly have the same causes, especially outdated technologies, cultures and structures.
 

This means they have overlapping solutions. Fixing one can efficiently fix the other.
 

They are disrupting each other. Finance is so highly regulated that disrupting the industry disrupts the regulatory process too, and vice versa.

They are creating a new state of permanent uncertainty, driving change that's too fast, fluid and unforgiving to manage by traditional means.

They will break and remake companies and industries

Leaders in the financial world need to understand these two forces, and understand how to thrive on - not struggle through - disruption.

Regulation Innovation is my video guide for these leaders.

• It's for both regulatory and business people at all levels, and for traditional companies and innovators of all sizes.
• It's practical -- short videos, maximum insight, concrete advice.

 It's a training tool

The initial videos cover:

• Welcome to the journey: Quick overview of the series
• The 5 tech trends: The key technology trends disrupting consumer finance and regulation, and why financial people are underestimating them
• Meet the innovators: Understanding the disruptors. Who are they, how do they think, what are they trying to do, how do they relate to the traditional industry?
• Meet the new regulators:  Understanding the daunting shifts facing regulators and policy-makers, and how they plan to meet them
• The 6 challenges:  the top challenges facing every financial provider
• The 7 strategies: Strategic approaches for each of the six, and overall

Click here to see the introductory video.

And also watch our bonus video that answers the burning question, "Why does Jo Ann Barefoot have an Xbox -- since she's never played a videogame in her entire life -- and what the heck does it have to do with regulation and innovation"

Like any innovator, we're launching with an MVP (minimum viable product) which will evolve based on feedback. Please sign up, share the site with your colleagues and friends, and I'll look forward to everyone joining me on the journey!

One Way Street

I made fifteen speeches last fall on how technology is disrupting consumer finance and the huge regulatory challenges created by this transformation. My travels included moderating a panel at Money 20/20, the largest financial conference in the United States and maybe globally.  Over 10,000 people gathered in Las Vegas to explore the frontiers of fintech.

Nearly every session I saw there mentioned regulatory challenges. The same was true at the Milken Institute London Summit a few weeks earlier, which tackled technology issues ranging from finance to health, and at the Emerge conference last summer in Austin, and every tech-focused venue I attended.

It got me thinking: Why do innovation conferences talk constantly about regulation, while regulatory conferences barely mention innovation?

There are exceptions of course, but the contrast is still striking. Money 20/20 (which has a full regulatory track) drew a record audience. I’ve never seen 10,000 people assembled in one flat-floored room before (as opposed to stadium seating). You could hardly see the back of the room. Everyone was working on fintech: payments, mobile, digital currency and block chain, online lending, mortgage lending models, savings and investment tools, alternative data, cybersecurity, privacy, financial inclusion and access, global consumer empowerment, the millennial market, and on and on. Startups pitched ideas. Huge companies unveiled initiatives. The exhibit hall’s glitz rivaled the Vegas strip. Three thousand people saw a show. Hallways were jammed. Parties were everywhere. The energy was palpable.

Regulatory conferences have been setting records too – thousands of people are attending them.  Appropriately, they talk about regulations. Compliance experts, lawyers, regulators, and consultants explain what’s changing, how to interpret it, how to comply, what’s ahead. They all offer valuable insight, but they rarely address fintech, much less hail from that world. Most have not yet plugged into the innovation energy surge.

They need to, because innovation is revolutionizing financial services generally, and compliance specifically. Here’s why.

Disruption: Financial services is the first industry to face technology-driven disruption while also being pervasively regulated. This means that the disruption of the industry will disrupt the regulatory system too.

Speed: Financial people underestimate the speed and size of the coming transformation because the critical changes are happening outside their field of vision -- in technology, not finance.

For instance, people in finance think of “mobile” as being about mobile payments, but payments are actually just a tiny sliver of how mobile technology is remaking our lives, including our money lives. Financial people view Bitcoin and the blockchain as a payment issue too, while this technology will actually restructure huge swaths of the economy, business models, and even internal operations. Financial people address privacy by complying with Regulation P’s requirements for handling their customers’ information, while privacy is meanwhile being deeply rethought as big data and artificial intelligence revolutionize finance and everything else. Financial people think of consumer credit regulatory issues in terms of rules like the Equal Credit Opportunity, Fair Housing Act, or Fair Credit Reporting Act, while innovators are using alternative data and new data analytics to invent new models for underwriting and pricing, opening huge frontiers of both business and regulatory change. Finance people see “robo-investing” as an exotic new issue, missing how “machine learning” and artificial intelligence will revolutionize every aspect of how people invest, save, spend, borrow, and manage their money.

And that list doesn’t even include innovations that have barely reached the financial industry’s radar at all.  One is breakthroughs in natural voice technology that, combined with big data and machine learning, will completely change financial “education” and how consumers are coached to make money choices. Another is what will happen as people easily and automatically receive ratings of financial companies and products in their phones. Another is the movement into finance by “Big Tech.” Google, Facebook, Apple, Amazon and others already offer consumer financial services and are likely to expand them. These companies are deeply embedded in the daily activities of hundreds of millions of people. They could provide more financial products and/or become an intermediating layer – a filter or advisor -- standing between their customers and traditional providers, changing the very structure of the market.

Surprise: A third reason the financial industry underestimates these changes is that the huge tech trends driving it – big data, artificial intelligence, mobile, the block chain and voice technology – are converging. As they merge, everything will escalate and accelerate.

Lagging regulatory guidance: Fourth, innovation-related issues will bring high spikes in regulatory risk because their novelty and rapid evolution will outpace policy-making. This will force the industry into a regulatory wilderness with few guideposts and unfamiliar dangers lurking everywhere, as regulators decide after the fact that new activities are causing consumer harm.

Aging regulatory tools: One more blind spot is that, despite conventional wisdom, some innovators actually have compliance advantages. This is partly because their products tend to be simple and transparent, and partly because some startups use clean, new high-tech compliance tools that are both effective and efficient. The widespread assumption that startups will be hobbled by regulatory barriers is partly true but flawed. They may even raise the bar for everyone.

The traditional industry already faces dilemmas sparked by these shifts. Compliance and risk staffs find themselves trying to protect their companies against regulatory risks that cannot be clearly assessed, amidst pressure from business units pursuing innovation. The compliance profession has evolved around expertise in implementing detailed technical rules, not navigating regulatory ambiguity, especially on the unfamiliar terrain of high-tech new products, channels and partnerships.  

Legal and compliance staffs are already confronting questions like these:

• Can our bank partner with an innovator, or buy one, or provide it with banking services?
• How can we assure such third parties satisfy regulators’ rules on third-party risk including on cybersecurity, privacy, AML, and reputation risk?
• Can/should we, or our third-party partner or vendor, use alternative data and data analytics to evaluate and price consumer loans, without risk fair lending violations, especially on disparate impact? If we don’t, could we eventually face criticism for not using these inclusive alternatives?
• Should we allow/prevent our customers from letting personal financial management (PFM) and other providers, including small startups, access and help manage their accounts?
• Can we implement a mobile banking or payment service and get disclosures right?
• Do we have the holistic data needed to know whether consumer outcomes raise UDAAP risks?    
• Should we explore helping our customers access robo-investing options and if so, what are the regulatory challenges?
• How much should we communicate with customers by text, on what subjects?
• Can we close or repurpose branches in lower-income neighborhoods, since most of our banking has shifted to being online? And can/should we design special mobile services for lower-income customers?
• Can we offer technology-based services in languages other than English, without triggering discrimination risks if we cannot automate and deliver every phase of the product life-cycle in the alternative language?
• Can we strengthen our AML and security protocols for non-loan products by requiring higher-risk customers to send us a picture of their photo ID and a selfie, without risking fair lending violations?
• Can we make our services appeal more to millennials without violating rules that add complexity, delay, and low utility compared to innovative competitors?
• How would payments system innovations, including real-time processing, impact our business and regulatory models for services like overdrafts or money transmission?
• How should we view the move by some banks to create open platforms, so innovators can write apps on their systems?

Regulation and technology are the top challenges facing traditional financial companies. The two seem different, even unmixable. In reality, they increasingly are two sides of the same coin.

Partnering is especially crucial. One Money 20/20 speaker said startups used to believe they would overthrow the banks, but now just want to partner with them. One person said to me, “Everyone has to pair off -- choose a partner and go to the dance.”

What does it take to do that well, for the traditional company and the innovator? That seems like great topic for regulatory conferences in 2016.

Or, how about inviting tech innovators to talk about the big changes coming and what they will mean for finance?

And what if both groups – innovators and regulatory experts – started attending each other’s conferences, and built a real, bustling two-way street?

A two-part version of this post also appeared in a guest blog at Banking Exchange magazine.

Part 1

Part 2

Books I Packed for Boston

People sometimes ask me to recommend books on innovation and regulation.

I recently moved to Boston for my Harvard fellowship, which will be devoted to writing my own book on regulation and innovation.  I thought I'd share a bit of the bookshelf I boxed up for the trip.

It's an eclectic mix with authors ranging from a Nobel Peace Prize winner to an anarchist.

I'd already packed others, including the indispensable book on consumer financial protection, Reference Guide to Regulatory Compliance, by my friend and former colleague Lyn Farrell.

The old book in the box - standing vertically with the spine mostly obscured -- is Ralph Nader's 1965 game-changer, Unsafe at Any Speed.  That was a half-century ago, when the consumer protection laws were young, and so was I, and so was Ralph Nader.  Time for an update?

Readers:  What do you suggest I read?

A Wonky Week

In the last three days, I brought three new technologies into my life.  I got Windows 10 (and therefore Cortana).  I got Google Photo. And I got an Apple Watch.

The speed with which they are changing me is breathtaking.

Both Siri and Cortana are tending to my every need (and by the way, they are funny).

The watch is gently tapping my wrist with incredibly helpful reminders.

And my photos are creating stories about my life, and even animations (my watch lets me know they are there.)

I've only begun to learn to use all this, but four things strike me about what they mean for financial services.

First, they all take the initiative to offer me help. When fully integrated with financial products, this will close the access gap for the millions of people who don't know where to start or whom to ask.  Help will be offered. Guidance will start where the person is, and go from there.

Second, voice technology will be the financial democratizer. When you can get cheap guidance by having a conversation, the doors open wide for millions of consumers.

Third, they are all using artificial intelligence - neural networks - to think and learn.  They need very little instruction and set up. They are figuring out what I want and need and like, and just getting it for me.

Fourth, they all showed up at the same time. Any one of them alone is transformative.  To have them all arrive together, allinstantly and automatically weaving their activities together for me - did I mention the word "breathtaking"?

Note that they are from three different companies - Microsoft, Google, and Apple. But they are all busily integrating with each other as they orbit around me and my needs. They are consumer-centric, not product-centric.

They reinforce the critical point that new technologies are converging on consumer finance.  Each is huge, alone. When they combine, everything changes. And remember, these are early-stage innovations. They're improving fast.

They are all trying to astonish and delight me, and are succeeding beyond what I could have imagined a week ago. In the past three days, I've probably said the words, "oh wow," a hundred times.

Yes, I know all this will bring lots of new problems. Huge ones.

Still....wow.

Photo Credit to 9to5mac.com

Game of Regulatory Thrones

GAME OF REGULATORY THRONES – Winter is coming

Like all Game of Thrones fans, I’m still reeling from last week’s season finale. Unlike most, though, I’m also thinking about banking (and I don’t mean the Iron Bank).

A few days before the last episode, I had spoken on innovation and regulation at CFSI’s Emerge conference in Austin. Answering an audience question, I suggested the financial regulators consider creating an interagency council on how technology innovation will impact their work. My remark sparked a Twitter exchange with CFSI’s Rob Levy about whether such an approach would be practical, given that the regulators kind of have their hands full.

Rob seemed to me to be a likely GoT fan, so I tweeted a message to him – “winter is coming.”

Turns out, he’s mainly into House of Cards.  But that thread got me thinking further about the challenge the agencies face in regulating innovation with sufficient speed, clarity, and consistency, while filtering out the bad from the good.

If you’re not into the GoT phenomenon, the first thing to know is that Game of Thrones is not (as I embarrassingly once thought) a game. Rather, it’s HBO’s wildly popular series based on the Song of Ice and Fire books by George R.R. Martin. Its story is set in a magical past where seven powerful families rule kingdoms within a far-flung empire and vie to dominate it all by winning the central Iron Throne.

This drama is profoundly engrossing. So engrossing that both the characters and the audience constantly forget that something else is happening. A far greater menace is gathering, one that seems likely to obliterate all these warring parties, together. A supposedly extinct race of superhuman beings called Wight Walkers has reawakened in the north, beyond a high ice wall that has been guarded against their possible return for thousands of years.

From the series’ very first scene, the audience knows this risk is rising. All of the audience and some of the characters are reminded of it intermittently throughout the story. A few prescient characters fully understand it and in fact are playing the game specifically to unite a kingdom that can fight back. 

For most, though, this overarching danger is unnoticed. Many scoff at warnings, thinking the problem doesn’t even exist. The rest figure that, at worst, it’s remote – distant in both space and time. Everyone has urgent priorities -- here, now, absorbing all their attention.

Of all the kingdoms inside the wall, only the northernmost – the one closest to the ancient danger -- has retained some cultural alertness to it.  For centuries, they have cautioned each other with the words, “winter is coming.”

Game of Thrones is obviously an imperfect metaphor for our regulatory system. Our financial agencies rarely fight, much less seek to rule each other. And they of course do see and work with the big changes evolving in technology.

Furthermore, tech innovation is not a menacing force. To the contrary, it is bringing massively positive impacts as well as new risks.

Still, though, I think this metaphor merits thought. I have become convinced that technology disruption is the most important issue now facing the financial system, and the financial consumer. I think the regulators will have to move it toward the center of their agendas – despite still being overloaded with post-crisis work -- rather than mainly viewing it as a component of other topics.

And I hope they will do this together, because these changes are coming fast, in huge and converging technology trends that will sweep around them all – all the agencies, all types and sizes of financial providers, and all financial consumers, bringing change that needs unified collaboration and thought.

Do you agree?  Disagree? Please share your ideas!

And if you’re a GoT fan, feel free to tie your comment to the story. I’m always hoping to spark more dialogue on my website so our readers can benefit from each other’s thinking (I receive lots of input, but most of it comes privately just to me). In writing this post, I fleetingly considered inviting readers to suggest which GoT characters remind them most of real figures in our financial and regulatory community. I abandoned the idea, of course, as images came to my head of nominations for real-life counterparts for, say, Ramsey Bolton, or  Joffrey Baratheon.  We want to have fun and some edge here, but we don’t want to be mean!

Within that guideline, if you think GoT offers parallels and lessons for financial innovation and regulation, please post them!

To get you started (and to prove I’m not the only person pondering GoT and banking together), enjoy this thoughtful Forbes article by contributor Adam Ozimek on why Westeros lacks a central bank…and whether the Night’s Watch could help (Sam as the next Fed chair?).

Maybe actually spring is coming, if we prepare.