The comment period on a critical new initiative to promote innovation in financial services from the Consumer Financial Protection Bureau closed this Monday. My colleague John Berlau and I filed comments supporting the effort, which you can view here.
The proposed “regulatory sandbox” and “no-action letter” policies are a critical part of the Bureau’s attempt to reinvent itself as a more balanced regulator, moving away from a “zero-sum” mindset that the only way to protect consumers is through the heavy hand of government. One tool of the proposal, no-action letters, are agency pronouncements that state that the agency has no present intention to bring an enforcement action against a firm on a particular point of law. Meanwhile, the regulatory or “product” sandbox is a set of regulatory tools that enable innovative firms to test their business models for a set period of time without having to comply with the whole swath of financial regulations.
These are commonsense solutions to regulatory problems for financial technology firms. In the United States, much regulation of financial markets derives from statutes that were drafted many decades ago. The National Bank Act—a major, enduring piece of legislation —even hails from the Civil War. While they have occasionally been modified over time, these decades-old laws are often an uneasy fit for innovative financial firms. Fintech companies are often faced with ambiguity as to which laws, regulations, and agencies govern them. Companies trying to do the right thing may find themselves on the wrong side of the law—or rather, dated interpretations of the law—as a result. Having “flexible” regulatory tools such as no-action letters and regulatory sandboxes can mitigate some of these problems.
The proposed initiative is significant due to the fact that the Obama-era Bureau’s innovation policy was virtually non-existent. While the agency was founded under the Dodd-Frank Act in 2010, by 2019, the Bureau had issued just one no-action letter to the financial technology firm Upstart. Even then, the letter was “subject to modification or revocation at any time at the discretion” of the Bureau. Further, the Bureau’s letter was explicitly non-binding, stating that the Bureau may initiate a retroactive enforcement or supervisory action against the company if appropriate. Therefore, to obtain uncertain benefits, Upstart was required to hand over propriety data on its currently unapproved underwriting operations, notwithstanding the fact that the Bureau retained authority to enforce laws retroactively against the company. This is no assurance at all.
This failure to promote innovation and competition as part of a consumer protection framework is an explicit violation of the Bureau’s objectives. 12 U.S. Code § 5511(b)(3), (5), for example, states that the Bureau’s objectives include:
(3) outdated, unnecessary, or unduly burdensome regulations are regularly identified and addressed in order to reduce unwarranted regulatory burdens;
(5) markets for consumer financial products and services operate transparently and efficiently to facilitate access and innovation.
The purpose of the Bureau in pursuing consumer protection is not only to enforce the law but to also facilitate innovation and competition. Indeed, innovation is an essential element of any consumer protection framework.
Innovation can solve many consumer protection problems. Take the example of small-dollar lending and a new fintech product called “Dave,” one example of many fintech firms that are replacing loan officers with algorithms and brick and mortar stores with iPhone applications. Dave is a mobile application that synchronizes with a customers’ financial accounts and analyzes their spending habits. Dave then builds the customer a budget in order to better predict when they are at risk of overdrawing their account. If a customer is indeed going to overdraw their account, Dave will advance up to $75, interest-free, to cover the shortfall—a small dollar loan to be paid back from the consumers next paycheck. Rather than charging relatively high interest rates, as done by a typical payday lender, Dave is a subscription-based service charging merely $1 per month.
Contrast the innovative business model of Dave with the Bureau’s payday lending rule under the previous director. The Bureau’s original rule was incredibly strict, imposing an underwriting standard that threatened to make between 75 to 91 percent of all loans unprofitable. We at CEI have written extensively on the flaws in the rule and support its revision.
Nevertheless, even assuming that the Bureau’s original rule was both necessary and effective, it is still an inferior form of consumer protection as compared to an innovative, market-driven solution like Dave. Where strict regulation merely takes away choices from the consumer, innovation can give consumers more and better choices. This improvement in the lending market is something that the Bureau by itself could never achieve, no matter how many regulations are promulgated or lawsuits are filed.
Innovation is a crucial aspect of improving consumers’ lives, and it deserves an equal place amongst the Bureau’s consumer protection priorities. A new, innovation-friendly consumer protection framework can be to the benefit of all—consumers, firms, and the regulatory agencies that oversee them. It is far from a zero-sum game. We at CEI applaud the Bureau’s initiative in establishing a pro-innovation regulatory framework, and look forward to commenting on the final product.