Fed should open the payments system to fintechs
The Federal Reserve operates a financial infrastructure that allows banks to efficiently transfer money, facilitating secure consumer payments and helping to maintain a stable American financial system. An increasingly important group of next-generation, nonbank fintech firms such as PayPal or Amazon (and, importantly, whatever new firms rise to challenge them), could benefit from accessing the same cost-effective system as their more traditional competitors. More important, American consumers stand to benefit.
Unfortunately, several high-ranking Fed members have recently expressed reticence about letting fintechs in. This concern is somewhat misplaced, and the Fed should seek to open up the payments system.
The Fed should want to allow fintechs in, under the right conditions, because that would best further the mission that justifies the payments system in the first place: serving the needs of consumers. (There is a separate question as to whether the Fed could legally allow fintechs to enter the system. If a change in law is required, it will realistically require the Fed’s support.)
Currently, access to the Fed payments system is generally limited to federally insured depository institutions, i.e. banks and credit unions. Fed officials’ main concern is that nonbank fintechs lack the risk mitigation measures necessary to safely access the system. While it’s wise and appropriate to be concerned about the safety of the system, this puts the cart before the horse.
The Fed could make access to the payments system contingent on the appropriate safeguards being in place. And it could, and should, establish objective, risk-based criteria for accessing the payments system, with an eye to encouraging competition, and allow any financial institution that meets those criteria to join.
In other words, there is no reason to believe that a firm must be a federally insured depository to be reasonably safe. The United Kingdom, for example, has opened its system to fintech, showing that safety, innovation, and competition can go together. The Fed should follow suit.
Here in the United States, state-licensed money transmitters are generally subject to examination, capital and bonding requirements to ensure they can safely transfer funds, and they are regulated by the Consumer Financial Protection Bureau and federal bank regulators to the extent they work with banks. Additionally, recipients of the Office of the Comptroller of the Currency’s proposed federal fintech charter would be subject to examination and requirements just like other nationally chartered banks.
To the extent the Fed thinks additional oversight is needed, it could always require that oversight as a condition of access. The major difference between the banks that currently access the Fed’s system and fintechs is the presence of federally insured deposits. The presence of deposits is a bad justification, however, since deposits can be withdrawn by depositors, in many cases at a moment’s notice. Nondepositories could substitute equity, long-term corporate debt or a bond for deposits, if necessary.
In addition to reservations from the Fed, banks are not in favor of fintechs getting access to the payments system unless they face the same rules banks face. However, this isn’t necessarily the right standard. Depository banks and fintechs have different business models that may generate different risks, and regulation should reflect this. If fintechs can be as safe as banks with less burdensome rules, they should not be forced to comply with the same rules out of a desire for “fairness.” The same goes in reverse: There is no need to force traditional banks to comply with rules directed at risks unique to fintechs.
It is important to remember that the Fed’s payments system is a means to an end, and that end is the efficient transfer of money in support of the economy. It exists to benefit Americans, not the banks. The Fed should want to make its payments system as effective as possible. To be sure, part of this means guarding against risk, but it also means keeping it flexible and open to innovation and competition.