All policymakers and regulators claim to love innovation, especially if it might help the underserved. Unfortunately, regulators' thinking often fails to keep up with their rhetoric.

A particularly frustrating example is the emerging opposition from some in the government, including Sen. Mark Warner, D-Va., and Comptroller of the Currency Thomas Curry, to a regulatory sandbox for financial services. Sandboxes provide a space where companies can try new ideas, under the watchful eye of regulators, but with some degree of regulatory forbearance, including the waiver of certain rules or limits to enforcement actions.

Opponents fret that a sandbox would provide companies with a way to avoid consumer protection laws. However, sandboxes need not be a Hobbesian "war of all against all," where the powerful prey on the weak. Instead — provided they are done right — sandboxes can offer an environment where companies can innovate while ensuring consumers are protected.

Fear and uncertainty about regulatory risk are major impediments to companies pursuing innovative financial products. Concern is especially high for innovators trying to serve populations who need help the most. The fear of facing the regulator's wrath chills innovation, deprives consumers and encourages firms — especially small innovators — to stay under the radar. In addition to harming companies, innovation and consumers, this state of play isn't good for regulators. Refusing to let innovators experiment in a permissive environment keeps regulators in the dark. For regulators, who all too often have to play catch up, this reality ought to be reason enough for them to accommodate innovators.

Regulatory sandboxes are a potential solution to innovators' and regulators' problems. In the U.K., the Financial Conduct Authority runs a sandbox program focused on financial technology companies. This sandbox allows firms to test new products that regulators deem are truly innovative and potentially beneficial to consumers. (Of course, one wonders whether regulators can judge whether a product meets these criteria. Regulators, like the rest of us, can't see the future until it's here.) The FCA also requires firms to have appropriate consumer safeguards, such as the wherewithal to compensate consumers who are harmed if the test goes awry.

Likewise, a U.S. sandbox could help encourage innovation without jeopardizing consumers. In exchange for greater transparency from the company, regulators could agree to limit the company's potential liability for future consumer protection violations. In this model, companies would not be able to escape the responsibility for compensating inadvertently harmed consumers, but would have the assurance that the government would not assess fines and penalties. Of the three justifications for sanctioning a company — compensation, punishment and deterrence — only the first is appropriate for companies operating with transparency and in good faith.

Taking fines, penalties and the reputational harm that comes from an enforcement action off the table would remove a major source of risk and uncertainty for innovators. But consumers would remain protected. Not only would consumers be able to enjoy the fruits of innovation, but entrepreneurs would compensate consumers for any inadvertent harm suffered in the process. Given the nature of the product and anticipated number of customers, a firm can estimate in advance the potential for consumer harm. By contrast, fines, which are driven by the whims of the regulator, can often dwarf the compensatory damages, and may bear little or no relationship to actual customer harm. For example, in the Wells Fargo scandal dealing with unauthorized accounts, the bank may end up paying only $5 million in compensation to consumers while it must pay $185 million in fines.

While fines in addition to customer restitution are appropriate for intentional bad acts, a firm that wants to try a new product to better meet the needs of consumers and acts in good faith doesn't deserve regulators penalizing it or dragging its name through the mud. Without having to worry about outsized and arbitrary risk, firms could pursue innovation with confidence while still being responsible for making customers whole if they are harmed.

Needlessly spurning useful tools based on a misunderstanding of how they would work in practice prevents progress and doesn't protect the public. While consumer protection is vital, it is not incompatible with innovation or providing certainty to companies trying to improve options for the public. Policymakers and regulators should match their rhetoric with action and provide regulators and companies the space they need to build a better future.

Brian Knight is a senior research fellow in the Financial Markets Working Group with theMercatus Center at George Mason University.