Regulation is not necessarily the nemesis of innovation.

Those words might sound shocking coming from a venture investor and startup founder. But among the lessons of the 2008 financial crisis were that, if left unchecked, innovation can have unintended consequences, and not all "innovators" care about those consequences if there are sufficient profits for them. Regulation plays an important role in protecting the public good.

However, regulation can work against the public good when it prevents advances that can create new products, open up new markets or lower costs.

Communication dialogue
Recent proactive dialogue between state regulators and fintech industry stakeholders is a starting point for continued work on enhancing the state-level regulatory system for financial innovators. Adobe Stock

Regulation and compliance have particularly profound effects on startups. The upfront costs of compliance are a formidable barrier to entry. A substantial amount of funding, energy and time are consumed getting to market, independent of even validating if the market finds a new product valuable. Government and startup timetables do not align particularly well. Ambiguity about how actions will be treated and when a regulator will respond (if ever) wreaks havoc on product development cycles, business plans and fundraising.

A regulator might respond to a question from an innovator seeking more clarity or certainty with the answer, “We don’t know and we don’t know when we’ll know.” But venture capitalists don’t find that answer particularly reassuring. Likewise, licensing requirements that require due diligence on significant owners adds friction to an already tenuous process. Explaining to a lead investor that he needs to submit personal tax returns and fingerprints can kill a deal.

Incumbents and regulators may argue that these complications are the cost of doing business, but they stymy progress in serving customers. That’s bad for everyone. Too much focus on regulatory outcomes stalls the progress of innovators that can provide incumbents with new tools through partnerships and acquisitions. Similarly, regulation can slow down “intrapreneurs” working internally to move their company into a new business area, with heavy upfront costs and the timeframe for returns pushed far into the future.

The complexity of a 50-state regulatory regime overlaying the federal one exacerbates the issue. A federal fintech charter, like the one proposed by the Office of the Comptroller of the Currency, is helpful in some respects but it is not a panacea. It is my opinion that the hurdle required to receive such a charter will keep it out of reach for many and could have the unintended consequence of stifling innovation.

But an improved state-level system could be a tremendous advantage. Working closely with a cooperative regulator, innovators large and small can rapidly test a concept within state lines.

This only works if several criteria are met. First, the regulator has to be willing to engage. Second, there needs to be a means to scale beyond that single state. Lastly, energy spent on compliance that doesn't improve outcomes needs to be minimized if not eliminated. Towards that end, there are many opportunities to make this process more effective and efficient without doing away with the spirit of the 50-state system.

I was invited to speak at the annual meeting of the Conference of State Bank Supervisors last year. Some state regulators have picked up the gauntlet of arguing for proactive dialogue. For example, regulators and private-sector representatives recently joined forces for two days of dialogue in Chicago over fintech-related issues. The dialogue between 70 participants representing state-level regulators, investors, incumbents and startups in the payments and online lending spaces from around the country was a great starting point for continued work.

Customers lose when innovation is stifled. They also lose when regulation is only the result of bad, sometimes really bad, things happening. Regulators and innovators need to become allies in this process. A healthy tension must exist but it must be balanced by a cooperative dialogue and desire to move things forward.

Jason Henrichs

Jason Henrichs

Jason Henrichs is managing director of FinTech Forge and co-founder of FinTEx Chicago, a member-driven fintech association.

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