Why State-by-State Fintech Oversight Doesn't Work
The Office of the Comptroller of the Currency is considering allowing financial technology (or fintech) firms to become special purpose banks. This new status would allow them to largely avoid the state-by-state regulation that currently applies to them, but not to their bank competitors. Unsurprisingly, this prospect is not popular with state regulators, as reported in a recent American Banker story. They argue that such a move would weaken consumer protection and increase risk.
Much of the promise of "fintech" is that it allows firms to profitably serve groups that have had difficulty accessing financial products and services in the past. Technology offers new efficiencies that lower costs for companies and the consumers they serve. For example, because fintech lenders don't have physical branches, they are able to match capital to borrowers nationwide with a lower cost structure. This may give them the extra margin necessary to make otherwise unprofitable loans. Likewise, new money transmission services like Circle, which don't rely on traditional agent networks, may be able to offer less expensive payments.
State-by-state regulation imposes heavy burdens that reverse the cost savings and expanded reach available through fintech. Here's how:
First, complying with state-by-state regulation is expensive, difficult and time consuming. For example, getting lending licenses from all of the states can cost in excess of half a million dollars and take up to a year. Both of these consequences can be a massive disadvantage to young companies trying to compete with incumbents.
Second, the many inconsistencies across state laws take an otherwise national market for lending or payments and artificially chop it into silos. This fracturing hampers firms' ability to provide a consistent product nationwide, depriving them of economies of scale. Finally, fintech companies have to monitor any rule changes by all of the states and the federal government. Rather than dealing with the hassle and expense, some firms just give up. Consumers end up paying more or missing out on products and services altogether.
The inefficiency and expense are bad enough, but they are compounded by an unfair regulatory landscape. Banks enjoy a different and far more consistent set of rules. This wasn't always the case. Prior to 1980, state-chartered banks were not able to export interest rates across state lines like their nationally chartered competitors. Concerns about competitive equity caused Congress to provide state banks with equal powers. As the late Sen. Dale Bumpers, D-Ark., a supporter of the effort, said, "Institutions offering similar products should be subject to similar rules."
This principle is just as apt in the present circumstance. Why should products that are functionally equal, from the end consumer's perspective, be subject to dramatically different rules? The products that fintech firms offer are not identical to bank products, but the differences do not justify the wildly different regulatory regimes.
Finally, state-by-state regulation can deprive citizens of political autonomy. In a national market, the impact of state regulation does not stop at the state border, but the political representation does. Firms forced to comply with the laws of each state in which they sell products may not offer a particular product anywhere in response to one state's ban, even if other states would welcome the product. States that offer particularly lucrative markets — think New York and California — set the regulatory tone for the rest of the country. Firms can't afford to avoid those markets, so they tailor their products to the regulations in those states. Not only do customers in other states help to bear the resulting costs, but these customers are effectively being regulated across state lines. Customers pay for and live under rules written by policymakers who are not politically accountable to these customers. You might think of it as regulation without representation.
Conversely, federal regulation would provide much broader democratic input. While the federal banking rules may preempt state laws, they do not deprive the citizens of those states of political redress. Whereas only some consumers have representatives in Albany or Sacramento, all of a firm's customers are represented in Washington D.C.
State regulators' concerns that they may not be able to protect their citizens if the federal government provides federal rules for fintech is also likely misplaced. In both the banking and securities contexts (two areas with significant federal preemption), states are still able to enforce anti-fraud and general consumer protection laws. Although state regulators can't dictate the terms of the market, they can and do pursue the malicious actors that threaten harm to residents in their states.
State regulators should not allow their good intentions to overshadow the best interests of the citizens of their states. The federal government — through either OCC regulation or statute — can provide a more consistent and equal regulatory playing field for fintech.