FinTech is Playing a Role in Improved Economic Mobility: A Federal Regulatory Sandbox May Help

By: Gabrielle Murphy

FinTech firms can help improve access to banking services and close the wealth gap; a “Sandbox” may be a step the government can take to foster innovation in this industry.

“What’s your Venmo?” It’s a common question that follows every day activities like splitting a pizza, buying coffee for co-workers, or booking a hotel for a girls’ weekend. It’s hard to imagine what people did before this major peer-to-peer payment system was developed. Financial instruments like Venmo have not only made everyday activities easier, but they have also worked to make banking more accessible for individuals facing barriers to traditional financial services. The companies designing these financial tools face barriers themselves,  like the navigation of complex regulatory requirements. One way the government could support this industry is through the implementation of a Federal Regulatory Sandbox, a government sponsored program for companies to test run applications and products while receiving guidance from regulatory experts in addition to other aid. In exchange, companies share key information with the government that can be used to assess whether regulations in place are operating effectively and efficiently to protect consumers.

FinTech, or Financial Technology, is an industry of firms that utilize technology to improve finance-related activities and implement innovative alternatives to traditional finance providers. Some of the most basic FinTech products are things many of us have already adopted, like mobile payments now offered by most mainstream banks. Companies have also used artificial intelligence (“AI”) to create “virtual assistants” that can make text or voice enabled payments or send fraudulent alerts, and have developed crowdfunding platforms as well as digital lending and credit options.

Some FinTech firms have also developed products, applications, and services that benefit individuals that face barriers to traditional financial services like low- to moderate-income (LMI) consumers by closing gaps that exist in traditional banking and offer alternatives to predatory services. There are about 1.7 billion people worldwide without access to traditional banking services like checking accounts. Many people are unaware of how many people residing in the U.S. are unbanked or underbanked. As of 2017, approximately 6.5% of American households lack access to traditional banking services and approximately 24.2% have limited access. That means over 32.6 million households have inadequate access to services as basic as bank accounts or credit. The is largely because LMI consumers are more likely to face obstacles imposed by fees and minimum balances and predatory services like check cashers and payday lenders. All of these obstacles negatively impact economic empowerment and mobility, especially for LMI consumers.

Some FinTech firms are working as social innovators to close this banking gap. Bee, for example, is a mobile application where users can sign up for a bank account right in the application. In this platform, users can make mobile deposits and receive text updates. Bee’s founders host pop-up kiosks to promote more users to their service. Fees are lower because these applications do not have the overhead costs of traditional “brick and mortar” banks, which are typically passed on to consumers. Other firms assist with savings, debt repayment, budget management, and even offer short-term small-dollar credit or other lending options available to LMI customers.

FinTech firms, however, face a number of barriers, like navigating complex regulations. Regulations come from a myriad of government bodies such as the Treasury Department, the Consumer Financial Protection Bureau (CFPB), the Office of the Comptroller of the Currency (OCC), the Securities and Exchange Commission (SEC), and the Commodities Futures Trading Commission (CFTC). Some examples of regulations include registering with these agencies, acquiring licenses, making reports pursuant to anti-money laundering requirements, and complying with anti-discrimination laws. In addition to federal laws, FinTech firms must also adhere to varying state laws. Both federal and state regulations are essential to protecting data privacy, cybersecurity, and consumer protections, but the resulting complexity is an obstacle to firms with a lack of regulatory knowledge needed to bring their ideas forward.

A key way the government could support this industry, and foster innovation, is through the creation of a Federal Regulatory Sandbox. Sandboxes are government programs, that can operate at either the federal or state level, where firms are given the space and guidance to conduct limited launches of products and services with actual customers. Sandboxes benefit firms, the government, and consumers. Firms benefit by gaining regulatory knowledge and guidance while fine-tuning their business operations. They can better understand how to set up internal systems for regulatory compliance, where their security and consumer protections may need strengthening and whether any unforeseen operating costs have been discovered. The government also benefits by gaining an understanding of how FinTech firms operates as well as whether regulations are doing what they need to do effectively and efficiently in light of technological developments by assessing sandbox trial results. Consumers benefit from all the above as innovative products are launched while consumer protections keep them safe.

Other countries, most notably the UK, have seen success with sandboxes. The UK’s Financial Conduct Authority (FCA) first implemented a sandbox program in 2016. The FCA is now in the midst of their sixth cohort, or group of firms participating in the sandbox at a given time, and is currently accepting applications for a seventh. Firms participate in cohorts of 18 to 29 participants.  After being selected through an application process, the primary trial process lasts several months and involves individualized guidance as products are tested with real consumers. As firms transition out of the sandbox, they report relevant findings to the government, obtain legal advice from regulatory experts, and use their learning experiences to fine-tune their business models. Assessment of the UK Sandbox process shows promising findings: firms were able to access the market faster and cheaper, had more financing options, and have developed additional consumer protection safeguards.  

A few firms participating in the UK’s sandbox program have targeted the banking needs of LMI consumers. Community First Credit Union, in an effort to close the banking gap of LMI consumers, tested an initiative to create an identity token that would support customers that lack traditional forms of ID required to open a bank account. Oval, in an effort to increase LMI consumers’ access to saving and investing, created an application that automatically sets aside small amounts of money, either a set weekly amount or a percentage of spending, and automatically moves this into savings, invests it, or pays off existing loans.

Some states in the U.S. have started to implement sandboxes. Arizona, for example, launched a sandbox in 2018, which allows participants to test-drive products for up to two years and engage in certain financial services activities under regulatory supervision without having to obtain costly traditional state licenses prior to operation or pay other compliance-related fees. Arizona’s sandbox currently has five firms testing products. Align Income Share Funding is testing an income-sharing agreement, ENIAN is testing a platform for investors to compare different opportunities in renewable energy, and MO Technologies USA LLC is testing AI to be used in the determination of  loan terms. Arizona’s sandbox is limited to guidance that pertains to Arizona state laws, not federal laws.

Federal legislative proposals have also been introduced, in order to establish a program that would help companies navigate federal regulations. One example is the Financial Services Innovation Act (H.R. 4767), introduced in 2019, which would mandate 10 federal regulatory agencies to each create an office for sandbox programs within their respective agency. A more successful, but still not perfect example, are the sandboxes enacted by the CFPB in 2019 that are narrow in scope. Companies, for example, are required to make certain disclosures to consumers of financial products, but under the new CFBP’s Trial Disclosure Policy, companies can explore alternatives to traditional disclosures without the threat of liability. Additionally, the Compliance Assistance Sandbox Policy allows for companies to receive CFPB guidance in relation to specific, narrow applications of federal law.

A federal sandbox should be introduced in the U.S. and should be implemented through the creation of a single, centralized office, or committee of regulators from each key agency, so that firms may work with regulations from multiple regulators, not just one agency at a time. Features of an ideal sandbox should include regulatory experts to provide guidance in navigating regulations, foster information sharing between firms and regulators, and provide help obtaining operating licenses. However, consumer protections should be front and center to any proposal. To this end, a federal sandbox proposal should involve extensive testing and reporting. This would allow firms to learn, and then enter the market at more efficient costs and would also allow the government to learn, streamline regulations, and enhance consumer protection laws. Some federal agencies, like the Treasury Department, have voiced support for such a proposal.

Overall, FinTech is influencing banking for everyone, but most importantly FinTech has the ability to close the banking gap and reduce the wealth gap. The creation of a federal regulatory sandbox would promote innovation and lead to vigorous and competitive financial markets while enhancing the efficiency and effectiveness of consumer protections.