Payments 3.0: Can Fintechs Control Their Destiny?

A new regulatory framework is coming to fintech.

While none of the regulators has proposed a new rule yet, my prediction is that the Consumer Financial Protection Bureau will create a new regulation that will apply directly to fintechs. This will be done to address concerns that come from relying on issuing banks to discipline their third-party partners.

The failure this spring of Synapse, which provided software for fintechs, left people without access to their money and showed  FDIC insurance is not the end all, be all for protecting deposits. Recent consent orders against issuing banks showed regulators are concerned about the way banks are overseeing third parties.

Even the Government Accounting Office put out a recent report recommending Congress update the financial regulatory structure because gaps exist in oversight and consumer protection.

The CFPB did attempt to apply consumer protections to digital wallets in its prepaid-accounts rule. Many companies avoided falling under the rule by marketing themselves as debit accounts and arguing that the rule doesn’t apply. But the rule itself says the structure of an account is not the determining factor of whether something is a prepaid account. So there was room for the CFPB to exercise oversight over those products.

Two things prevent the prepaid-accounts rule from being the solution to the issues raised by Synapse’s failure. The first is that PayPal challenged the prepaid rule in court, arguing that digital wallets should not fall under the rule. The most recent ruling (which I wrote about in my May column) agrees with PayPal. The second reason is that nothing in the prepaid rule solves the problem of what happens if the fintech fails, but the underlying bank doesn’t.

It is much more likely that regulators will see the need for a new fintech rule. While it is possible that Congress could fill the gap with legislation, that is unlikely to happen in an election year. And, though it seems any rule created under one administration is not likely to survive into the next, both sides of the aisle have grievances with tech companies. So, the industry should not take comfort in the idea that a political change in Washington could protect it.

What would a new fintech rule look like?

At a minimum, we can expect a focus on information gathering and record keeping.

Rules exist today for know-your-customer, but a new rule might strengthen the requirements for information collection and verification. Nothing prevents the CFPB from adding additional requirements for non-banks. Perhaps device fingerprinting or some biometric would become part of the digital-wallet KYC regime.

Regulators also may codify the way account records are created, maintained, and shared across the value chain. They may require that all fintech accounts contain enough information to guarantee pass-through insurance, and that all the accounts have regular updating of the balances owed to each customer. Another requirement might be that fintechs maintain reserves that become de facto self-insurance for their depositors.

These are just some possibilities. Remember that the prepaid rule started as a short rule designed to standardize disclosures for general purpose reloadable prepaid cards. It quickly ballooned into a rule that attempted to cover every possible problem that could arise with prepaid cards and digital wallets.

The other reality is that states that feel like the feds are not acting quickly enough may attempt to impose their own rules and legislation.

The fintech industry needs to start thinking about how it is going to make the case that it can safely hold consumer funds and convince regulators, and maybe legislators, to write a rule it can live with.

—Ben Jackson bjackson@ipa.org