Written by Jonah Crane, FinTech Innovation Lab Regulator in Residence; Former Deputy Assistant Secretary, Financial Stability Oversight Council, United States Treasury Department
The U.S. Treasury Department last week released a report on nonbank financial services, with a particular focus on FinTech innovation. The report was just that–a paper with no legal or regulatory status. But it is an important signal that this Administration, like the prior one, sees value in the innovation that FinTech is bringing to financial services. In particular, Treasury found that “innovations in financial technology expand access to services for underserved individuals or small businesses and improve the ease of use, speed, and cost of such services.”
The report dives into several tricky areas–including the potential for artificial intelligence to enable better underwriting decisions, but also the possibility of unintended bias and the difficulty of unpacking AI’s “black box” to understand the drivers of a particular outcome. These are not easy issues, but it is clear that regulators are grappling with them, and are improving their own understanding of the relevant technologies, the implications for financial services, and the ways in which those technologies fit–or don’t–within existing regulatory frameworks.
That progress was evident when this year’s FinTech Innovation Lab class visited Washington D.C. in late May for a full day of meetings with five regulators.
At nearly every stop, we had in-depth discussions about the various types of AI and machine learning being deployed across financial institutions. From market surveillance to fraud detection to customer service, AI is becoming embedded in numerous financial services and business processes. In the past, regulators expressed wariness about AI, and concern about the transparency and auditability of many AI applications.
This year, we discussed sophisticated methods for understanding the outputs of AI-related tools, and how AI might fit within existing model risk management frameworks. Regulators were interesting in answering questions like: how should AI-driven models be tested? How effective are simulations? What about a “champion/challenger” approach, where multiple models be run live simultaneously and the “best” results are chosen? One regulator wondered whether this might be a useful subject for testing in a regulatory sandbox.
Our meetings and the Treasury report also highlight that regulators are now taking the next steps in deepening their engagement with the FinTech community, even inching towards collaboration. The Treasury report proposes a unified, regulatory sandbox-like framework for coordinating targeted regulatory relief. The OCC has openly discussed the possibility of participating in bank pilot programs. The CFPB has announced it is working on its own sandbox-like program. And the CFTC is exploring the latest frontier in FinTech-regulatory engagement: innovation competitions or “tech sprints.” When the Lab companies visited Washington, several U.S. regulators had just returned from participating in the UK Financial Conduct Authority’s fifth tech sprint, which was focused on AML/KYC solutions. The experience seemed to rub off, creating excitement about the potential gains from deeper collaboration.
Finally, both the Treasury report and our meetings focused on the keys to a good FinTech-financial institution partnership. One regulator likened a partnership to a marriage, highlighting the importance of aligned values and goals. Others stressed the need for a clear exit strategy and the importance of not getting overly dependent on a single partner for critical services. Regulators have issued guidance on partnering with FinTech providers, and are actively considering whether additional guidance is warranted. The Treasury report encourages regulators to harmonize and tailor their oversight of banks’ third-party risks.
The mindset of US regulators continues to evolve. Some U.S. regulators have long recognized the benefits of innovation–the CFPB when it launched Project Catalyst back in 2012, and the OCC with its initiatives around “Responsible Innovation” beginning in 2016. But as regulators deepen their understanding of FinTech innovations, their fear of the unknown is softening, and they increasingly understand the value of innovation for consumers, financial firms, and regulators themselves. We hope through our engagement that the FinTech Innovation Lab can play a small role in helping regulators gain exposure to cutting-edge technology, and ultimately create faster feedback loops between incumbent financial institutions, regulators, and FinTech providers.