It’s Time For A Federal Fintech Sandbox

It’s Time For A Federal Fintech Sandbox

It's Time For A Federal Fintech Sandbox

FinTech – An income-share agreement as an alternative to personal loans. A cheap money transfer system for the unbanked. A faster, cheaper payment processing system. What do these innovative financial products have in common? They’re all being tested in Arizona’s fintech sandbox. And they all represent the potential of a regulatory sandbox to allow financial institutions and fintech companies to improve the consumer banking experience. It’s a future I find exciting and want to see become available to banks nationally, as I believe it will accelerate needed innovation and result in positive developments for consumers.

What’s a fintech sandbox, and why does it exist?

A regulatory “sandbox” is a program that allows regulated companies to apply for a limited exemption to certain banking regulations in order to test new products. The U.K. launched the first sandbox in 2016, and it’s widely regarded as having helped establish that country as a center of fintech innovation. Since then, at least 27 other countries have created or are planning their own sandboxes. Legislation was proposed in the U.S. in 2016 that would have created a federal sandbox, but the idea has stalled. Arizona, Wyoming and Utah have stepped up and created their own state-level sandboxes.

I believe a federal sandbox program has enormous potential to foster banking innovation and would be a triple-win. It’d be good for fintech companies, offering them more room to experiment, test and iterate. It would be good for banks, making it easier for them to keep up in the race to create a modern, seamless consumer experience. Most importantly, it would be good for consumers, giving them access to more specialized banking products to meet their evolving needs.

Without a sandbox, the process to innovate is onerous.

The process for banks to create a new consumer-facing product is onerous. If a bank decides to work with a third-party vendor to help develop the product, that vendor must go through a strict vetting process. This process will involve checking the company’s information security practices, financial stability and ability to comply with the multitude of regulations that cover the banking sector. It’s time-consuming and expensive.

Then the product itself — which might still be in its early stages — is subjected to regulatory scrutiny as if it already exists. A bank must demonstrate that the new product wouldn’t put the bank in financial jeopardy. The new product must comply with consumer regulations, like Fair Lending requirements, disclosure requirements, anti-money-laundering rules and so on. Multiply the above process by every state or federal regulator with oversight for a particular bank, and it quickly becomes a nightmare. All this must happen before any new product can be launched or tested with consumers.

Imagine if other new tech products had to comply with multiple layers of overlapping regulations before they could even start a beta test. When a new product is this complicated and costly to develop, there’s no room for the kind of creativity and experimentation that characterizes true innovation. It’s not real innovation if you must know all possible outcomes before you get started. This level of prior investment also translates into little tolerance for a product failing.

If you believe the modern approach to innovation is correct — that breakthroughs come when you test many ideas quickly and get as much feedback as possible, as early in the process as possible, and recognize that many ideas will fail — then it’s easy to see why innovation has been slow and mostly incremental in the banking sector.

Sandboxes offer a risk-based approach to innovation.

A sandbox would significantly lower the barrier to entry for new consumer financial products, without exposing either banks or consumers to unnecessary risk. Different countries and states have adopted different models, but to me, a sandbox should set some basic guardrails and then allow for as much experimentation as possible. An approach that seems sensible to me is limiting the experiment’s size by the size of a financial institution — so a new product couldn’t be tested on more than X% of a bank’s customers or involve more than Y% of its assets.

On the consumer protection side, I’d advocate for a standard that passes the sniff test. New products shouldn’t be discriminatory or nontransparent in nature or have hidden fees or unsavory practices. By working with the regulator, banks should install reasonable consumer protections in case there are unintended consequences. Banks should always disclose to consumers when they’re participating in a beta product in a sandbox environment and solicit feedback about the experience. Several innovative technology companies have already educated consumers about what it means to take part in a beta test and have set their expectations accordingly.

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