View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

For release on delivery
8:45 am EST
December 2, 2016

The Opportunities and Challenges of Fintech

Remarks by
Lael Brainard
Board of Governors of the Federal Reserve System
at the
Conference on Financial Innovation at the Board of Governors of the
Federal Reserve System
Washington, D.C.

December 2, 2016

On behalf of the Board of Governors, I would like to welcome you to our
conference on emerging financial technologies, or fintech. I’d like to begin by
remembering our Federal Reserve colleague Teresa Curran--executive vice president and
director of Supervision at the Federal Reserve Bank of San Francisco--who recently
passed away after a long illness. Teresa’s leadership on fintech was one of her many
extraordinary contributions to the System. With her characteristic enthusiasm, Teresa
helped us prioritize this topic early on and had a strong influence in helping shape our
work program--with an emphasis on assessing the opportunities and challenges of fintech
in a balanced way. We already miss her wise counsel here. I’m sure Teresa would have
appreciated this conference’s gathering of academics, industry participants, and
policymakers to exchange information and discuss current research related to financial
Why Is Fintech Important?
In my remarks today, I’d like to share a few thoughts about emerging financial
technologies and their relevance to our work. 1 Fintech has the potential to transform the
way that financial services are delivered and designed as well as the underlying processes
of payments, clearing, and settlement. 2 The past few years have seen a proliferation of
new digitally enabled financial products and services, in addition to new processes and
platforms. Just as smartphones revolutionized the way in which we interact with one

These remarks represent my own views, which do not necessarily represent those of the Federal Reserve
For a review of the potential of distributed ledger technologies to change payment, settlement, and
clearance processes, see the forthcoming Federal Reserve Board Finance and Economics Discussion Series
paper titled “Distributed Ledger Technology in Payments, Clearing and Settlement.”

-2another to communicate and share information, fintech may impact nearly every aspect of
how we interact with each other financially, from payments and credit to savings and
financial planning. In our continuously connected, on-demand world, consumers,
businesses, and financial institutions are all eager to find new ways to engage in financial
transactions that are more convenient, timely, secure, and efficient.
In many cases, fintech puts financial change at consumers’ fingertips--literally.
Today’s consumers, particularly millennials, are accustomed to having a wide range of
applications, options, and information immediately accessible to them. Almost every
type of consumer transaction--ordering groceries, downloading a movie, buying furniture,
or arranging childcare, to name a few--can be done on a mobile device, and there are
often multiple different applications that consumers can choose for each of these tasks
based on their preferences. It seems inevitable for this kind of convenience, immediacy,
and customization to extend to financial services. Indeed, according to the Federal
Reserve Board’s most recent survey of mobile financial services, fully two-thirds of
consumers between the ages of 18 and 29 having a mobile phone and a bank account use
mobile banking. 3
New fintech platforms are giving consumers and small businesses more real-time
control over their finances. Once broad adoption is achieved, it is technologically quite
simple to conduct cashless person-to-person fund transfers, enabling, among other things,
the splitting of a check after a meal out with friends or the sending of remittances quickly
and cheaply to friends or family in other countries. Financial management tools are


Board of Governors of the Federal Reserve, Consumers and Mobile Financial Services 2016
(Washington: Board of Governors),

-3automating savings decisions based on what consumers can afford, and they are helping
consumers set financial goals and providing feedback on expenditures that are
inconsistent with those goals. In some cases, fintech applications are automatically
transferring spare account balances into savings, based on monthly spending and income
patterns, effectively making savings the default choice. Other applications are providing
consumers with more real-time access to earnings as they are accrued rather than waiting
for their regular payday. This service may be particularly valuable to the nearly 50
percent of adults with extremely limited liquid savings. 4 It is too early to know what the
overall impact of these innovations will be, but they offer the potential to empower
consumers to better manage cash flow to reduce the need for more expensive credit
products to cover short-term cash needs. 5
One particularly promising aspect of fintech is the potential to expand access to
credit and other financial services for consumers and small businesses. By reducing loan
processing and underwriting costs, online origination platforms may enable financial
services providers to more cost effectively offer smaller-balance loans to households and
small businesses than had previously been feasible. 6 In addition, broader analysis of data
may allow lenders to better assess the creditworthiness of potential borrowers, facilitating


The Federal Reserve Board’s Survey of Household Economics and Decisionmaking finds that 46 percent
of households report that they would need to borrow money or sell something in order to pay an
unexpected expense of $400. The report of survey findings is available on the Board’s website at
Robo-advisors are making investing and retirement planning cheaper and more accessible, filling a
particular need as the coverage of employer-provided retirement plans has declined. According to Insider
Newsletter published by Willis Towers Watson (vol. 26, no. 2, February 2016), only 20 percent of Fortune
500 companies offered a defined-benefit plan to salaried new hires in 2015, down from 59 percent among
the same employers in 1998.
For more information on fintech and small business lending, see Karen Gordon Mills and Brayden
McCarthy, “The State of Small Business Lending: Innovation and Technology and the Implications for
Regulation,” Harvard Business School Working Paper (2016),

-4the responsible provision of loans to some individuals and firms that otherwise would not
have access to such credit. In recent years, some innovative Community Development
Financial Institutions (CDFIs) have developed partnerships with online alternative
lenders, with the goal of expanding credit access to underserved small businesses. 7
The challenge will be to foster socially beneficial innovation that responsibly
expands access to credit for underserved consumers and small businesses, and those who
otherwise would qualify only for high-cost alternatives. It would be a lost opportunity if,
instead of expanding access in a socially beneficial way, some fintech products merely
provided a vehicle to market high-cost loans to the underserved, or resulted in the digital
equivalent of redlining, exacerbating rather than ameliorating financial access inequities.
We are also monitoring a growing fintech segment called “regtech” that aims to
help banks achieve regulatory compliance more effectively. Regtech firms are designing
new tools to assist banks and other financial institutions in addressing regulatory
compliance issues ranging from onboarding new customers to consumer protection to
payments and governance. Many of the current solutions are focused on Bank Secrecy
Act (BSA) regulatory requirements, including know-your-customer (KYC) and
suspicious activity reporting requirements. The solutions utilize new technologies and
data-analytic techniques that may reduce the costs and time needed for banks to identify
and assess customers’ money-laundering and terrorist-financing risks. However, it is too


Most recently, Regions Bank announced a partnership with Fundation, an online lender, and TruFund, a
CDFI, to provide small-dollar loans to underserved small businesses (for more information, see In 2015, Lending Club and the Opportunity
Fund, a California-based CDFI, announced a partnership intended to provide $10 million in loans over a
period of five months to 400 small businesses in underserved areas of California (for more information, see

-5early to tell the degree to which innovative approaches to customer due diligence, such as
KYC utilities, will deliver efficiency gains such as those outlined in the recent Bank for
International Settlements Committee on Payments and Market Infrastructures report on
correspondent banking. 8
Ensuring Risks Are Managed and Consumers Are Protected
While financial innovation holds promise, it is crucial that financial firms,
customers, regulators, and other stakeholders understand and mitigate associated risks.
There is a tension between the lightning pace of development of new products and
services being brought to market--sometimes by firms that are new or have not
historically specialized in consumer finance--and the duty to ensure that important risks
around financial services and payments are addressed. Firms need to ensure that they are
appropriately controlling and mitigating both risks that are unique to fintech as well as
risks that exist independently of new technologies.
For example, some fintech firms are exploring the use of nontraditional data in
underwriting and pricing credit products. While nontraditional data may have the
potential to help evaluate consumers who lack credit histories, some data may raise
consumer protection concerns. Nontraditional data, such as the level of education and
social media usage, may not necessarily have a broadly agreed upon or empirically
established nexus with creditworthiness and may be correlated with characteristics
protected by fair lending laws. To the extent that the use of this type of data could result
in unfairly disadvantaging some groups of consumers, it requires careful review to ensure
legal compliance. In addition, while consumers generally have some sense of how their



-6financial behavior affects their traditional credit scores, alternative credit scoring methods
present new challenges that could raise questions of fairness and transparency. It may
not always be readily apparent to consumers, or even to regulators, what specific
information is utilized by certain alternative credit scoring systems, how such use impacts
a consumer’s ability to secure a loan or its pricing, and what behavioral changes
consumers might take to improve their credit access and pricing.
Similarly, fintech innovations that rely on data sharing may create security,
privacy, and data-ownership risks, even as they provide increased convenience to
consumers. Recent examples of large-scale fraud and cybersecurity breaches have
illustrated the significance of possible security risks. As the data sets that financial
institutions utilize expand beyond traditional consumer credit histories, data privacy will
become a growing concern, as will data ownership and whether or not the consumer has
any say over how these data are used and shared or whether he or she can review it for
accuracy. The Consumer Financial Protection Bureau recently issued a request for
information to better understand the benefits and risks associated with new financial services
that rely on access to consumer financial accounts and account-related information. 9

In addition to the risks I have outlined that are specific to new financial
technologies, firms also must control for risks that have always been present, even in
brick-and-mortar financial institutions. For example, risks around the BSA and AntiMoney Laundering rules cut across all segments and all portfolios. Similarly, firms must


er_Access_to_Financial_Records.pdf. The Consumer Financial Protection Bureau believes that
“consumers should be able to use their financial records and account information and securely share access
in an electronic format.”

-7monitor credit and liquidity risks of loans acquired or processed via fintech platforms,
especially given that these products have not been tested over an economic cycle.
Furthermore, as a general rule, the introduction of new products or services
typically involves heightened risks as a financial institution enters into new areas with
which it may not have experience or that may not be consistent with its overall business
strategy and risk tolerance. Banks collaborating with fintech firms must control for the
risks associated with the associated new products, services, and third-party relationships.
When incorporating innovation that is consistent with a bank’s goals and risk tolerance,
bankers will need to consider which model of engagement is most appropriate in light of
their business model and risk-management infrastructure, manage any outsourced
relationships consistent with supervisory expectations, 10 ensure that regulatory
compliance considerations are included in the development of new products and services,
and have strong fallback plans in place to limit the risks associated with products and
partners that may not survive.
With the growing number of partnerships between banks and fintech companies,
we often receive questions about the applicability of our vendor risk-management
guidance. We are actively reviewing our guidance to determine whether any adjustments
or clarifications may become appropriate in the context of these arrangements. We hear
concerns from community bankers in particular about their internal capacity to undertake
the requisite due diligence and ongoing vendor management on their own, especially with
much larger vendors, and questions about whether the interagency service providers
supervision program might be relevant in this context. We are thinking about whether


See Supervision and Regulation Letter 13-19/Consumer Affairs Letter 13-21, “Guidance on Managing
Outsourcing Risk,”

-8changes brought about by fintech and fintech partnerships may warrant consideration of
any changes to the interagency supervision program for service providers.
Regulatory Engagement
I believe that the Federal Reserve is well-positioned to help shape this innovation
as it develops, and it is important that we be clear about our expectations and mindful of
the possible effects of our actions. The policy, regulatory, and supervisory decisions
made by the Federal Reserve and other financial regulators can impact the ways in which
new financial technologies are developed and implemented, and ultimately how effective
they are. It is critical that fintech firms and financial institutions comply with all
applicable legal protections and obligations. At the same time, it is important that
regulators and supervisors not impose undue burdens on financial innovations that would
provide broad social benefits responsibly. An unduly rigid regulatory or supervisory
posture could lead to unintended consequences, such as the movement of innovations
outside of the regulated banking industry, potentially creating greater risks and less
The rapid pace of change and the large number of actors--both banks and
nonbanks--in fintech raise questions about how to effectively conduct our regulatory and
supervisory activities. In one sense, regulators’ approach to fintech should be no
different than for conventional financial products or services. The same basic principles
regarding fairness and transparency should apply regardless of whether a consumer
obtains a product through a brick-and-mortar bank branch or an online portal using a
smartphone. Indeed, the same consumer laws and regulations that apply to products
offered by banks generally apply to nonbank fintech firms as well, even though their

-9business models may differ. However, the application of laws and regulations that were
designed based on traditional financial products and delivery channels may give rise to
complex or novel issues when applied to new products or new delivery channels. As a
result, we are committed to regularly engage with firms and the technology to develop a
shared understanding of these issues as they evolve.
Fundamentally, financial institutions themselves are responsible for providing
innovative financial services safely. Financial services firms must pair technological
know-how and innovative services with a strong compliance culture and a thorough
knowledge of the important legal and compliance guardrails. While “run fast and break
things” may be a popular mantra in the technology space, it is ill-suited to an arena that
depends on trust and confidence. New entrants need to understand that the financial
arena is a carefully regulated space with a compelling rationale underlying the various
rules at play, even if these are likely to evolve over time. There is more at stake in the
realm of financial services than in some other areas of technological innovation. There
are more serious and lasting consequences for a consumer who gets, for instance, an
unsustainable loan on his or her smartphone than for a consumer who downloads the
wrong movie or listens to a bad podcast. At the same time, regulators may need to revisit
processes designed for a brick-and-mortar world when approaching digital finance. To
ensure that fintech realizes its positive potential, regulators and firms alike should take a
long view, with thoughtful engagement on both sides.
When we look back at times of financial crisis or missteps, we frequently find that
a key cause was elevating short-term profitability over long-term sustainability and
consumer welfare. It was not long ago that so-called exotic mortgages originally

- 10 designed for niche borrowers became increasingly marketed to low- and moderateincome borrowers who could not sustain them, ultimately with disastrous results. In
addition to the financial consequences for individual consumers, the drive for
unsustainable profit can contribute to distrust in the financial system, which is
detrimental to the broader economy. It is critical that firms providing financial services
consider the long-term social benefit of the products and services they offer. Concerns
regarding long-term sustainability are magnified in situations where banks may bear
credit or other longer-term operational risks related to products delivered by a fintech
firm. One useful question to ask is whether a product’s success depends on consumers
making ill-informed choices; if so, or if the product otherwise fails to provide sufficient
value to consumers, it is not going to be seen as responsible and may not prove
sustainable over time.
The key challenge for regulatory agencies is to create the right balance.
Ultimately, regulators should be prepared to appropriately tailor regulatory or supervisory
expectations, to the extent possible within our respective authorities, to facilitate fintech
innovations that produce benefits for consumers, businesses, and the financial system. At
the same time, any contemplated adjustments must also appropriately manage
corresponding risks.
Federal Reserve Fintech Engagement
To better understand technological changes in lending, payments, and other areas,
the Federal Reserve has been engaging with a wide range of market participants to
understand barriers to socially beneficial innovations. Our unique structure, with Board
and Reserve Bank staff in over 30 locations, allows us to tap expertise in markets and

- 11 innovation centers across the country to help establish channels of communication,
including with nonbank participants with whom we may not otherwise have regular
The Federal Reserve also engages in ongoing communication with other
regulators to promote, to the greatest extent possible, consistency in approaches and
alignment of supervisory requirements. Exchanging ideas and discussing fintech
innovations with other regulators is critical to understanding and vetting risks and, where
appropriate, reaching consistent views regarding the application of laws, regulations, or
Finally, we recognize the value of technical expertise. With fintech, as with any
other emerging financial product or service, the Federal Reserve is learning as much as
we can to ensure that we have a robust understanding of the technologies and activities in
which banks and other financial firms are engaging, and to inform the development of
our policy and supervisory approaches. To that end, the Federal Reserve Board has
established a multidisciplinary working group that is engaged in a 360-degree analysis of
fintech innovation. We are bringing together the best thinking across the Federal Reserve
System, spanning key areas of responsibility--from supervision to community
development, from financial stability to payments--to assess the impact of technological
development on the Federal Reserve’s responsibilities. As part of this effort, Federal
Reserve senior officials and staff have been closely watching developments in fintech,
evaluating its impact on financial services delivery, and assessing the policy and
supervisory implications in this arena.

- 12 Conclusion
Current developments in the digitization of finance, including the establishment
of new business models, are important and deserving of serious engagement on the part
of policymakers and regulators. As policymakers, we want to facilitate innovation where
it has the potential to yield broad social benefit, while ensuring that risks are thoroughly
managed. In safeguarding the public interest, the first line of analysis and protection will
always rest with the market participants closest to the new technologies and product
innovations and to the organizations that consider adopting them. But regulators also
should seek to analyze the implications of technology developments through constructive
and timely engagement. We should be attentive to the potential social benefits of these
new technologies, prepared to make the necessary regulatory adjustments if their safety
and integrity are proven and their potential benefits found to be in the public interest, and
vigilant to ensure risks are well understood and managed.