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American financial institutions are already facing an incredibly complex regulatory environment. What’s coming will only make matters more challenging.
Why? A convergence of emerging policy priorities in Washington is creating a raft of new compliance risks. This trend can have increasingly negative impacts on industry innovation by directing time and resources that could instead be allocated toward improving product development or client services.
Institutions that hope to stay ahead of the regulatory curve will need to revitalize their compliance operations with a tech-first approach and involve compliance early on in any product or service development efforts. Doing so saves time and money and helps drive a culture of continuous innovation during regulatory ebbs and flows.
The future of open banking regulation
At the recent Money 20/20, Consumer Financial Protection Bureau (CFPB) Director Rohit Chopra announced the rule-making process, pursuant to Section 1033 of the Dodd-Frank Act, to develop regulations that will “strengthen consumers’ access to, and control over, their financial data.”
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This is a major step toward “open banking” and “open finance” that will have significant ramifications for financial institutions that offer deposit accounts, credit cards, digital wallets and other transaction accounts.
Under this rule (which should be finalized in 2024), covered firms will be required to provide consumers with their financial information or provide it to a third party at the consumer’s instruction. Other proposals will also be considered, such as efforts to ease the process of transferring accounts between companies and new requirements surrounding personal financial data privacy.
Disrupting the U.S. financial sector
The overarching goal is to bolster competition in the marketplace by making it easier for consumers to switch financial services providers, forcing companies to innovate and compete to keep customers. The regulatory impact will involve major new requirements related to customer data: data portability, data sharing, data security, data storage and more.
Banks and other companies that handle personal financial data will have to make changes to their internal processes and digital infrastructure, such as establishing secure data sharing methods like APIs, to meet these regulations. Some companies will even have to adjust their business models.
Chopra deemed the initiative one of the “most important rules the CFPB is working on, or will ever work on in its history,” foreshadowing the broad ramifications the rule could have on the U.S. financial sector.
New disclosure requirements
Another regulation to monitor is the SEC’s proposed rule requiring registrants to disclose robust amounts of information about climate risks and greenhouse emissions, which should be finalized in the coming months. Disclosures will require extensive reporting and information sharing on companies’ environmental practices and strategies, especially around reducing emissions, creating new compliance hurdles.
In addition to Section 1033 of Dodd Frank and ESG, financial institutions should prepare to face new compliance requirements related to digital assets (especially cryptocurrency following the FTX collapse), data privacy, cybersecurity and more. In the coming era of divided government, President Biden will likely become more reliant on executive orders to advance his regulatory agenda.
Compliance costs for banks have already increased an estimated 60% since the 2008 economic crisis, and the fact that these regulatory challenges may arrive during a recession makes things even worse.
New solutions for a new era
During economic downturns, companies are forced to stretch budgets and make tough decisions about their workforce, growth strategy and product development. Rising compliance costs don’t help. Any additional dollars spent on navigating CFPB, SEC, or Treasury regulations reduce budgets for innovation, impacting individual companies, U.S. economic competitiveness and the financial industry as a whole.
Compliance will stifle innovation unless business leaders bring innovation to their compliance systems and processes to maximize efficiency and minimize costs.
Additional training and manpower are likely part of the solution, but the core focus for compliance teams is to adopt new technologies that more rapidly identify new or relevant regulations and better coordinate the enterprise operations.
Adopting and implementing enterprise software solutions that rely on artificial intelligence (AI), machine learning (ML) and cloud computing is the most cost-effective and efficient mitigant to an increasingly complex and expensive regulatory environment.
Compliance part of the “innovation engine”
Still, just having the latest tech is not a silver bullet. Forward-thinking FinTech innovators are also changing the way they work with compliance to maintain their pace of innovation. Compliance teams should be brought in during the early stages of product or service development — even during ideation.
Incorporating compliance feedback and expertise during development can significantly reduce delays caused by compliance challenges. Compliance should not be viewed as a “gate to pass through” at the final stage of product development, but as part of the innovation engine that moves companies forward.
It’s impossible to fully predict the future regulatory landscape. But with adequate tools and workflows, financial institutions and FinTech innovators can work smartly to minimize risk while maximizing innovation.
Kevin Jacques and Ben Malka are partners at Cota Capital, a San Francisco-based technology investment firm.
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Kevin Jacques, Cota Capital