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Encouraging Responsible Financial Innovation for Main Street

The Brief

If guided by the right policies and regulations, financial innovation can benefit Main Street and help address some of the problems it faces, such as a loan gap for small businesses seeking small dollar loans of $250,000 or less.

Can new technology and innovation make finance work better for Main Street businesses and consumers? The answer depends on the direction public policy takes.

In the lead-up to the 2008 financial crisis, the lax attitudes toward financial innovation resulted in a proliferation of many new products that were poorly regulated and did not work as well as advertised, such as collateralized debt obligations (also known as CDOs). These innovations helped fuel a speculative housing bubble that devastated Main Street. As a result, financial innovation lost much of its luster.

However, if guided by the right policies and regulations, financial innovation can benefit Main Street and help address some of the problems it faces, such as a loan gap for small businesses seeking small dollar loans of $250,000 or less.

Public policy needs to ensure that new technologies and innovations are encouraged in a responsible manner that meets a need and benefits the end-user. The Bipartisan Policy Center’s Task Force on Main Street Finance has suggested ways to help promote such responsible innovation, some of which are listed below.

  • Financial regulators can create an office of innovation to help build their technical expertise. Regulatory agencies often need to regulate new technologies and innovation, but without adequate technical expertise this can be difficult and lead to ineffective and inefficient regulation. By creating an office of innovation, regulatory agencies can better recruit, train, and utilize staff with the right technical expertise, so they are more adaptable to new changes in the marketplace. These offices can also work together to help the regulatory agencies better coordinate with each other and help ensure regulation is more effective and better tailored to new challenges.
  • Financial regulators can develop “innovation greenhouses” to foster responsible innovation. A challenge with regulating financial innovation is that without testing the innovation in the real world it is difficult to know its impact. Policies that are too strict can discourage many beneficial innovations from entering the market, while those that are too lenient can lead to a proliferation of products and services that prove harmful. Regulators can strike a smart balance by creating an “innovation greenhouse” (or what has been called a “regulatory sandbox”) program that gives innovators leeway to test new products and services in a limited market environment for a well-defined period of time. The program can encourage sensible experimentation until regulators can determine how to best regulate the innovation.
  • Congress can direct the Federal Trade Commission to develop a simple disclosure form for non-banks making small business loans and cash advances. A Federal Reserve study provides evidence suggesting that many small business borrowers would benefit from more disclosure from fintech lenders. Some fintechs have already pushed for greater regulation of their industry to ensure more transparency for these borrowers. Congress can help improve transparency by directing the Federal Trade Commission to develop a simple loan disclosure form for non-banks that is easy to understand and provides small business borrowers with the most relevant information they need to make good decisions. The development of this disclosure form can be guided by existing self-regulatory measures, such as the SMART Box.
  • Congress can amend the National Bank Act to give the Comptroller of the Currency the explicit authority to issue a special purpose charter for non-banks. The Office of the Comptroller of the Currency (OCC) began accepting applications for national bank charters from non-bank fintech companies. A national charter for fintechs can help them avoid a patchwork of regulations across states, while ensuring they are properly regulated. Unfortunately, the authority used by the OCC to create the non-bank charter was not designed for this purpose. Congress can correct this problem by giving the OCC the explicit authority to create a special purpose non-bank charter that is designed for regulating fintechs. This can ensure the charter is flexible and well-suited for meeting the unique regulatory challenges posed by the evolving fintech industry.

Recognizing the importance of encouraging financial innovation in a responsible manner is important. Policymakers seem to be taking this issue seriously. For example, Federal Deposit Insurance Corporation Chairman Jelena McWilliams recently announced the opening of an office of innovation at her agency. The FDIC becomes the latest federal financial regulator, including the Consumer Financial Protection Bureau and Commodity Futures Trading Commission, to open an office of innovation, which is a welcome development.

The right policies such as building the government’s regulatory expertise and better tailoring regulation to adapt to the dynamic marketplace can make finance work better for Main Street. And we should remember that the financial system works best when it works for Main Street.

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