Technology grows at an exponential rate. When we consider what progress was made in the space of a decade in the 18th century, it’s nothing like what a decade can achieve today. This poses a serious issue to regulators, though. Innovation is generally considered a positive thing, but it needs to be in a somewhat controlled environment.
The “finance” part of fintech has been around longer than the “tech” part, or at least, it has developed at a slower pace. Because of this, financial regulation is a little more set in stone, and arguably to some, extra harsh in order to compensate for its lagging in the tech sphere.
The 2008 catalyst
There may have been many factors that led to the 2008 crisis – perhaps the most serious existential threat that capitalism has ever faced – but it commonly comes down to moral hazards and casino banking – things that regulation aims to fix.
A little bit like how the paradigm of airport security shifted after 9/11, a wave of regulation was introduced after the 2008 banking failures. At the crux of the subprime mortgage crisis, it was a matter of banks handing out mortgages too frivolously, and then collating these debt packages into Collateralised Debt Obligations (CDOs). Basically, bunching up lots of bad debt and selling it on with no accurate gauge of how risky those products really were. This created a knock-on effect when repayments weren’t being met, and the whole debt-based system collapsed.
The most important regulations that were introduced in the US in the aftermath were the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Troubled Asset Relief Program and the Emergency Economic Stabilization Act.
Many criticized the Dodd-Frank reform because it made US banks less competitive than their foreign rivals, showing they were indeed somewhat effective.
The need for fintech reform
Most regulations and compliance are created with the intention of protecting the customer. Enforcing stricter protocols around data, for example, helps minimize data breaches and boost security – this is particularly important for financial companies where deposits are at stake.
Crypto is a good example of unregulated finance, and as we have seen, it is inundated with scams. Many exchanges, for example, have lost customers millions of dollars worth of crypto due to hacking. But, pump and dumps, fake companies receiving investment and dashing, and many other scams regularly take place.
These are less common in traditional finance, though it can be argued wealth helps negate some regulators. We have seen similar pump-and-dump shenanigans from the likes of Elon Musk go unpunished. Still, there’s no doubt that fewer scams would exist in crypto if it was more regulated, which is why many worry about regulators lagging behind innovation regarding fintech.
The stringent regulation of money transfers can help consumers send and receive their money with confidence – they needn’t store 12 seed words in a drawer under their bed or buy a £70 ledger hardware wallet just to keep their money safe.
The drawbacks of fintech regulations
Everything good that has come out of modern-day fintechs is from two things: competition and investment.
Somewhere along the line, for better or worse, tech startups have been given increasingly high valuations, even at their early stages. More years into the future are used when looking at cash flow to determine valuations – decades into the future being factored into the current price. Regardless of the drawbacks and dangers this poses for investors, it at least shows that fintech startups have an abundance of cash.
But it’s the other point regarding competition that is more seriously threatened by regulation. We can see how quickly many startups left the UK immediately after Brexit because they had to jump through more hoops, paperwork and costs when dealing with the rest of Europe.
The reality is that money transfers are suffering from regulation – their own compliance is very harsh because the penalties for non-compliance can be steep. Whilst some companies seek to be regulated by tier-1 bodies like the SEC, many do not bother entering the US market at all because life is easier without it. The FCA can be a similar story for the UK, too.
It varies by location, but onboarding and Know Your Customer can be extensive, meaning you must send back and forth a lot of paperwork just to sign up with an FX broker, remittance company or stockbroker. The increase in resources and costs of compliance is always passed on to the customer.
And, even if you can get through the door, there are many complaints from customers using the likes of Wise that their transfers have disappeared. Wise is usually referred to as the peak of customer experience, with a slick interface and state-of-the-art modern financial infrastructure. Yet, transfers will often get suspended because they’re rejected by Wise’s automated compliance protocol or they’re awaiting further approval. The blame here goes to the FCA, but is it a necessary evil?
During the invasion of Ukraine, we saw the power that financial regulators can have as a geopolitical weapon. Russia was banned from SWIFT and had other financial regulatory punishments sent their way. This was effective in squeezing the Russian economy and the Russian people. Many point to “what if we only had crypto”, which is very unregulated, in highlighting the dangers it would have presented and the lack of sanctioning power the west would have had.
It’s a certainty that Russia would have been less affected by sanctions due to decentralization and more black market deals would have been conducted. But, as a Russian citizen who had nothing to do with the war, it would have been a blessing.
This helps summarize financial regulation within fintech right now. We likely need to respond more quickly to tech innovation with regulation in order to stabilize economies, create deterrents, protect customers, and suffocate black markets. But for individuals and businesses, it can impede on their freedoms and make day-to-day activities less efficient and more costly. It’s no surprise, then, that crypto-enthusiasts tend to be individualists and ardent libertarians, whilst the resistance against it is from left-leaning liberals and collectivists.
We are yet to see if crypto becomes nationally integrated and validated through regulation, or if it remains to be the wild west. But until then, we can draw upon it in regards to both the benefits and dangers of regulation within mainstream fintech – or lack thereof.