Access Denied: The Regulatory Threat to Financial Inclusion
Financial technology (“fintech”) offers consumers a flexible and efficient way to manage their finances.[1] Digital finance solutions are less costly than traditional financial services enhancing access to the financial market for underserved and underbanked populations.[2]. Over the last decade, the mass adoption of internet-enabled smartphones and improvements in data analytics and cloud computing have enabled innovators to disrupt the finance industry further.[3] In the last few years, regulators at the federal and state levels have raised concerns about the risks of fintech to consumers as well as the overall financial system.[4] As a result, fintech regulations are quickly evolving, and regulators are applying greater scrutiny to fintech activities.[5] This disjointed regulatory scheme is responsible for regulatory arbitrage and high compliance costs, adversely affecting fintech innovators and threatening financial inclusion.[6] Financial accessibility is also jeopardized by the Department of Justice (“DOJ”) crackdown on big tech.[7]
Fintech services are generally delivered as software or through mobile applications (“apps”).[8] Most of these services depend upon the use of application programming interfaces (“APIs”), which are a cost-efficient way for systems to share information securely.[9] The use of APIs, complex algorithms, and low-cost data collection processes allows fintech companies to provide financial tools to consumers at an affordable price.[10] Moreover, fintechs have found alternative ways to assess a borrower’s credit risk, reducing obstacles for those generally deemed unworthy of credit.[11] In the modern age, all one needs to access digital financial services is a smartphone.[12]
The Fintech Regulatory Landscape
No singular regulatory body is responsible for overseeing fintech activities. [13] Both federal and state agencies exercise jurisdiction over the fintech industry, often clashing in their oversight. [14] At the federal level, fintech companies are subject to a number of federal finance laws. At the state level, fintechs must meet requirements for state consumer protection and data privacy laws.[15] This multilevel regulatory framework leaves room for regulatory arbitrage and induces higher compliance costs.[16]
By nature, digital financial services are inter-jurisdictional. [17] Therefore, fintech companies must set aside substantial capital to meet state compliance, which can be drastically different from one another.[18] A firm seeking to operate in one specific state may spend upwards of $1 million to obtain the necessary licenses valid for only 1/50th of the country.[19] To compensate for these costs, fintechs may increase prices, threatening to lessen access for underserved communities.[20] The fragmented regulatory framework precipitates a greater need for digital finance companies to consult with lawyers.[21]
Regulatory arbitrage, whereby companies exploit systemic gaps for commercial gain, is another result of the complex fintech regulatory regime.[22]. In fact, fintech providers do not have to look hard for loopholes because federal regulators employ an entity-based regulatory approach while state regulators employ an activities-based approach.[23] For instance, federally chartered fintechs may enjoy immunity from state laws.[24] Likewise, where fintechs partner with banks to offer banking or lending services, they may also avoid regulatory scrutiny. [25] Evasion of fintech regulations increases the risk of data leaks, cyber-attacks, and money laundering.[26] Such arbitrage is preventable with the proper framework.[27]
An effective fintech regulatory scheme is necessary to protect consumers and promote access to the financial services industry.[28]Fintech governance must be agile to account for rapid changes in technology.[29] Cooperation between federal and state regulatory bodies is essential to fill gaps some fintech companies exploit.[30]
The Rise of Antitrust Scrutiny
Antitrust law in the U.S. aims to prevent harm to consumers.[31] The Sherman and the Clayton Acts, which govern antitrust law, prohibit conspiracies that unreasonably restrain trade, mergers, and acquisitions (“M&A”), which may substantially decrease competition.[32] When evaluating anticompetitive behavior, regulators measure effects on competition by assessing market concentration, profit margins, capital expenditure, market value, and other factors.[33] Analyzing digital platforms has proved particularly challenging, mainly where they operate within the financial system.[34] It can be arduous for policymakers to determine market concentration for these types of platforms because (1) users engage with a multitude of digital finance products and (2) it is not always clear how to differentiate between them.[35]
Concerns around competitive practices for fintechs operating in the banking sector have increased with the unbundling of services and the elimination of traditional intermediaries.[36] The financial system traditionally relies upon intermediaries to facilitate payments and money transfers.[37] In essence, advancements in fintech have reduced the need for some of the existing infrastructure, decreasing competition.[38] Regulators are not the only parties bringing antitrust lawsuits against tech companies; consumers are as well.[39]
In July 2021, President Biden ordered the DOJ and Federal Trade Commission (“FTC”) to analyze the effects of competition of large tech firms and other nonbank entities entering the consumer finance market.[40] Shortly thereafter, the FTC indicated a future of heightened scrutiny for M&A involving venture-backed fintech startups.[41] Acquisitions and mergers are the primary exit strategy for most startups.[42] An environment that is unfriendly toward M&A is also unfriendly toward investors. In 2023, global investment in fintech reached a five-year low.[43] Less investment in fintech solutions may not only impede future innovation, but also hinder expansion of access to underserved populations, potentially exacerbating existing inequity in the financial market.
With antitrust enforcement looming above the tech industry and a fragmented regulatory framework challenging fintech innovators, the threat to accessibility in financial services is immense. Regulators must reconsider their efforts in light of this peril, as broader access to finance promotes a healthier and more equitable economy.[44]
Footnotes
