How to Regulate the Financial System in the Digital Age
In 1920, after the disaster that followed the First World War, contemplating the period before it, Keynes noted:
„The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantities as he might see fit, and reasonably expect their early delivery upon his doorstep; he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprises of any quarter of the world, and share without exertion or even trouble, in their prospective fruits and advantages”.
It invokes, of course, the benefits of globalization, but it was obviously marked by the power of the new developments in communications and the impact they had on the economy and society.
Subsequent evolution was considerable – the transition from analogue to digital technologies has been made, cross-border clearing and payment infrastructures have been created, electronic stock exchanges have emerged, and new communication channels emerged. Supported by the widespread use of the internet and smart mobile devices, technology has become even more democratized and a supporters of various mass phenomena.
Among new developments, we mention blockchain technology, which promises to revolutionize the payment system, allowing faster, safer and more efficient transactions, and artificial intelligence (AI), which offers new experiences in the relationship with the user etc. It is not very clear what the future of these technologies will be, but the current results are encouraging. Recently, in the field of financing international trade, for example, they have managed, using distributed ledger technology, to reduce the duration of the entire process of preparing the documentation and granting the credit from over 10 days to less than 24 hours. And his is just one example.
The fly in the ointment
One problem that has not been resolved, however, in relation to these technologies, is that of regulation. In the age of the digital revolution, financial services are no longer the exclusive purview of banks, but are also offered by non-banking financial institutions such as start-ups and technology companies (fintech companies), which come with new business models, outside of the traditional regulatory framework. Beyond the benefits they offer, the way they are implemented comes with numerous risks that derive from the novelty and disruptive potential they have. They may undermine consumer safety, cybersecurity, can be used in money laundering and terrorist financing activities, and can affect the stability of the financial system as a whole.
Operating outside of the regulatory framework that applies to traditional financial institutions, the fintech sector is the propitious environment for conducting illicit activities, for improper use of data etc. There have been numerous situations where blockchain technology, for example, has been used for Ponzi schemes, drug trafficking (we consider Bitcoin usage), ICO (Initial Coin Offer) scams etc. Also, biometric technologies that allow the reproduction of individuals' characteristics, such as fingerprints, have been subject to data theft.
In the above, the main challenge to which the regulatory authorities must respond is the following: how to regulate the fintech sector without inhibiting the potential of digital finance providers for innovation. An answer may be the one provided within a recent article by the IMF President, Christine Lagarde: with creativity, flexibility and expertise.
Currently, there are few jurisdictions worldwide that have adopted regulatory frameworks that specifically address the needs of the fintech sector. This is normal if we consider that digital technologies are still in their infancy and it takes time for them to enter the market and be widely adopted by users.
In most countries, fintech companies are subject to regulations that apply to banks or traditional non-banking financial institutions, depending on the sector in which they operate – payments, lending, crowdfunding, insurance etc. Most of the time they are not adapted to their particularities and functioning needs and they can create constraints that can affect the incentives of companies in this sector for research and development, for innovation. In addition, some are very easy to avoid.
In the US, for example, a fintech company that wants to enter the P2P (peer-to-peer) lending market must comply with numerous laws in the field of consumer protection, money laundering and terrorist financing (BSA – Banking Secrecy Act), data protection (GLBA – Gramm-Leach-Bliley Act), or in its field (TILA – Truth-in-Lending Act, ECOA – Equal Credit Opportunity Act, FCRA – Fair Credit Reporting Act) and responds to a large number of regulatory authorities (CPFB – Consumer Financial Protection Bureau, FinCEN – Financial Crimes Enforcement Network etc.), depending on the type of license it holds. Moreover, for one to have the authorization to operate in this niche, one must meet a number of fairly strict authorization requirements (they may opt for an ILC – Industrial Loan Credit type bank charter, at the state level, or for a federal bank charter, for example) which can be frustrating and costly for a company that is not familiar with meeting compliance requirements.
In the European Union, the situation is not much different. The directives that exist at European level apply to a limited number of activities (payments – see PSD2 – the payment security directive,, crowdfunding) and for the others (granting loans or concluding insurance through P2P platforms, for example) companies must meet similar requirements to those previously mentioned, applied at the level of the Member States. In France, for example, a P2P lending company can choose to function as 1) a credit institution, 2) a financing company, 3) a crowdfunding intermediary or 4) an intermediary in banking transactions, each with their own specific authorization requirements and compliance.
So far, no widely accepted solutions have been proposed on the issue of regulating the use of digital technologies in the financial sector. In most countries, this is under debate. As several voices show (with which we agree), viable solutions should come from the agreement between technology providers, financial institutions and regulators. At present, however, there is some confusion at the market level, generated by the different visions they have regarding the type of measures that should be applied.
Moving in the right direction
There are signs, however, that there is a growing interest in regulators for the fintech sector and that things are moving in the right direction. Various international bodies (FSB – Financial Stability Board, BCBS – Basel Committee on Banking Supervision, IOSCO – International Organization of Securities Commissions) and regulatory authorities have lately expressed consistent interest in understanding how these technologies work and in what manner they can be regulated, according to their interests and their fields of activity. In the US, for example, the OCC (Office of the Comptroller of the Currency) has tried to introduce a fintech charter that would offer less severe operating conditions from the compliance perspective.
Feasible solutions regarding the definition of a model that will ensure a certain level of harmonization of the regulatory frameworks for the fintech sector seem to come from the large international organizations. In March 2018, the IMF and the World Bank launched the Fintech Bali Agenda, the first guide for their member states on the construction of regulatory frameworks in the field of digital finance. Among the recommendations contained in it were the following:
• Monitoring developments closely to deepen understanding of evolving financial systems to support the formulation of policies that foster the benefits of fintech and mitigate potential risks;
• Adapting regulatory framework and supervisory practices for orderly development and stability of the financial system and facilitate the safe entry of new products, activities, and intermediaries; sustain trust and confidence; and respond to risks;
• Safeguarding the integrity of financial systems by identifying, understanding, assessing, and mitigating the risks of criminal misuse of fintech, and by using technologies that strengthen compliance with anti-money laundering and combating the financing of terrorism (AML/CFT) measures;
• Ensuring the Stability of Domestic Monetary and Financial Systems by considering the implications of fintech innovations to central banking services and market structure, while: safeguarding financial stability; expanding, if needed, safety nets; and ensuring effective monetary policy transmission.
The above recommendations could be a starting point in understanding how the fintech sector should be regulated. In our opinion, a prudent approach of the entire process, in the spirit of the proposals made by the Fintech Bali Agenda, could be the key to implementing efficient regulatory frameworks in this sector.
In this context, taking into account the recommendations of the IMF and the World Bank, a number of general principles could be emphasized that would underpin the implementing of regulatory frameworks that meet the needs of the financial system in the current period.
The first one, supported by a large proportion of those involved in the debate on regulating the fintech sector, should be that of focusing on risks and not on developers or technologies themselves. Recent examples show us that, in those jurisdictions where the regulatory and supervisory authorities have reacted restrictively, their actions mainly focused on products and services. In countries like India and China, the use of the ICO (Initial Coin Offer) has been banned . Also, in the US, the state of Texas has banned lending through P2P platforms, despite their expansion in other regions .
A restrictive regulatory policy, however, can be harmful from at least two points of view. First, it could discourage the use of technologies that, if implemented in a different context or by other categories of digital financial services providers, would not generate risks and could bring benefits to users. Secondly, it would be an obstacle to innovation.
A second principle should be achieving a very good understanding of how these technologies work. This could significantly contribute to establishing the direction in which the use of blockchain, artificial intelligence (AI), biometric technologies and others are heading and in understanding the topology of the risk environment they generate. Only in this way, can the best decisions be made in terms of regulations that may be implemented.
In this context, a measure that would contribute to a better understanding of the fintech sector would be to intensify the collaboration between the regulatory/supervisory authorities and the providers of digital financial services within “Fintech Centers” and the sandboxes/ cyber ranges, which can ensure the testing of technologies in a controlled environment. Currently, there are several states whose regulatory and supervisory authorities have set up Fintech Centers. These include Australia, Canada, the USA, Honk Kong, Japan and others. Sandboxes have also been set up in over 20 jurisdictions worldwide.
One last principle we would like to refer to is the way in which the regulations for the fintech sector can be implemented. In this context, we consider that it should be taken into account that adapting the existing norms to the operating particularities and needs of the fintech companies could be more efficient than defining new regulatory frameworks that would work in parallel with those applicable to traditional financial institutions.
These measures (eventually with a focus on different activities – payments, loans, crowdfunding, insurance etc.), though not an exhaustive list, would allow for a more efficient adjustment of the norms as new technologies are discovered or new risks arise. In addition, the existing rules could better respond to certain categories of risks, especially since some are similar to those generated by traditional financial institutions.
Photo credit: pxhere.com.
 Buckley R., Barberies J.N., Arner D.W. (2016), The Evolution of Fintech: A New Post-Crisis Paradigm?, University of New South Wales Law Research Series, Sydney.
 Christiansen, B., Maalouf, K., Brandt, P., Seve, M., Piquet, F., Sandman J., Seidner, G. (2018), A look at US and EU Fintech Regulatory Frameworks, February, https://www.skadden.com/insights/publications/2018/02/a-look-at-us-and-eu-fintech-regulatory-frameworks.
 Lagarde C. (2018), A regulatory approach to fintech in International Monetary Fund (IMF) (2018), Money Transformed. The future of currency in a digital world, F&D (Finance&Development), Volume 55, Number 2, June 2018, https://www.imf.org/external/pubs/ft/fandd/20Arner D.W. 8/06/pdf/fd0618.pdf.
 Fintech regulation in the USA, Lexology (2019), https://www.lexology.com/library/detail.aspx?g=bf6638f5-b77c-457f-a0c7-aaf7e0483467.
 Keynes, J.M. (1920), The Economic Consequences of the Peace, Macmillan and Co., London.
 Un livre blanc HSBC – Bain appelle à la collaboration entre plateformes “blockchain”, Le Moci No. 302, Paris, Novembre 2018, https://www.lemoci.com/actualites/finance-assurance/finance-export-un-livre-blanc-hsbc-bain-appelle-a-la-collaboration-entre-plateformes-blockchain/.