Throughout its history, finance follows a predictable pattern. Waves of excessive risk-taking are followed by the three common corrections: a flight to safety, regulatory scrutiny, and jail time for the worst offenders. The junk bond market imploded along those three familiar lines in the late 1980s. Ditto for the 2008 financial crisis.
In 2021, a 10-year wave of fintech innovation and disruption culminated in a $1.3T market cap for public companies listed in the F-Prime Fintech Index. Then, in 2022, the market fell back to Earth and the usual corrective results followed in 2023. In their flight to safety, investors abruptly demanded capital efficient growth and cut fintech valuation multiples. By now we could fill a school bus with the fintech executives who are either under indictment, awaiting charges, or already in jail, including leaders at FTX, Bitwise, Frank, Wirecard, Terraform, and Binance. And in the last 12 months, regulators have finally started to throw their weight around the fintech sector. In our most recent State of Fintech report, my partners and I refer to 2023 as the year of “reg on, risk off.”
For now, we wanted to take a look at the more enduring element of any corrective cycle: regulatory action. The fintech industry experienced a meaningful shift in regulator scrutiny, rule-making, and enforcement in 2023, which will have a lasting impact on the sector.
Banking
The Office of the Comptroller of the Currency (OCC) has is scrutinizing the relationships between fintech startups, banking-as-a-service providers (BaaS), and chartered banks. This triad has been incredible valuable to the fintech ecosystem, but banks like Blue Ridge Bank, Cross River Bank, and First Fed Bank have recently found themselves in the regulatory crosshairs. Many banks are responding by suspending fintech startup programs, re-asserting stricter compliance controls, or exiting the space altogether. It’s clear to us that regulators would prefer chartered banks bypass BaaS providers and manage fintech programs directly. We think BaaS and embedded banking is here to stay, but it will become more expensive and everyone is moving more slowly until the regulatory guardrails solidify.
The Consumer Financial Protection Bureau (CFPB) has been busy making headlines with proposals to cap overdraft and not-sufficient-funds fees. While in aggregate these will not make a big impact on the banking industry, we think it’s a fascinating culmination of neobank disruption which taught consumers (and apparently regulators) that banking could function without the fees.
In the realm of open finance, the CFPB proposed Section 1033 of the Dodd-Frank Act enshrining consumer access to their financial data with banks (though notably not yet with brokerages). Thanks to aggregators like Plaid, Quovo, and Yodlee, the US has had de facto open access for years, but it is good to see it protected, though we’re watching for unintended consequences if new limits are placed on secondary use of the data.
Payments
FedNow, and the renewed push for real-time payments (RTP) in the US, is a big story, though the lack of deadlines or forced bank support ensures we will see much slower adoption in the US than in countries like Brazil and India. Of course, there are many other reasons the US would have adopted more slowly, like credit card rewards and already high-performing alternative payments rails.
We are focused on how risk and fraud will be addressed with RTP, and see increased scrutiny of other digital wallet transactions as a preview. Fed Reg E does not require banks to reimburse consumers who mistakenly send funds through error or fraud, yet the CFPB is understandably looking at the $1 trillion of digital wallet transactions and asking if they should. Bowing to pressure, last year Zelle voluntarily began reimbursing some affected consumers, and we believe we will eventually get to a greater harmonization of consumer protections regardless of the payment rails.
Finally, it wouldn’t be a year without someone complaining about interchange, though last year the Federal Reserve actually proposed a debit card interchange fee reduction that would be the first since 2011. As before, fintech companies could side-step the lower fees by working with exempt banks under the Durbin Amendment to the Dodd-Frank Act (banks with less than $10B in assets.)
Lending
Seems like everyone is asking how to regulate By Now Pay Later (BNPL). In the OCC’s December bulletin, the regulator issued new requirements for banks that support BNPL transactions around risk management, disclosure guidelines, and borrower safeguards. The CFPB issued its own report focused on similar issues. And following Callifornia’s lead that formally incorporated BNPL under state lending laws in 2020, many states are addressing BNPL this year. We expect BNPL to gradually align with other consumer lending regulations, but this will not materially slow its rapid growth.
Across the country, states are passing or considering legislation dealing with early wage access (EWA), where hourly workers can smooth out pay cycles by accessing their wages without waiting for weekly or monthly pay cycles. Nevada and Missouri adopted laws that protect users from large fees when using EWA, while a law in Connecticut (and another pending approval in California) would designate EWA as a “loan.”
Wealth and Asset Management
In March, the Department of Labor urged retirement fund providers to “exercise extreme care” when considering an investment in cryptocurrency, opting for statements over regulation for now.
More regulation is coming for the private funds industry (aka Alternatives) with a notable step in that direction in 2023. At $16T in assets and an expanding base of retail investors, the Securities and Exchange Commission (SEC) began requiring registered advisors to make quarterly disclosures about their fees, as well as performance and potential conflicts of interest.
Proptech
While more litigation than regulation, in October, a federal jury found that the National Association of Realtors had colluded with some of the largest real estate brokers in the US to inflate commissions. The ruling had immediate implications for property tech companies like Redfin, Zillow, and Opendoor, which all saw their stock price sink in the aftermath. It is remarkable that US consumers continue to pay such high commissions for selling a home, but it remains to be seen whether this ruling can do what Redfin and a decade of digitization has not.
Crypto
Several jurisdictions, including the European Union, released detailed crypto regulatory frameworks seeking to prevent fraud, money laundering, and other forms of illegal financing via cryptocurrency. Here in the US, the SEC is continuing its policy of “regulation via litigation,” filing roughly 55 enforcement lawsuits during Chairman Gensler’s term at the agency’s helm. And in a huge milestone for the crypto sector, the SEC also approved the listing of 11 bitcoin ETFs.
Conclusion
Heightened regulation follows waves of innovation and increased risk-taking, and that’s generally a good thing. The lag permitted a decade of new startups to innovate, expand consumer options, and further digitize the financial industry. 2023 marked the beginning of the “reg on, risk off” era, and while regulation may go too far as well, we think the increased regulatory scrutiny will prove beneficial. We must all work with regulators to develop regulation that protects consumers while permitting innovation, gives businesses clear rules to comply with, and if not too much to ask, harmonizes disparate regulatory frameworks across analogous products (e.g., payment rails) and across federal and state regimes.
The fintech industry experienced a meaningful shift in regulator scrutiny, rule-making, and enforcement in 2023, which will have a lasting impact on the sector.