The U.S. financial system has an unrivaled history of resilience and creativity. Banks, credit unions and other financial institutions, supported by tech companies, policy makers and regulators, have overcome unimaginable crises over the last 100 years—the Great Depression, two World Wars, the S&L Crisis, the terror attacks of 9/11, the Great Recession and COVID. But we’re now facing age related as well as new external threats that require immediate changes to protect and strengthen the system.
Not One, but Two Elephants in the Room
Reliance on outdated legacy systems—a huge problem in its own right—exacerbates these threats by constraining innovation, wasting precious resources and hampering risk management. U.S. financial institutions need to invest in new technologies and build new, efficient products to satisfy changing customer expectations as well as maintain leadership in an increasingly competitive, fast-moving, technology driven global financial market.
Also, our regulatory framework needs to evolve to support new charters that inspire innovation. Pioneers of new bank products and financial services, often operate in uncharted compliance waters with difficulties accessing the U.S. payment systems. This constrains investment and innovation as well as exposes customers to potentially unacceptable or, worse still, unforeseen risks.
If left unaddressed, these two conditions will further compromise our global financial services leadership, constrain our economy and stifle innovation necessary to adapt, compete and win.
Everyone Has a Plan Until…
We can’t allow our history to obfuscate the growing threats to U.S. leadership in global financial services. The same is true of the U.S. dollar’s status as the global reserve currency and preferred medium of exchange. China has long been leveraging massive foreign investments in shipping hubs, natural resources and foreign infrastructure to encourage adoption of new trading paradigms that bypass the United States. Moreover, a BRIC currency and/or trading system, with adoption and scale, would chip-away at the U.S. dollar and represents an alternative to the U.S. financial system. Geopolitical and military conflicts are also triggering additional economic, trade and financial challenges.
Add U.S. bank technology deficits and a licensing construct that discourages investments in financial innovations, and this one-two-three combination will do serious damage. As Mike Tyson famously put it, “everyone has a plan until they get punched in the mouth.”
I’ll outline two ideas—a mix of offense and defense—to support the United States’ efforts to not only maintain, but expand its leading position through innovation while adding strength, greater resiliency and adaptability to our financial system and economy.
1. Incentives for Financial Institutions to Modernize Their Tech is Urgently Needed
As one U.S. banker shared with me, “Banks are museums of technology.” Many core banking systems are ancient, and countless other systems are outdated making them expensive and difficult to operate, while also creating significant obstacles to innovation. Corroborating this, a former board member of a top 5 European bank reported having more than 10,000 different systems that required maintenance. Given the age and diversity of these, there’s a shrinking pool of engineers skilled in their obsolete coding languages and the systems themselves. And from an environmental perspective, these legacy systems consume more energy than newer software, cloud services, and other technology—except for Bitcoin and some blockchains, which are energy hogs.
We need to motivate U.S. financial institutions to update their technology—now. Financial institutions face many obstacles to innovation and one is capital. Product and technology executives lament that 75% to 95% of their IT and product development budgets are consumed by:
protecting consumer data and systems from hackers, including rising threats from sophisticated nation-state attackers and organized crime syndicates;
funding the care and maintenance of numerous existing, antiquated systems;
keeping products in compliance with changing regulations.
Moreover, the interpretation and implementation of Basel III will increase capital reserve requirements, even as some of the measures are watered down. This will increase pressure on publicly traded financial institutions at exactly the point in the cycle when rising bad loans and falling interest income means they’re already looking at cutting expenses and curtailing cap-ex investments.
Let’s rise above partisanship, put country first, and create a financial technology investment act. We should structure the incentive so it’s tied to domestic employment of technology workers which will also have a positive effect on the U.S. job market and economy.
The Fed pushed to digitize check processing and clearing for more than a decade—but the industry was unwilling to invest in tech to support this until airplanes couldn’t transport paper checks between processing centers after 9/11. We can’t afford to wait for another catastrophe to force our hand.
2. New Types of Charters with Access to the Payment Systems Will Spur Innovation
What can we learn from the OCC’s decision in 2020 to offer a fintech bank charter? First, the comment period raised legitimate concerns. But sadly, instead of thoughtfully addressing these concerns, while also being determined to support new forms of financial institutions, the result was a new fintech charter that looked just like old bank charters. It was a big yawn and fell far short of what’s needed and others around the globe have found works. Moreover, it’s been mired in expensive and distracting legal battles for years wasting precious resources and further discouraging investment for innovation.
Whether it’s overcoming the bias toward maintaining the status quo, resisting pressure from some banks, reassuring state regulators who have concerns, educating consumer groups or rising above partisan politics—we need to come together to protect our future by evolving our licensing and regulatory framework.
We need a federal regulatory paradigm that encourages financial services innovations to include:
new types of regulated entities with limited, special-purpose, clearly defined charters;
rules for these charters that protect customer funds while preventing taxpayer risk if a firm fails;
right-sized capital requirements and fees (far less than the capital required for the fintech charter).
A “safe” financial system and an “innovative” financial system are not mutually exclusive. For example, requirements to safeguard customer funds and charters that prohibit extension of credit would eliminate many risks and protect customer funds without FDIC insurance and/or taxpayers being on the hook for new regulated entities that fail.
By the way, this wouldn’t preclude banks from participating in the leading edge of innovation. Banks in other countries have funded or partnered with Electronic Money Institutions and similar entities to deliver innovative, cost-effective products faster than they could themselves.
Some new business models or products, like Banking-as-a-Service, embedded finance, open banking, buy now, pay later and digital currencies, face regulatory uncertainty or wake to find unexpected business threatening rules.
Given the diversity of new financial products and business models, we need a fresh special-purpose charter construct and clear rules of the road to fuel innovation, protect users and taxpayers. Also, new charters should include a master account at the Fed to prevent dependence on fearful or reluctant commercial banks for deposit holding and access to the U.S. payment system.
Our Global Leadership Position & Economy Is at Stake
While the U.S. financial system is remarkable in its size, scope, complexity, creativity and resilience—it must improve for the U.S. to remain the global leader in financial services that fuels both our own economy and, by extension, much of the world’s.
We need to incentivize financial institutions to modernize outdated software to deliver new products faster, leverage new tech like AI, and better defend against a growing number of external threats.
We need to evolve our regulatory framework to inspire investment in new, special-purpose regulated entities for the benefit of U.S. and global customers, leap-frogging other countries with common-sense regulations that protect users while encouraging innovation.
We can’t be distracted or complacent, too awestruck to know where to start, nor stuck in a “this is how it’s always been” mentality or fearful that these ideas are too big to tackle. Teething pain from these ideas or messiness getting them right will be minor compared to the consequences of not acting—this pain will be felt for decades and will be far worse than an upper-cut to the gut and a left-hook to the face.
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