KT Fintech Blog

The KT Fintech Blog provides insights into how the emergence of fintech is fundamentally changing virtually every aspect of the financial services landscape and how traditional businesses navigate this rapidly evolving industry.

Category: Payment Processing

Posted on Thursday, November 30 2017 at 12:00 pm by
Federal Reserve Vice Chairman for Supervision Speaks About “Prudent Innovation in the Payment System”

Written by Eamonn K. Moran

Earlier today, Federal Reserve Board Vice Chairman for Supervision Randal Quarles delivered remarks at the 2017 Financial Stability and Fintech Conference sponsored by the Federal Reserve Bank of Cleveland, the Office of Financial Research, and the University of Maryland’s Robert H. Smith School of Business, Washington, D.C. His remarks focused on financial stability and fintech, along with financial innovation.

Quarles observed how new technologies have raised productivity and living standards and contributed to economic growth, along with bringing new conveniences to our lives. He noted that, “[n]ot surprisingly, both the banking industry and technology firms have also been seeking innovations in financial services that mirror and complement changes that have been made in other industries.” Such financial innovation includes changes to consumer lending, financial advice, and retail payments.

He noted that in his new role as vice chairman for supervision at the Federal Reserve, he views innovation “as something that can and should be fostered, but of course [he] must also scrutinize these innovations from a different perspective. That is to say, it is appropriate not only to evaluate the potential of innovations to improve on existing services, but also to judge their ramifications for the safety and soundness of the institutions we supervise and for financial stability.”

Quarles concentrated his remarks on the U.S. payment system, including the “necessary trust and confidence that the system requires, the tension between the need for financial stability and the need to innovate, and the challenges that digital currencies, in particular, present relative to the current system.” In his view, these considerations “highlight the need for a prudent approach to innovation in payment systems.” With respect to payment system innovation, he commented that “we should recognize that there can be a tension between the need for financial stability in the overall payment system and the need to innovate to keep up with the demands of modern technology and lifestyles,” but that this tension is “not necessarily troubling” since innovation does involve some amount of risk. He believes that this tension can be addressed by “balancing the benefits of innovation with the safe and reliable operation of systems and critical activities.” Noting that payment systems present unique challenges to managing the potential tension between financial innovation and stability, Quarles commented that the “essential problem is how to achieve scale and manage financial and technical risk at the same time,” which means that innovation in payment systems can take longer than in other industries.

Regarding private digital currencies, Quarles believes that the financial industry is increasingly recognizing the need to separate the concept of digital currencies from the new technologies – such as distributed ledgers – that the have been employed to transfer assets. He noted that the industry is taking a cautious approach to using new technologies in “limited production settings,” which “appears to reflect the weight of responsibility the financial industry bears for protecting both their customers and their reputations.” Because the “currency” or asset at the core of some digital currency systems is not backed by other secure assets, has no intrinsic value, is not the liability of a regulated banking institution, and in lending cases, is not the liability of any institution, he observed that the treatment and classification of this asset is complicated, especially as it relates to financial stability issues if more wide-scale usage occurs.

Quarles believes that the consideration of a central-bank-issued digital currency to the general public “would require extensive reviews and consultations about legal issues, as well as a long list of risk issues, including the potential deployment of unproven technology, money laundering, cybersecurity, and privacy,” among other issues. That said, he is supportive of continued research into digital currency issues, including highly liquid and secure limited-purpose digital currencies for use as a settlement asset for wholesale payment systems.

In his view, the alternative to privately issued digital currency in the United States is not necessarily a publicly issued digital currency. Rather, Quarles views the near-term alternative as building on the “trusted foundations of the existing payment system” and working to “improve private-sector payment services.” The focus of this appears to be enhancing and improving the banking system’s services. He noted that what the United States currently lacks is “the sort of ubiquitous, real-time payment system that would allow banks and their customers to make transfers and settlements of funds across the banking system instantly, conveniently, and securely all the time.” In closing, Quarles is optimistic that there is potential for a number of these desirable innovations to be offered using a variety of existing and new technologies without posing financial stability risk.

Posted on Wednesday, October 11 2017 at 9:00 am by
CFPB Makes Accommodations for Certain Fintech Products in Final Small Dollar Lending Rule

Written by Eamonn Moran

On October 5, the Consumer Financial Protection Bureau (CFPB or Bureau) released its long-anticipated final rule on small-dollar lending, which covers payday, vehicle title, and certain high-cost installment loans. Along with providing consumer protections governing the underwriting of covered short-term and longer-term balloon-payment loans – including payday and vehicle title loans – the rule also contains disclosure and payment withdrawal attempt requirements for covered short-term loans, covered longer-term balloon-payment loans, and certain high-cost covered longer-term loans. In one of the most significant differences from the proposal, the Bureau is not, at this time, finalizing the ability-to-repay determination requirements proposed for certain high-cost installment loans, but it is finalizing those requirements as to covered short-term and longer-term balloon-payment loans.

We note that the rule excludes from coverage some new fintech innovations, such as certain no-cost advances and programs to advance earned wages when offered by employers or their business partners.

Based on prior discussions with various stakeholders, the Bureau solicited and received comments on the proposed rule in connection with the definition of lender under proposed 12 C.F.R. § 1041.2(a)(11) about some newly formed companies that are seeking to develop programs that provide innovative access to consumers’ wages in ways that do not seem to pose the kinds of risks and harms presented by covered loans. The CFPB acknowledges that some, but not all, of these companies are fintech businesses. In addition, their business models differ – some are developing new products as an outgrowth of businesses focusing mainly on payroll processing, for example, while others are not associated with consumers’ employers but rather are focused primarily on formulating new means of advising consumers about how to improve their cash management approach. In particular, the Bureau observes that a number of these innovative financial products are seeking to assist consumers in finding ways to draw on the accrued cash value of wages they have earned but not yet been paid. “Some of these products are doing so without imposing any fees or finance charges, other than a charge for participating in the program that is designed to cover processing costs. Others are developing different models that may involve fees or advances on wages not yet earned,” the Bureau states.

The Bureau notes that some efforts to give consumers access to accrued wages may not be “credit” at all, while other initiatives are structured in more complicated ways that are more likely to constitute “credit” under the definition set forth in § 1041.2(a)(11) and Regulation Z. For instance, when an employer allows an employee to draw accrued wages ahead of a scheduled payday and then later reduces the employee’s paycheck by the amount drawn, there is a plausible argument that the transaction does not involve “credit” because the employee may not be incurring a debt at all. This is especially likely where the employer does not reserve any recourse upon the payment made to the employee other than the corresponding reduction in the employee’s paycheck. On the other hand, if an employer cannot simply reduce the amount of an employee’s paycheck because payroll processing has already begun, there may be a need for a mechanism for the consumer to repay the funds after they are deposited in the consumer’s account.

The Bureau has decided in 12 C.F.R. § 1041.3(d)(7) to exclude such wage advance programs – to the extent they constitute credit – from coverage under the rule if they meet certain additional conditions. The Bureau notes that the payment of accrued wages on a periodic basis, such as bi-weekly or monthly, “appears to be largely driven by efficiency concerns with payroll processing and employers’ cash management.” In addition, the Bureau believes that the kinds of risks and harms that underlie many of the new requirements in the rule “may not be present where these types of innovative financial products are subject to appropriate safeguards.” The Bureau has concluded that “new and innovative financial products that meet these conditions will tend not to produce the kinds of risks and harms that the Bureau’s final rule is seeking to address with respect to covered loans.”

This accommodation may be an attempt to foster and support innovation in the industry that poses little to no consumer risk. The Bureau states that it has “consistently expressed interest in encouraging more experimentation in this space,” but also cautions that “nothing prevents [it] from reconsidering these assumptions in a future rulemaking if there is evidence that such products are harming consumers.” The Bureau made changes in the rule in response to comments it received. In particular, the Bureau’s changes appear to be supportive of certain promising innovations, including innovative income-smoothing and financial management products and services. It is reasonable to expect the regulators to make additional accommodations for fintech-related products and services in the future, assuming that there are appropriate safeguards and consumer protections put in place.

For a more detailed summary of the rule along with additional takeaways, please click here.

Posted on Wednesday, October 4 2017 at 9:00 am by
6 Key Takeaways: FinTech and Financial Institutions — The Next Generation Strategy

Kilpatrick Townsend’s Michelle Tyde recently spoke at the 2017 President & CEO Georgia Bankers Conference on the topic of “FinTech and Financial Institutions — The Next Generation Strategy.”

Key takeaways from that presentation include:

  • The digital revolution has impacted virtually every area of business – telecommunications, logistics, travel, and retail. In the financial services industry, technology driven FinTech companies are transforming the way customers access and manage their money.
  • While financial institutions have been risk adverse since the 2008 financial crisis, focusing on regulatory and compliance issues, FinTechs have innovated the industry offering enhanced products and services in areas such as payments and lending, to emerging areas including robo-advisory and blockchain systems. According to PWC, more than 20% of financial services business is at risk to FinTechs by 2020.
  • Given the proliferation and impact of FinTechs on the industry, financial institutions can no longer afford to ignore the disruption caused by FinTechs. They must implement a strategy to adapt to and benefit from the FinTech-fueled changes to industry.
  • Both parties bring significant strengths to the table. Financial institutions manage risk and are optimized for security and regulatory compliance. FinTechs are agile and innovative. A partnership between financial institutions and FinTechs can maximum the parties’ strengths and assets. Hence, collaboration, FinTegration, is a necessary strategy for financial institutions in the FinTech era.
  • In collaborating with FinTechs, financial institutions must implement a new digital business model which focuses on self-directed services, customer experience, data analytics, and cybersecurity. Financial institutions can leverage a number of FinTech solutions including cloud services, APIs, and data analytics.
  • Outside counsel can assist financial institutions in structuring a collaborative partnership with FinTechs that maximums the benefits of technological innovations while minimizing the associated compliance and cybersecurity risks.