How regulation fuels fintech innovation
The term ‘red tape’ has long since been something of a dirty word in business and it can be difficult to accept that we do rely on regulation to make the business world workable.
With each new iteration of payments regulation, like the introduction of PSD2, we see an onslaught of doom-mongering coverage on the harmful effects it will have upon the industry and its stakeholders, potentially causing friction in the payments process, for example. In the crypto industry, founded on fringe libertarian ideals of stateless personal sovereignty, we see a similar dynamic with the introduction of regulation that treats crypto like any other financial instrument met with howls of dismay.
This is odd, given that new regulation within fintech over the last 20 years has largely been positive, and has even paved the way towards new forms of businesses, such as regtech. Of course, regulations are never perfect, attested by PSD becoming PSD2, which in turn is soon to be replaced by PSD3, but they have helped keep us all on the straight and narrow. It’s true regulation increases complexity when compared to an impossible laisse-faire system, it does so on an even playing field – everyone operates on the same level of complexity.
Fintech regulations journey
Regulation is almost never universally popular, and it is far too common that we see companies trying to circumvent it. With that in mind, it’s helpful to remind ourselves of what happens when the sector is unregulated. A stark example is the 2008 financial crash, which happened, in large part, because of a lack of effective regulation. At the time, money could be lent to lenders who had no ability to pay it back (so-called ‘sub-prime’ mortgages) and banks could buy their debt for pennies on the dollar to effectively gamble on. When their bets inevitably failed, major institutions collapsed and others had to be bailed out for trillions of dollars.
The post-Dodd-Frank bull run
The US’s response was the Dodd-Frank act, with similar regulations elsewhere, which led to the second-longest bull-run in US history: 132 months, with an S&P return of 400.5%. If the recent pandemic had never taken hold, it’s probable that we would still be in that bull run. Did Dodd-Frank impede innovation? Of course not: the whole fintech industry as we know it was developed in a post-Dodds environment.
For all the calls to cut red tape, no fair-minded person would argue that the financial world should be entirely unregulated. It is more the case that people want fewer regulations, but those regulations that do exist need to be perfect. This is a near-impossible task, particularly when digital transformation has made finance exponentially more complex. A more realistic expectation is that effective regulation facilitates innovation for the betterment of the sector. On top of this, we should put paid it the notion that regulation stifles innovation – that is only true of poor regulation.
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An eagerness to let go of the reins by one government also doesn’t make much difference for companies working across national borders. PSD2 might be transnational, but now that the UK is out of the EU our companies will have to deal with different rules on both sides of the channel, and further afield these regulations multiply.
We also need to hope there are no economy-destroying scams on the scale of 2008 happening, and the zero-interest rate policies that were a key feature of that era’s recovery are beginning to wind down before they distort the economy too badly. As a result, we should have learned that regulations benefit everyone. However, as the introduction of crypto regulations showed, there are still those who don’t want to play by the rules, or any rules.
Regulation as a solution to complexity
The argument against regulations is that they exacerbate complexity, which introduces additional barriers of entry, greater operational costs, and stifles innovation. However, this is a superficial argument that ignores the opportunities it creates and discounts both the importance and advantages of protecting the consumer.
When every company in a given area is working from the same standards creates a fair and even playing field and drives demand for services that address any complexity created by regulation. Having strong, but well-targeted regulations pave the way for RegTech that can not only complexity directly for both the business and the consumer. Everybody wins.
For example, Anti-Money Laundering (AML) and Know Your Customer (KYC) regulation could increase complexity, but they also create the opportunity for greater automation. Open banking, introduced via PSD2, is another example of where regulatory changes created an entirely new section of the industry.
3DSecure: reducing fraud, enhancing consumer protection, creating more dependable revenue streams for business
One of the most widely used examples of this is 3DSecure: instead of putting the onus on each payments company and merchant to carry out SCA Authentication on card payments for themselves with their own systems, 3DSecure gives them a solution that can easily be plugged in – many smaller merchants won’t even need to think about PSD2 compliance because of how easy it’s become. But it’s not just reducing complexity – it helps manage fraud and reduces the likelihood of chargebacks, thereby protecting the customer and creating more dependable revenue streams for the business.
These are far from the only benefits. Regulations, done well, facilitate the basis for automation, increasing productivity. Individual regulations can be debated on their own merits, but the notion of regulation itself as a force for good has been proven time and time again to be a benefit to the fintech space and the world at large.
Scott Dawson is Head of Sales and Strategic Partnerships at DECTA
With over 20 years of experience within the payments industry, he was formerly Commercial Director at Neopay and has also held senior positions at PSI Holdings, Neteller and ClickandBuy
