What are federal regulators doing with regard to oversight of emerging financial technology? That question is at the heart of a letter Sens. Sherrod Brown (D-Ohio) and Jeff Merkley (D-Ore.) recently sent to the leaders of the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation (FDIC), the Consumer Financial Protection Bureau (CFPB), the Office of the Comptroller of the Currency (OCC), and the National Credit Union Administration (NCUA).

What happened

Fintech firms have expanded their presence and products in the financial system in recent years, the lawmakers wrote, with offerings ranging from alternative payment systems to mobile payments to cash advance products, some with new structures and business models and others that largely resemble those of existing federally regulated firms.

While applauding the work of the financial regulators keeping an eye on the burgeoning industry so far, Sens. Brown and Merkley wondered what more could be done, asking about "the tools the regulators have to ensure effective oversight of fintech companies" in order for members of Congress to better understand their enforcement.

The diversity of business models found in fintech firms presents a challenge to regulation, the legislators noted, with research suggesting there are at least 4,000 fintech firms providing financial services (compared with 5,289 commercial banks with FDIC insurance).

"Some fintech companies have formed formal partnerships with financial institutions while others may interact with depository institutions less formally, such as through the payment system," according to the letter. "Some companies aim to form partnerships with small community banks and credit unions, while some small financial institutions have voiced concerns that they view fintech companies as competitors. Some fintech companies sell loans or securities to financial institutions."

Given this range, the Senators asked the regulators to share what each agency has done to study and understand the various types of fintech firms (such as marketplace lending, alternative payments, consumer lending, blockchain and distributed ledger, virtual currencies, personal finance management, robo-investing or saving, small business financing, merchant cash advances, education financing, crowdfunding, or invoice financing) and the agency's role in supervising or regulating the firms, including the possible considerations that should be given to nonbank companies to obtain a full or limited federal banking charter.

One possible avenue for regulating fintech firms could be via the regulation of third-party service providers, the lawmakers noted, as the agencies have issued guidance on the regulatory expectations for management of third-party relationships with enforcement power in place.

Recent events "raise questions" about the relationship between regulators, financial institutions, and third-party service providers, Sens. Brown and Merkley said, "specifically the policies and internal controls put in place to address possible risks associated with certain lending practices and transactions with financial institutions. Depository institutions were among the institutional investors that purchased loans from online marketplace lenders."

Details about the agencies' guidance and expectations for financial institutions that partner or otherwise engage with fintech companies were requested, as well as the factors considered by the agencies when determining whether and how to use their authority to examine and regulate third-party service providers and the steps being taken to ensure financial institutions understand the risks and benefits to partnering with or acquiring fintech companies. How often has each agency directly examined third-party service providers that are fintech companies, the Senators asked.

A third option raised additional questions for the lawmakers. If a fintech company is neither regulated directly by the agencies nor as a third-party service provider, "there are concerns that applicable federal consumer laws may not extend to consumers engaging with fintech companies, and that consumers or small business owners may not understand that protections provided by federal financial institutions do not apply to the products and services offered by these companies."

Further, the use of alternative data and proprietary algorithms to underwrite loans poses the potential for violations of fair lending laws and consumer protection statutes such as the Fair Credit Reporting Act, the letter added, not to mention issues with the portability of data. Equally at risk: small businesses, which may also be lacking protections.

To address these concerns, the Senators requested "a description of the direct and indirect authority that your agency has to supervise companies that make consumer and small business loans and advances; your views on alternative data to underwrite loans or advances, and the ability of your agency to enforce consumer protection and fair lending laws," among other questions.

Finally, Sens. Brown and Merkley asked the regulators to consider the global nature of fintech and the need for both interagency cooperation as well as international coordination. "While fintech may increase the availability of financial services across borders, there may also be complicated implications for international law," they wrote, asking what types of coordination and cooperation already exist both within the United States and internationally.

To read the letter from Sens. Brown and Merkley, click here.

Why it matters

Fintech oversight remains a hot topic, as demonstrated by the letter from the lawmakers, who expressed concern about the adequacy of the current patchwork of regulations, with some companies directly regulated by the agencies, others the subject of indirect oversight as a third-party service provider to a regulated entity, the potential for coverage by consumer protection laws, or—most troublingly for the Senators—nothing at all. As fintech continues to grow and evolve, legislative inquiries and concerns may expand pressure on regulatory agencies to craft more focused and direct rules which balance oversight and compliance against a desire to refrain from significantly impeding innovation.