The US Financial System: A Need for a More Adaptable Regulatory Architecture
The US is witnessing a significant shift in its financial landscape as technology continues to reshape the way we manage and move money. This evolution has allowed innovators to specialize in distinct areas of financial services, thereby disrupting traditionally monopolistic models. However, the existing regulatory framework has yet to catch up with these changes, potentially stifling innovation and risking the creation of an unnecessary binary divide in our financial system.
Time for a New Regulatory Approach
It is becoming increasingly evident that the current regulatory approach, which forces providers to choose between nonbank and bank status, is not conducive to fostering innovation. This binary choice, which often positions the insured depository institution as the preferred option, can potentially concentrate risk and stifle innovation. Moreover, this outdated approach threatens US leadership as global peers surge ahead with more flexible licensing models.
However, as Federal Reserve Board Governor Chris Waller recently emphasized, there is a way forward. What we need is a coherent framework that can accommodate the rapidly evolving financial landscape. This framework involves creating a ladder of licenses and charters, each tailored to specific activities and risks.
The Ladder of Licenses and Charters
This proposed system of licenses and charters would offer a range of advantages. For one, it would allow firms to choose the model that best aligns with their business needs. Regulators would benefit from clearer oversight, while consumers would enjoy the fruits of enhanced competition. Such a system would stimulate innovation and foster trust, ensuring a level playing field where no firm gains an unfair advantage.
To create this framework, policymakers must acknowledge three fundamental truths.
Recognizing the Evolution of Banking
Firstly, the business of banking is not static – new methods not based on taking insured deposits will be a central feature. Defining a “bank” too narrowly and forcing all services into the traditional insured depository institution model carries significant risks. It can limit innovation, competition, and access to financial services by blocking new approaches. It also risks over-concentrating risk and pushing institutions that don’t wish to take insured deposits outside of the bank regulatory perimeter.
Understanding the Role of Tailored Charters and Specialized Banks
Secondly, tailored charters and specialized banks should not be seen as deregulatory. Instead, they are strategic decisions based on the activities pursued by the entity. Firms seeking specialized charters are prepared to accept higher compliance costs and regulatory requirements for certain privileges, such as access to payment rails. This ensures activities are supervised under rules fit for purpose, providing stronger oversight and creating space for specialized players to innovate and compete.
Appreciating the Value of Charter Diversity
Thirdly, charter diversity strengthens the financial system. Just as biodiversity bolsters ecosystems, diversity in the financial sector makes it more robust. A financial system made up of varied institutions is less susceptible to shocks than one concentrated in a single model.
Conceptualizing a Ladder of Charters
Conceptualizing this proposed ladder of charters, the first rung would recognize technology firms and service providers. Clear third-party risk management and partnership requirements would support responsible innovation, competition, and consumer choice. The next rung would cover state-licensed lending and payments companies, which currently operate under clear regulatory structures but often lack consistent access to federal systems.
The following rungs would include a range of state and federal nondepository institutions — so-called Tier 2 and 3 banks — that can deliver core payments activities without taking insured deposits. The ladder would also consider different forms of insured depositories, such as industrial loan companies (ILCs), which can provide unique firms with banking services subject to essential safeguards.
Finally, regulators must open the door to novel technology-driven models for traditional insured depository institutions and increase de novo approvals. Embracing technology-driven banks is crucial as they offer alternatives to legacy banking approaches and can serve broader sets of Americans.
Conclusion
The stakes are high. Clinging to outdated paradigms yields a brittle system that concentrates risk and cedes ground to global competitors. In contrast, a ladder of licenses and charters offers a smarter path: one that matches oversight to activity, nurtures innovation and competition, and ensures resilience. Modernizing charters is not about deregulation, it is about building a system that is safer, more adaptive, and more competitive for the challenges of the 21st century.
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