Michael S Barr: Managing the promise and risk of financial innovation
Speech by Mr Michael S Barr, Vice Chair for Supervision of the Board of Governors of
the Federal Reserve System, at the DC Fintech Week, Washington DC, 12 October
2022.
* * *
Thank you, Chris, and thank you for the invitation to speak to you today about the
opportunities and risks of innovation. For the purposes of our discussion today, I will be
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focusing on financial innovation supported by new technologies, or fintech. In the fall
of 2017, we managed to get Chris to accept an invitation to speak at a fintech
conference in Ann Arbor, so it's about time that I returned the favor. Since then, we
have continued to see major changes in technologies and the financial services and
products they support. In looking over the materials for that conference, however, I'm
struck by how the key themes have remained constant over, not only the last five years,
but arguably for centuries. Financial innovation has always brought promise and risk,
and the urgent need to get regulation right. In 1610, when Dutch merchants and
bankers were otherwise busy creating global finance, a series of destabilizing bank runs
also moved them to establish a ban on short-selling. Many of the issues we grapple
with today are not as new as we think.
Supporting Innovation with Appropriate Regulation
First, let's start with the promise. Every day, we all have countless interactions with the
financial system-depositing our paychecks, buying groceries, paying rent, borrowing,
saving, and insuring against important risks. The promise of fintech is that it can make
financial products and services better, faster, cheaper, and more available. Financial
innovation supported by new technologies can disrupt traditional providers by spurring
competition, creating products that better meet customer needs, and extending the
reach of financial services and products to those typically underserved.
To realize the benefits of innovation, we need to manage relevant risks. We have seen
through history that excitement over innovative financial products can lead to a pace of
adoption that overwhelms our ability to assess and manage underlying vulnerabilities.
As we saw in the lead up to the Global Financial Crisis, innovative financial products
can mask emerging risks, resulting in significant harms to businesses and households
and ultimately undermining financial stability. These products can leave consumers
vulnerable if they are not coupled with meaningful disclosures and basic protections
against abusive practices. Innovation can lead to disruptions of existing markets, which
may be beneficial, but may also generate new systemic risks.
Guarding against these risks is one of the jobs of financial regulation and supervision,
and I'll talk through a few examples of how we are working to do so now. But I would
note with some humility that striking the right balance between creating an enabling
environment that supports innovation and managing related risks to businesses,
households, and the stability of the financial system is no easy task. When regulations
are too prescriptive or regulators too cautious, they run the risk of stifling innovation and
locking in the market power of dominant participants in ways that can raise costs and
limit access. When regulation is lax or behind the curve, it can facilitate risk-taking and
a race to the bottom that puts consumers, businesses, and the economy in danger and
discredits new products and services with consumers and investors. I believe everyone
has a stake in getting the regulatory balance right.
Striking the Right Balance for Crypto-Asset Activity
Crypto-assets have grown rapidly in the last several years, both in market capitalization
and in reach. But recent fissures in these markets have shown that some crypto-assets
are rife with risks, including fraud, theft, manipulation, and even exposure to
moneylaundering activities. Crypto-asset-related activity, both outside and inside supervised
banks, requires oversight that includes safeguards to ensure that crypto service
providers are subject to similar regulations as other financial services providers. We
continue to work on this issue from the overriding principle that the same type of activity
should be regulated in the same way. This principle holds even when the activity may
look different from the typical activities we regulate, or when it involves an exciting new
technology or a new way to provide traditional financial services.
The Board is working with our colleagues at the Office of the Comptroller of the
Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) to ensure that
crypto-asset-related activities banks may become involved in are well regulated and
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supervised, to protect both customers and the financial system. Many of these
activities pose novel risks, and it is important for banks to ensure that any
crypto-assetrelated activities they conduct are legally permissible and that banks have appropriate
measures in place to manage those risks. In August, the Board issued supervisory
guidance that outlines the steps Federal Reserve-supervised banks should take prior to
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engaging in crypto-asset-related activities.
The recent volatility in crypto markets has demonstrated the extent of centralization and
interconnectedness among crypto-asset companies, which contributes to amplified
stress. While banks were not directly exposed to losses from these events, these
episodes have highlighted potential risks for banking organizations. When a bank's
deposits are concentrated in deposits from the crypto-asset industry or from
cryptoasset companies that are highly interconnected or share similar risk profiles, banks may
experience deposit fluctuations that are correlated and closely linked to broader
developments in crypto-asset markets. In addition, misrepresentations regarding
deposit insurance by crypto-asset companies can cause customer confusion and lead
to increased withdrawals at banks providing deposit services to crypto-asset firms and
their customers during times of stress.
The Fed is working with the OCC and the FDIC on these issues and highlighting them
to supervised institutions. For example, it is important for banks to understand some of
the heightened liquidity risks they may face from certain types of deposits from
cryptoasset companies. This effort is not intended to discourage banks from providing access
to banking products and services to businesses associated with crypto-assets. Our
work in this area is focused on ensuring risks are appropriately managed. Looking
ahead, there are additional types of crypto-asset-related activities where the Fed may
need to provide guidance to the banking sector in the coming months and years.
Regulating Stablecoins
Because crypto-assets have proved to be so volatile, they are unlikely to grow into
money substitutes and become a viable means to pay for transactions. However,
stablecoins, which purport to maintain a stable value, have greater capacity to function
as privately issued money. For this reason, they pose specific, and well-understood
risks, similar to other types of money-like assets. History has shown that money-like
assets are subject to runs that can threaten financial stability. Stablecoins linked to the
dollar are of particular interest to the Federal Reserve. As Chair Powell said the other
day, a central bank is and will always be the main source of trust behind money.
Stablecoins borrow that trust, so we have an abiding interest in a strong federal
prudential framework for their use.
Over time, stablecoins could pose a risk to financial stability, and it is important to get
the regulatory framework right before they do. Here too, the Fed is working with other
regulatory agencies. The President's Working Group report on stablecoins that came
out about a year ago called upon Congress to take the necessary action to ensure that
stablecoins, particularly those that serve as a means of payment, are subject to
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prudential regulation. Congress should take action to provide a strong federal
framework for prudential oversight, and regulators must also use existing authorities.
Recognizing the Risks of Tokenizing Bank Liabilities
We are seeing banks explore a variety of different models to issue dollar-denominated
tokens on distributed ledger networks. The proposals range from issuance of tokens on
private, controlled networks to facilitate payments within or among banks, to proposals
that explore issuance of freely circulating tokens on open, permissionless networks. As
banks explore different options to tap into the potential of the technology, it is important
to identify and assess the novel risks inherent in those models and whether those risks
are surmountable. For instance, with some models that are being explored, the bank
may not be able to track who is holding its tokenized liability, or whether its token is
being used in risky or illegal activity. While there is work underway on technical
solutions for managing these risks, it remains an open question whether banks can
engage in such arrangements in a manner consistent with safe and sound banking and
in compliance with relevant law. Given these open questions, banks looking to
experiment with these new technologies should do so only in a controlled and limited
manner. As banks experiment, I invite them to engage with their regulators early and
often to discuss the benefits and risks of new use cases, ensuring they are consistent
with banking activities conducted in a safe, sound, and legally permissible manner.
Advancing Customer Autonomy
Let me mention an example of where I think regulators could play a more active role in
shaping how innovation is changing the financial products landscape. Over the past
decade, digitization of financial services has led to the creation of vast amounts of
customer data. Advancement in technologies now facilitates greater connectivity and
secure data sharing between banks and nonbanks. This has served as the foundation
for open banking and the development of new types of financial products and services
that offer consumers greater customization and an end-user experience with less
friction, compared to traditional banking.
Jurisdictions around the world have taken different approaches to open banking. Some,
such as Australia, Britain, and the European Union have adopted a regulatory approach
to facilitate open banking by implementing specific regulatory frameworks that are built
upon the concepts of consumer data rights, data privacy, and competition. So far, the
United States has taken more of a market-driven approach to open banking. The
Consumer Financial Protection Bureau is charged with implementing regulations to give
consumers access to their financial data, pursuant to Section 1033 of the Dodd-Frank
Act. While this is not an "open banking" rule, it will set the stage for consumers to gain
greater control when it comes to sharing their data with prospective providers. The goal
of this effort is to advance consumer autonomy, enhance competition for financial
services, and to provide easier portability of account information from bank to bank as
well as nonbank providers. I look forward to hearing more on this from the CFPB.
Providing Public Sector Support for Payment Innovation
So let me now turn to how the Federal Reserve is taking proactive steps to work with
the private sector to support innovation. The Federal Reserve has been working on
modernizing our payment system for a few years now, and we are in the final stages of
creating the FedNow Service, a new platform for digital payments that will safely,
efficiently, and instantaneously move money. FedNow will improve safeguards on
instant payments, making the financial system safer. And it will improve access to the
financial system by reducing payment delays and the high costs associated with those
delays. As I have discussed extensively in my writings and speeches, these costs are
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particularly borne by those least able to afford them.
Banks and service providers will be able to build innovative financial products using
FedNow's real-time, low cost, safe payment rails, benefiting households and
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businesses. We plan to launch FedNow between May and July next year. It will help to
lower costs, extend access, and improve security for consumers and safety for the
financial system.
No conversation about payments innovation is complete without mention of central
bank digital currencies (CBDC). The Federal Reserve has not made any decisions
about whether to issue a CBDC, and if we believe it makes sense to do so, we would
want the support of Congress and the Administration. In the meantime, we're doing the
work of understanding the technological requirements of such a system, deepening our
understanding of potential policy tradeoffs, and taking a look at how other countries are
thinking about and experimenting with CBDCs.
Let me end where I began: We need to get the guardrails right to successfully support a
dynamic marketplace of innovative financial products and services. We have a
responsibility to ensure that regulation and supervision foster innovations that improve
access to financial services, while at the same time safeguarding consumers, financial
institutions, and financial stability. Thank you.
I am grateful to Christine Graham, Laura Lipscomb, and John Maggs of the Federal
Reserve Board for their assistance in preparing this text. The views expressed here are
my own and do not necessarily reflect those of the Federal Reserve Board or the
Federal Open Market Committee.
2
Board of Governors of the Federal Reserve System, Federal Deposit Insurance
Corporation, and Office of the Comptroller of the Currency, "Joint Statement on Crypto-
Asset Policy Sprint Initiative and Next Steps," (PDF) joint press release, November 23,
2021.
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Board of Governors of the Federal Reserve System, SR Letter 22-6/CA-22-6:
Engagement in Crypto-Asset-Related Activities by Federal Reserve-Supervised
Banking Organizations, August 16, 2022.
4
See the President's Working Group on Financial Markets, Federal Deposit Insurance
Corporation, and Office of the Comptroller of the Currency, Report on Stablecoins (PDF)
(Washington: PWG, FDIC, and OCC, November 2021).
5
For example, see Michael S. Barr, No Slack: The Financial Lives of Low-Income
Americans
(Washington: Brookings Press, 2012).
6
Board of Governors of the Federal Reserve System, "Federal Reserve updates
FedNow Service timing to mid-2023, marks beginning of full-scale pilot testing," news
release, August 29, 2022.