Supervision must not hinder innovation, Fed governor asserts

Bank regulators need to create a supervisory environment that does not hinder integration of responsible innovation into the strategic direction a bank chooses, the Federal Reserve’s community bank representative said Thursday.

“Supervisors need to recognize and be thoughtful about how we might affect the way banks consider innovation,” Federal Reserve Board Gov. Michelle (“Miki”) Bowman told the “Fed Family” Luncheon at the Federal Reserve Bank of San Francisco. “Here at the Federal Reserve, I think it’s vital that we look closely at our work to make sure we are not hindering prudent innovation between community banks and fintech firms,” Bowman said. “We need to think about how our guidance sets expectations for the way banks should engage third parties. We should explore more effective ways to interact with banks, including through new types of outreach and education.”

Bowman told the group that she recognizes the need to ensure that the Fed’s guidance on outsourcing risk management reflects the business realities of all the banks the Fed supervises.

“For instance, regulators’ third-party risk management frameworks discuss particular types of contractual terms and, where appropriate, audit rights by a bank over its service providers,” she said. “However, when a community bank is in negotiations with large vendors, such as cloud service companies and core service providers, they may not be in a position to make demands. As the largest vendors grow even larger, this will get even harder for small banks.”

The Fed governor also asserted that compliance concerns can make it difficult for a community bank to work with small partners. “A small fintech firm may lack a traditional financial history, raising questions about how a bank can evaluate the fintech firm’s status in the industry, corporate history, or financial condition. It certainly can be difficult for a small bank’s staff to evaluate a wide range of potential technology vendors.”

Bowman said the Fed is working to understand (by communicating with banks and financials under its supervision) how the industry is “weighing questions relating to innovation and how bank regulators may or may not impact those considerations.”

“As a regulator, my priority will always be facilitating a banking system that is safe and sound and in which consumers are treated fairly,” she said. “But regulators also have to ask: How can our approach to supervision be modernized so that it supports responsible innovation by our supervised institutions?”

Community Banking in the Age of Innovation