Back to General Resources

HFSC Hearing: Fostering Financial Innovation: How Agencies Can Leverage Technology to Shape the Future of Financial Services

House Committee on Financial Services
Subcommittee on Digital Assets, Financial Technology, and Inclusion
Fostering Financial Innovation: How Agencies Can Leverage Technology to Shape the Future of Financial Services
Tuesday, December 5, 2023

Topline

  • Members from both parties questioned regulators on their agencies use of Artificial Intelligence.
  • Democrats discussed illicit activity in the cryptocurrency ecosystem and pressed regulators on their response to the risks posed by crypto.

Witnesses

  • Valerie A. Szczepanik, Director of the Strategic Hub for Innovation and Financial Technology (FinHub), Securities and Exchange Commission
  • Donna Murphy, Acting Deputy Comptroller for the Office of Financial Technology and Deputy Comptroller for Compliance Risk Policy, Office of the Comptroller of the Currency
  • Mark Mulholland, Deputy Chief Information Officer for Management, FDIC
  • Ann Epstein, Assistant Director of the Office of Competition and Innovation, Consumer Financial Protection Bureau
  • Charles Vice, Director of Financial Technology and Access, National Credit Union Administration
  • Michael S. Gibson, Director of Division of Supervision and Regulation, Federal Reserve

Opening Statements

Subcommittee Chair French Hill (R-Ark.)

In his opening statement, Hill explained that innovation has always been at the heart of financial services, noting the long history of advancement in the fintech space. He warned that government agencies have the ability to stop innovation dead in its tracks and named the many ways that Congress has checked agency power to help foster innovation. Hill also referenced a recent GAO report that found agency innovation processes to be lacking. Hill discussed the Federal Reserve’s August announcement of its Novel Activity Supervision Program for enhanced supervision on new activities related to fintech and digital assets. He also noted that while the NCUA established its Office of Financial Technology and Access in January, it has yet to establish a workforce planning process to ensure the staff have the knowledge and skills necessary to carry out its mission. He also mentioned the CFPB’s Office of Innovation which was established in 2018 to encourage consumer friendly innovation but was replaced in 2022 by the Office of Competition and Innovation which discontinued the agencies previously two most innovation forward policies. Hill lamented that the OCC dissolved its Office of Innovation into the Office of Financial Technology and concluded that oversight is needed. Hill closed by saying he looks forward to the discussion at the hearing.

Subcommittee Ranking Member Stephen Lynch (D-Mass.)

In his opening statement, Lynch noted that under the Trump Administration, several regulators established Offices of Innovation to purportedly encourage innovation. He explained that some of these offices were simply a vehicle for lowering regulatory standards, and recounted how agencies issued rules that received pushback from consumer advocates and were the subject of litigation initiated by state regulators. Lynch cited the example of the CFPB issuing no action letters that were criticized for protecting individual companies from enforcement actions when they broke the law. He also cited the OCC attempts to issue fintech charters, which would have allowed non-bank fintech companies to operate like a bank without being subject to comprehensive oversight.

Lynch said Americans should want our regulators to police bad actors so innovative companies can have a level playing field. He explained that under the current Administration, regulators have transitioned their Offices of Innovation to focus greater attention on market monitoring, competition, and integrating innovation into existing regulatory functions. Lynch applauded the way the regulators have cautioned against the risk of digital assets, before concluding that innovation does not need to come solely from the private sector and calling for the encouragement of government agencies to innovate and improve financial access.

Full Committee Chairman Patrick McHenry (R-N.C.)

In his opening statement, McHenry expressed his increasing concerns that agency innovation offices are not operating as intended. He warned that these offices should not be used to smother innovation and concluded that the Biden Administration cannot continue to regulate by enforcement.

Testimony

Valerie A. Szczepanik, Director of the Strategic Hub for Innovation and Financial Technology (FinHub), Securities and Exchange Commission

In her testimony, Szczepanik explained that FinHub utilizes and augments the SEC’s expertise concerning cutting-edge technologies and innovation, which foreshadows the future direction of the financial industry. She added that FinHub helps coordinate the agency’s oversight of, and responses to, emerging financial technologies across numerous areas, including distributed ledger technology and digital assets, automated investment advice, digital marketplace financing, and artificial intelligence/machine learning. Szczepanik listed FinHub’s three major functions: serving as an external resource, as an internal resource, and as a domestic and international liaison for engagement.

Szczepanik explained that FinHub’s goal is to promote investor confidence and integrity in the market as the market incorporates financial innovation. She said she is eager to see new beneficial technologies succeed and emphasized that FinHub does not view new technologies as inconsistent with the SEC’s core mission of protecting investors; maintaining fair, orderly and efficient markets; and facilitating capital formation. She concluded that industry participants and others who take the time and effort to engage with the SEC staff, and with the staff of fellow regulatory agencies, play a critical role in shaping the future of Fintech.

Donna Murphy, Acting Deputy Comptroller for the Office of Financial Technology and Deputy Comptroller for Compliance Risk Policy, Office of the Comptroller of the Currency

In her testimony, Murphy noted that in 2016, the OCC became the first federal banking agency to establish a dedicated Office of Innovation. She explained that in October 2022, the OCC announced that it would build upon this successful work by creating the Office of Financial Technology, which incorporates the Office of Innovation, and focuses on ensuring that the OCC remains a leader in supporting responsible financial technology innovation and providing high-quality supervision of banks’ financial technology implementation and bank-fintech partnerships. Murphy noted the OCC’s current areas of focus include matters involving bank-fintech partnerships, AI, digital assets and tokenization, as well as other new and changing technologies and business models that affect OCC-supervised banks.

Murphy discussed how banks’ relationships with third parties, including fintech companies, continue to expand, while some OCC-supervised banks are partnering with non-bank fintech companies to expand their reach with respect to offering traditional bank products and services, such as deposit accounts, payments, and consumer lending. She explained that the use of third parties has significant potential benefits, while emphasizing that strong third-party risk management is essential to avoid harm to consumers or weakening of bank safety and soundness. Murphy also discussed the considerable and growing interest by the banking industry in a wide range of uses for AI, noting that the OCC remains focused on the potential risks of adverse outcomes if bank use of AI is not properly managed and controlled.

Murphy concluded that the financial industry’s attention in the digital asset space is shifting from crypto-assets to the tokenization of real-world assets and liabilities, and noted tokenization is driven by solving real-world settlement problems and shows promising potential for being developed in a safe, sound, and fair manner.

Mark Mulholland, Deputy Chief Information Officer for Management, FDIC

In his testimony, Mulholland explained that the FDIC recognizes that financial technology innovation in the banking sector offers important benefits, including enhanced operations, reduced costs, improved delivery of services, and greater financial inclusion. He noted that technology innovation also presents risks that financial institutions must manage, including consumer protection, privacy, and data risks. Mulholland said the FDIC is reviewing the President’s Executive Order on AI to establish appropriate governance to guide the use of AI across the agency and concluded that they will continue to focus on modernizing IT infrastructure, business applications, and practices to ensure FDIC organizations can support their core mission functions.

Ann Epstein, Assistant Director of the Office of Competition and Innovation, Consumer Financial Protection Bureau

In her testimony, Epstein discussed how many traditional financial services companies now see themselves as technology companies. She explained that newer technologies, like generative AI, are increasingly being used to market financial products and provide customer service, with potentially unexpected outcomes. Epstein noted that in October, the CFPB published a proposal for the Personal Financial Data Rights Rule, as required under Section 1033 of the Consumer Financial Protection Act.

She said the CFPB believes this rule, which would create new standards and norms for newer technologies that facilitate sharing consumer financial data, will create an environment in which new entrants can thrive, while simultaneously allowing consumers greater control and choice. Epstein added that the CFPB is also focused on ensuring that newer technologies, like AI, are used in ways that comply with existing law. She concluded that the Office of Competition and Innovation, and the CFPB as a whole, are focused on advancing a more sophisticated approach to competition and innovation.

Charles Vice, Director of Financial Technology and Access, National Credit Union Administration

In his testimony, Vice explained that the NCUA Office of Financial Technology and Access identifies barriers, challenges, and opportunities credit unions face in adopting and using technology to provide financial products and services to their members. He noted the NCUA Board recently adopted the financial innovation rule, which provides additional flexibility for federally insured credit unions to use advanced technologies and opportunities offered by the financial technology sector. Vice said the NCUA is committed to promoting effective and efficient uses of emerging technology, and mentioned several initiatives the agency has implemented, including a Virtual Examination Program and a Digital Asset Working Group.

Vice discussed the NCUA’s ongoing evaluation of digital identification technology and the NCUA’s ACCESS initiative which promotes financial inclusion using technology to achieve its goals. He cited the NCUA’s lack of supervisory examination authority over credit union service organizations and third-party vendors as a noteworthy vulnerability for the system. Vice concluded by promising that if Congress reauthorizes third-party vendor authority for the NCUA, the agency will adopt a program that prioritizes examinations based on the risks related to the National Credit Union Share Insurance Fund, safety and soundness, cybersecurity, consumer financial protection, and Bank Secrecy Act/Anti-Money Laundering compliance.

Michael S. Gibson, Director of Division of Supervision and Regulation, Federal Reserve

In his testimony, Gibson said the Fed’s approach to supervising and regulating innovation in banking is based on overarching principles, first of which is that activities that present fundamentally the same risks should be regulated in the same way, regardless of where or how the activity occurs or the terms used to describe the activity. He continued that the Federal Reserve has not taken and does not take a position on who banks can offer services to, so long as they remain within the confines of the law. Gibson added that the Fed has sought to be transparent about its expectations and approaches to novel activity supervision and regulation to provide a pathway for responsible innovation. He also acknowledged that the Fed must continue to learn, which is why they engage in regular outreach.

Gibson noted that banks are leveraging AI for a variety of applications, including fraud monitoring and customer service. He explained that while AI offers several benefits, it also poses risks, including data challenges, explainability, bias, cybersecurity, and consumer protection. Gibson said that given these risks, it is important that banks using AI are doing so in a safe, sound, and compliant manner, and noted Federal Reserve staff continue to work closely with other federal bank regulatory agencies to track and learn more about emerging practices regarding banks’ use of AI and related risk management. He concluded that innovation is not confined to the private sector, emphasizing that the Federal Reserve is focused on finding opportunities to use innovative technology to enhance its supervision of the banking industry.

Question & Answer

Artificial Intelligence & Digital ID

Rep. Frank Lucas (R-Okla.) asked Gibson to discuss how his office coordinates with other bank regulating agencies on AI and machine learning practices. Gibson said they engage with other regulators and agencies and take NIST’s standards and see how they apply in the banking industry.

Rep. Sean Casten (D-Ill.) asked how the SEC is currently using AI and if they are training data sets on AI. Szczepanik said the SEC is awaiting pending guidance from OMB about the internal use of AI. Casten then asked if the SEC is publicizing which datasets it is using to train AI. Szczepanik said that information was not public.

Casten cited reporting on private sector actors who are now using risk-thinking AI in anticipation of the SEC’s climate disclosure rule. He said it would be mutually beneficial for compliance if those models were using the same datasets that the SEC’s models are using. Szczepanik said the SEC’s internal use of AI will be guided by future guidance.

Rep. Bill Foster (D-Ill.) explained that deepfakes created with generative AI models make scammers more convincing and make it harder for financial institutions to verify the identities of their customers.  He noted that other countries have taken steps to provide citizens with a secure digital ID, biometrically synced to one’s smartphone, which allows individuals to remotely verify that they are who they say they are and defend themselves against deepfakes.

Foster asked Vice about the experience of credit unions who completed successful pilot tests of digital ID technology. Vice said digital ID reduces the time it takes to onboard. Foster also noted that several states currently issue mobile IDs attached to one’s smartphone and asked if the CFPB had received any requests from financial institutions regarding the use of mobile ID for identify verification and consumer finance. Epstein said she was not aware of any particular requests.

Cryptocurrency & CBDCs

Rep. Brad Sherman (D-Calif.) asked whether a loan secured by crypto is viewed as an unsecured loan. Murphy said regulators would have to look at the specifics of the loan, and noted there is very limited activity of that type in the national banking system. Sherman then asked whether banks make loans secured by crypto accounts. Murphy explained that in order to engage in that type of activity, banks would have to engage with their examiners. She added that she is not aware of a specific instance where the OCC has valued loans in that way.

Sherman asked Mulholland if any FDIC insured banks hold crypto as an asset on their balance sheet.

Mulholland noted the FDIC has issued guidance on this, and said he’d have to get back to Sherman.

Rep. Tom Emmer (R-Minn.) asked if FinHub had issued any guidance since Chair Gensler took office to clarify how the security laws apply to crypto. Szczepanik said FinHub’s role is to be a subject matter expert. Emmer replied that the answer is no.

Emmer asked Szczepanik if she did not consider Ether to be a security. Szczepanik said she can’t comment on a particular asset.

Rep. Maxine Waters (D-Calif.) asked how the SEC’s FinHub researches and evaluates illicit activity in the crypto system, and how FinHub assists the SEC in ensuring that bad actors in the crypto space are held accountable. Szczepanik said FinHub has the tools and technology to analyze trends in the digital asset market that may present harms to investors and markets and explained that FinHub passes that information along to their rulemaking colleagues.

Waters asked the witnesses if they had considered holding educational or special sessions on crypto with Members of Congress to discuss the problems and pitfalls that may occur. Waters suggested Members were advocating for cryptocurrency without knowing or understanding enough about it. Szczepanik said the SEC’s Office of Legislative Affairs would be happy to provide assistance.

Waters asked whether crypto companies are making huge contributions to Members of Congress. Szczepanik said she couldn’t comment on that.

Rep. Warren Davidson (R-Ohio) asked Gibson to provide an update on the Fed’s development of a U.S. central bank digital currency (CBDC). Gibson said the Fed is doing research on CBDC technologies, but emphasized that it’s just research at this point, not implementation.

Novel Activities Supervision Program

Hill asked Gibson how the Fed’s Novel Activities Supervision Program will foster innovation. Gibson explained that the goal is to ensure that the Fed’s examiners who are engaging with firms that are participating in novel activities have the expertise and training necessary to effectively supervise them, while understanding the benefits the firms are seeking and verifying that firms are managing the risks.

Lynch asked Gibson how the Fed is evaluating the risks of banks engaging in novel activities. Gibson: explained that when banks are dealing in new areas that pose novel risks, risks like Bank Secrecy Act / Anti-Money Laundering (BSA/AML) risks materialize.

Lynch noted many criminal operations seek to be paid in cryptocurrency, and asked Gibson if that reality guides the Fed’s approach to its Novel Activities Supervision Program. Gibson explained that banks are not holding those crypto assets, but they are dealing with crypto-related companies. He said the Fed has seen liquidity risks, and that crypto-related companies’ deposits have been unpredictable which create risks for banking organizations.

Lynch also asked how the Novel Activities Supervision Program evaluates novel technologies. Gibson said the Fed’s examiners are focused on the bank’s evaluation of the technology, and that they are more involved in ensuring compliance.

SEC’s Predictive Data Analytics Proposed Rule

Lucas asked Szczepanik about FinHub’s role in crafting the SEC’s proposed rule regarding the use of predictive data analytics used by broker dealers and investment advisers. She said FinHub acts as a subject matter expert and analyzes how certain applications work and what those risks are. She explained they provided expertise to staff working on the rulemaking.

Rep. Wiley Nickel (D-N.C.) expressed his concerns about the SEC’s proposed rule on predictive data analytics and the adverse effects it will have on innovation and retail investors. He explained that the proposal’s scope is extremely broad and warned that it will lead to higher costs. Nickel asked Szczepanik how involved FinHub was with the rule’s creation. Szczepanik said FinHub provided technical assistance to the staff who worked on the rule about emerging technologies.

 

 

For more information on this meeting, please click here.

For an archive of past SIFMA hearing coverage, please click here.