Policymakers struggle to keep up with the rapid pace oftechnology innovation. There are new business models that couldmake it easier and cheaper to meet the financial goals that can behampered by outdated regulations, according to a report by theInformation Technology and Innovation Foundation.

Information technology innovation has allowed financialorganizations to score easy wins to improve labor productivity,like automating data gathering and reducing the burden on creditunion tellers. However, “the next wave of IT-basedfinancial-services productivity will depend on significantlydifferent business and service models,” most notably by supplantingfirms that acted as intermediaries between the consumer and theservice provider.

“Fintech is poised to radically improve how consumers andbusinesses transfer money, make payments, save and invest, borrow,and insure themselves against risk,” Daniel Castro, ITIF vicepresident and co-author of the report, said. “These companies areexperimenting with new business models that improve quality, reducecosts and expand access to financial services for people who havebeen underserved in the past.”

However, compared to other information industries, “technologyhas enabled only incremental changes in financial services up untilnow,” he said. “The industry is poised to take a moretransformative leap. But in order to achieve that, the industrywill need buy in from policymakers.”

Fintech companies face a wide range of regulatory bodies andrules including banking laws, consumer protection disclosurerequirements, prohibitions on unfair, deceptive or abusivepractices, and anti-money-laundering rules. Companies that operateinternationally are subject to each country's financialregulations, as well as rules that force them to store citizens'data within that country.

Data localization makes it difficult, if not impossible forfintech to process data, according to the report, and does littleto protect customers' privacy. Instead, ITIF asserts that datalocalization policies are the result of “misguided self-interest:By creating rules that advantage domestic firms over foreign firms,many countries believe they will build a stronger domestic techindustry or gain short-term economic value, such as jobs indomestic data centers.”

Finally, the process of getting a rule passed in the UnitedStates is itself too slow, as regulators have to propose a rule,allow for public comment and review those comments before issuing afinal rule.

“These rules are often decided without regulators receivingreal-world feedback about regulatory effects, and once decided,rules are rarely revisited. As one regulator explains, this processincreases the pressure for regulators to get the rules right thefirst time to avoid 'protracted litigation over authority,' whichfurther increases the time it takes to implement them,” the authorswrote.

ITIF recommended 10 principles policymakers should consider asthey develop fintech regulations.

1. Support fintech transformation. Governmentsthemselves should be early adopters of fintech to promote broaderadoption, for example, allowing citizens to pay taxes and purchasehunting and fishing licenses on the same online platform, thereport suggested.

Governments can also look to fintech solutions to improvereporting and data management. ITIF pointed to Estonia, whichadopted blockchains earlier this year to secure patient healthrecords.

Critically, governments should fund research and development forfintech solutions, including those to address cybersecurity.“Government investment in R&D played a key role in developingvarious technologies, such as smartphones and the internet,”according to the report. “Because early-phase technology researchoften proves concepts rather than creates commercially viableproducts and can exhibit significant spillovers, firms are likelyto underinvest.”

2. Ensure regulations encourage innovation.Policymakers need to “draw clear boundaries and set priorities” forinnovations that warrant a greater level of scrutiny, ITIF wrote.“The goal of this prioritization is to signal to the market that acompany is not necessarily going to be subject to regulations justbecause it is tangentially related to fintech.”

3. Eliminate redundant regulations. Consumerdisclosure and anti-money laundering are two areas where fintechfirms may find themselves responding to multiple regulators. “Wherethere is a lot of overlap, policymakers should strive to coordinateand centralize these activities to streamline the process andreduce the regulatory burden on fintech companies.”

4. Regulate fintech at the national level. ITIFcalled for states to defer to national regulators regardingfintech, or to collaborate on a single approach.

5. Create incentives for fintech companies to protectconsumers. Regulators can go too far and punish companiesacting in good faith, the report noted, which could limitinnovation if organizations spend more time and money on compliancethan development. “To maximize its effectiveness and minimize anynegative effects, any agency action should create a system ofincentives that promotes desirable behavior and discouragesundesirable behavior in a marketplace.”

Furthermore, regulators should consider whether a company actedintentionally or negligently in wrongdoing and whether customerswere actually harmed before issuing enforcements, according to thereport.

6. Create tech-neutral rules. Rules shouldn'tfavor one type of application more or less than another. “Forexample, virtual currency businesses often function similarly tomobile payment businesses and transfer services. Each of thesetypes of businesses should function under similar rules,” accordingto the report.

7. Encourage a level playing field between incumbentsand new entrants. Credit unions are held to rules thatstartups can avoid, the report claimed. Similar to rules that aretech-neutral, regulations should police companies that offercomparable products and services, regardless of their size or age,by similar rules.

8. Promote cybersecurity in fintech. Ratherthan setting prescriptive standards, ITIF recommended regulatorscreate incentives for firms to improve their cybersecuritypolicies.

9. Support standards development and financial datainteroperability. ITIF encouraged governments and theprivate sector to work together to standardize data that is sharedand harmonize definitions.

“Though industry should lead standards development andharmonization, national governments can bring together disparatemarket players across different financial services industries,standards bodies, and encourage and promote interoperability acrossdifferent types of financial data,” according to the report.

10. Promote harmonization of internationalregulations. Harmonization should also occur betweendifferent countries, ITIF wrote. Digital currencies and onlinemarketplaces have already lowered barriers to trade between globalusers. Regulations regarding routing transactions, transparency,anti-money laundering, regulatory compliance and access to data forlaw enforcement should follow, according to the report.