Virtual Fireside Chat with Tracy Basinger and Kavita Jain

So I’ll start off with introductions before we get in the conversation. Our two speakers today, again, are Tracy Basinger and Kavita Jain. Tracy Basinger is the Executive Vice President and head of Financial Institution Supervision and Credit at the Federal Reserve Bank of San Francisco. In this capacity, she oversees bank supervision and regulation function for bank holding companies, state member banks, and foreign banking organizations throughout our 12th District. She also oversees the provision of liquidity to the payment system through the Fed’s discount window. Tracy began her career at the bank as an associate examiner and has since held a number of positions with increasing responsibility. This includes serving as a fed representative on the Basel Committee on banking supervision task force on fintech. And she’s also led the Federal Reserve System’s individual supervision initiative to research developments. Our other speaker is Kavita Jain. Kavita is a Deputy Associate Director in the Office of Innovation Policy at the Federal Reserve Board. In this role, she is responsible for coordinating the Federal Reserves regulatory response to emerging innovation opportunities and risks and banking. Prior to joining the board, Kavita was a Director in the Office of Financial Innovation at the Financial Industry Regulatory Authority, or FINRA, where she led several fintech initiatives, including including those related to blockchain, digital assets, reg tech, AI, data aggregation, and online capital raising. In addition, she has served in key positions in the offices of finance, strategy, and emerging regulatory issues at FINRA. Kavita was also named one of the leading women in fintech by Innovate Finance in 2019. So I’m going to just switch this over to our screens and I’ll just provide a couple opening remarks just to kind of set the stage and the context for our discussion today. So since the financial crisis in 2008, we’ve experienced a dramatic evolution in the fintech and banking space. We’ve seen tremendous innovations that have improved financial access for consumers, improved user experience, supported better risk management with new tools, and increase the digital presence of all types of financial services. COVID-19 has only enhanced that push to digital with more financial activity happening online today than ever before. And consumers and businesses are relying more on digital banking tools to save, borrow, pay and invest as well as to gain access to government relief measures. So today our conversation will really revolve around the innovation during change and a discussion of both new business models and relevant consequences. These innovations create both benefits and risks that can result in lasting impacts to our financial system, including the companies and communities within it. As Uncle Ben from “Spider-Man” would say, “With great power comes great responsibility.” So our goal as supervisors and regulators is to promote a safe and sound financial system, which includes being more engaged than ever on the dialogue around responsible, inclusive financial innovation. So to kick it off, I wanted to allow our speakers to talk a little bit about their respective groups and teams and how they’re engaging on digital innovation topics. So let’s start with you, Kavita.

Thank you, Mitchell. Thank you for the kind introduction. It’s such a pleasure to be here with you and Tracy to talk about innovation at the board. So the Federal Reserve Board is committed to facilitating responsible innovation while ensuring the safety and soundness of the financial system and protection of customers. I would say that our innovation strategy is based on a three-pronged approach, to engage, to collaborate, and to respond. With respect to industry engagement, I think that is a very important part of our innovation work. We meet with industry participants and other stakeholders on a regular basis, really, just to get a wide perspective on emerging innovation trends and what’s top of mind of the industry. And I should note that we meet not just with financial institutions. We also meet with fintechs. We meet with consumer advocates, academics, really just to get a broad view into innovation and its impact on our industry and consumers. And we do this through a variety of ways. So for example, hosting innovation office hours, like the one in this week virtually in San Francisco is one way of engaging with the industry. We held similar office hours in the planner earlier in the year, we’re hosting one in Cleveland, obviously had to pivot and move to a virtual format given the circumstances. But I will note that these types of engagements really are mutually beneficial and they provide a two-way learning opportunity. The second prong of our strategy is around collaboration. And this involves collaborating, not just internally within the ward, across various divisions, but also across the system. As we see a lot of innovation related, work’s been going on at the Reserve Bank, such as your team in San Francisco. We also collaborate extensively with our peer regulatory agencies with international standard setting bodies on innovation matters. And then finally the third prong is to respond. So just to close the loop in our discussions, the industry and our ongoing coordination and collaboration efforts, we hope to identify or learn key areas where the industry’s seeking clarity and in response, we can provide kind of the appropriate regulatory clarity to foster innovation.

Great, thanks, Kavita. So turning to you, Tracy, I’ll frame the question a little bit differently since you wear a lot of hats in your current role. You, in many ways, are the founder of our fintech group out here in the San Francisco Fed. Can you talk a little bit about why that came to be, why you started the group and what, if any, priorities have changed since then?

Yeah, sure. Happy to. Thanks, Mitchell. And thank you, Kavita, for joining us today. I’m looking forward to our discussion. So, if you think about five or six years ago, Mitchell, where early on in that sort of transition you were talking about in the proliferation of new fintech firms. And we were starting to hear more and more about fintech. And we finally asked ourselves, you know, is there something here and how should we be thinking about this? So in late 2015, we hosted a conference just to try and learn more. And we invited a wide range of stakeholders. At that time, you know, having fintech firms and bankers in the same conference was a bit challenging. The relationships between them all were quite different than they are today, but we’ve just, like I said, we really wanted to learn what was happening. And in particular, we were focused on the potential impact to consumers. Coming out of that conference, you know, our takeaway was that what was happening here was really significant and it had the potential to be transformational to the financial services system. And we believe that being located in San Francisco near the Silicon Valley where so many of these firms, particularly the consumer facing ones, were housed, that we had an opportunity to really engage in a different way to gain a better understanding and really help inform some of the policy discussions that we thought would need to take place. So that was sort of the impetus for us starting our team in 2016. And they really were focused initially on learning and engaging with the industry. And then we also jumped in early on and let some of the Fed’s initial work in fintech over the first couple of years. So like I mentioned, our team, they’re charged with internal and external engagement, sort of the key component of the external engagement is what we call our Fintech Navigate Program. That’s our local office hours program. And while that has moderated a little bit over the years in the early times of our team, we were taking meetings multiple days every week, sometimes multiple times in a day. So we felt like there was interest and hunger for this and that we were able to provide engagement with the industry. And while we were doing that, we were also participating in a lot of conferences speaking, or simply participating. And while we initially approached that engagement as about sort of being able to provide guidance to this industry, as things were evolving. We also learned early on that it was as much about us learning what’s happening in the industry as it was anything else, and that’s sort of how we have shaped things going forward, but this is really as much about us as regulators learning so that we make well informed decisions when we’re charged with that. We also have a big internal component. We host information sharing platforms, producing newsletters, produce a number of special reports on fintech related topics. And really one of the big things that we do is engagement with our supervisory teams, on participation on examinations, just as we’re gathering all this information, we really want to help translate that to how we supervise institutions and be able to collaborate through teams. So, you know, especially the goals of the team have remained the same over time. We’re focused on ensuring responsible innovation and helping ensure that our regulatory posture doesn’t in any way curtail responsible innovation. And, you know, somewhat of the focus has changed as new technologies emerge or has the industry has different engagement models, different partnership models, but the goals of the team remain the same.

Thank you, Tracy. And I do double down on that, that point you made about us really engaging in a two-way learning channel here because even these innovation hours have really been about not just fielding questions from our bankers and fintech companies, but also really learning as much as we can about some of the new technologies that are out there. So to kick off the discussion, I think the topic I want to start with is one that is, of course, on everyone’s mind. And that is COVID-19, and perhaps the innovation and the reaction to it. They say that, you know, necessity is the mother of invention. And so since the rise of COVID-19, there’s been an acceleration of change and innovation within our financial system to address the needs that are out there. So I’ll start with the first question, which is what are some of the innovations and related issues that either you have seen occur since the pandemic that have really stood out to you?

Yeah, I can start off with that. So you’re right. I mean, we’re definitely facing unprecedented times here and the current circumstances have significantly accelerated the use of digital banking, digital payments. Some reports I read claim that we have bolted five years forward in digital adoption in just a matter of a few weeks in the early months of COVID and digitization, really, we’re seeing this in, not just in banking, but in many other aspects of our life, right? Shopping, education, medicine, socializing. I mean, even just the fact that we’re hosting this chat in a digital format, I would say in that industry, from a retail consumer perspective, the biggest change we’ve seen is in two areas. One is where we’ve seen a large new segment of banking customers who are interacting with banks digitally now and who were not doing so before. So just let me offer you some stats to bring home that point. According to a recent J.D. Power Survey, 29% of survey respondents, so one in every three people who were surveyed, noted that they plan to continue to use online banking or that they are using and will continue to use online banking more than they did pre crisis. And then there was another report that said one out of every customers do not plan to ever return back to a branch office, even after it is safe to do so. The second area where I would say we’re seeing a significant shifts to digitization is in the digital payment space, not just with increase in online shopping, but also in areas like P2P payments or contact list payment options, where consumers are just more comfortable, or I should say where consumers are not comfortable with touching cash anymore. So this increase to is really welcome because it could potentially further innovation, but it’s also important to know that these developments bring with them increased risks, heightened risks in some areas like cybersecurity, online fraudulent transactions, operational resiliency, particularly where financial institutions may not be able to scale up and keep their efforts at pace with the rapid growth. So for example, you know, ratcheting up the cyber security operations, or scaling their operational infrastructure to meet the growing digital needs, or even just making sure that their employees who are now working remotely are trained to adequately address this change. So, you know, just offering kind of both sides of the acceleration and digitization that we’re seeing.

Yeah, I think that’s spot on, Kavita. And I think to your point, it’s creating both, it’s creating another set of challenges for financial institutions in the midst of a pandemic where customers are wanting to transition to digital channels and the banks are having to sort of accelerate those potential strategies while also managing the risks. You know, a couple other things I might highlight that we’ve seen during this pandemic. So we saw just last week, the first banking charter issued to a fully digital consumer bank. And we have other digital firms that are expressing interest in banking charters. So the pandemic seems to be playing a role in accelerating that early movement that was at a more measured pace to have entry into the banking system for these fintech related firms or digital firms. We’ve also seen the pandemic spur some partnerships and increase in how quickly these partnerships come together. And I’ll use the PPP, the SBA’s PPP loan program, as an example, where we saw a number of fintech firms move quickly to develop front ends, to help bankers deliver large volumes of PPP loans. And there were, like I said, a number of those that happened very quickly and enabled community banks, in some cases, to extend more of these loans than they otherwise would’ve been able to. And we’re seeing similar partnerships starting to develop as we move into the forgiveness space of this program. So I think we’re just lots and lots of evidence that the acceleration is going to continue and that we have sort of crossed the significant barrier to moving into digital banking services.

Great, yeah. Those are all great points. I think the other thing I wanted to bring up, and get your reactions are, is this topic of also equal access to financial credit? And of course this has popped up quite a bit during this crisis, even in government relief measure programs. So, while the pace of change has been impressive, I want to get a sense from the two of you, what does responsible financially inclusive innovation mean to you?

Yeah, I think that’s really important to talk about this today. ‘Cause we know that today’s financial system is not inclusive. We know that there are less branch offices and fewer services in low income and minority communities. The FDSC’s most recent survey of unbanked and underbanked households found that, while the number of those individuals are declining, one quarter of all households in the United States lack adequate banking services. And that number jumps all the way to 47% for black households. So almost half of all black households lack adequate banking services and then a recent New York Fed study called out the disproportionate impacts of the COVID on black-owned businesses. So we’re seeing it on both the retail and the commercial side. So as we move to digital delivery channels that are less reliant on physical branch location, I think it presents a great opportunity to reach underbanked and unbanked individuals. But I also think we need to consider other types of accessibility challenges that may present themselves with digital delivery systems that could in turn disproportionately impact individuals in low income or minority communities. I would encourage that we think about, you know, what types of device is the product or service available on? What does internet accessibility and bandwidth look like in these underserved communities? We’re seeing lots of issues today in marginalized communities where people don’t have the internet access or the computing resources they need to work or attend school remotely. And I just think it would be really unfortunate if these new services designed potentially to reach underserved areas actually exacerbated any existing disparities by providing some sort of digital service that was not widely accessible. So to circle back to your question, what does financial inclusive innovation look like? I mean, to me, it’s innovation that helps improve access to the banking industry and provide better tools to manage one’s financial life, regardless of who you are and where you live. And I believe it’s, that’s why it’s really important to understand the impact of any new product or delivery channel as we move into this direction. And I think it’s a great opportunity for service providers to engage regulators, to engage consumer community leaders and really ensure that you’re considering the full impact of any new product or services you want to deliver.

Yeah. And I mean, I think you hit the point, you know, spot on. I think this is really a great time for the industry to just pause and reflect and proactively think about not just how technology and innovation can be leveraged to facilitate financial inclusion, but also to think about whether there are current practices or technology-based solutions that may just inadvertently impede or obstruct inclusion.

Great, great points. So I do want to kind of transition to a slightly different topic. We’ve been talking about change that’s incurring really in the short term, I want to talk about a topic where change has been occurring, not just during COVID-19, but even before it, during the crisis, after the crisis, I should say, and this is this idea of bank and fintech partnerships and the vendor relationships and the ecosystem that’s out there. One of the analogies that I really like that I’ve seen out there is a comparison to this ecosystem, to the evolution in car manufacturing. And this idea that once upon a time car manufacturers were building cars from the bottom up with all parts included and over time that transitioned to more standardization around design. And so you had all these companies cropping up that were really specializing in specific types of car parts, like car seats and tires, for instance. And pretty soon you had car manufacturers outsourcing, were purchasing those parts from different vendors and then assembling that car. And presumably it was a higher performing, more cost-effective car, and so in the banking space, I think we’re seeing something similar where you’re seeing more and more service providers from fintechs that are providing very specialized solutions and tools for banks and then working in partnership with them. So the question I have to start off with, is what are some of the ways you think about the partnership and service provider models that are out there?

I like your analogy of car manufacturing to provision of banking services. You’re right, in the last 10 years post the 2008 financial crisis, we’ve really seen a confluence of several driving factors that has created this fintech revolution. So the mainstream adoption of digital mobile technologies, the availability of massive troves of beta, the emergence of cheap computing, and access to innovative technologies like AI. All of that come together and have led to this disruption, right? The industry’s creating new products and new services and rethinking of ways to make them available to consumers, which has created new business models, oftentimes offered by fintech companies. But I think the important point here is that ultimately in order to offer a banking service, whether it’s deposit taking or lending or payment, there needs to be a bank involved somewhere. So we’re seeing a proliferation of bank and fintech partnerships and the type of partnership and the role the banks may play varies. But I think to use your analogy, if a supply chain, the placement of the bank in the supply chain has also varied. Maybe I’ll just make a reference to a speech that was delivered by Governor Brainard a couple of years ago, and it still holds true. She talked about the different roles that banks are playing and what she referred to as a fintech stack. And she talked about how a bank could be at the bottom of the stack or at the top of the stack, depending on the partnership model. So in the model where the bank is at the bottom of the stack, essentially the fintech or the non-bank operates the front end of the customer facing interface. So an example of this is where banks offered the Bass Model of the banking as a service model. This is where some banks, and we’re seeing this, particularly with smaller community banks are offering its banking services via a third party fintech platform by the third party may then white label those services. So, the fintech platform really is the interface, the interface that the end consumer sees. This gives the banks really an opportunity to expand its market share. It gives it a new distribution platform and potentially the ability to reach a customer base that it may not have had access to otherwise. So it’s a great way for, again, particularly the smaller banks to tap into innovation. However, these types of relationships can also pose some new risks or some heightened risks and regulatory challenges as the bank’s relationship with the end customer now has an extra degree of separation. So that’s where the bank is at the bottom of this stack. Then on the other end of the spectrum, we are seeing financial institutions establish, partnerships where they remain at the top of this stack. So essentially with their offering innovative product and services directly to the end consumer, and then they at the backend, they partner with fintech to leverage the fintech’s innovation and technology. So it could be something like a data analytics tool or a data aggregation facility, whatever it may be, these types of partnerships have the potential to create more effective bank or efficient products and services for banks to kind of really expand. However, the downside here is that the banks that saves the touch models is that they need to put in a much higher level of investment, whether it’s in personnel or whether it’s in technology. So these are kind of the two ends of a partnership spec spectrum. And there are probably a variety of different types of partnerships somewhere along that spectrum that may involve two or three different types of intermediaries. And I just, I want to emphasize that bank fintech collaboration really is what we’re seeing is, has continued to promote advancement of our banking system, particularly for a smaller banking organization.

Yeah, I think, you know, Kavita, as I listen to you talk about all the different places where the banks are engaging in the stacks. I’m thinking about our third party risk management guidance and how you have to think about that differently and the different places in that, wherever they reside in the stack, but it really becomes sort of the key piece, the key consideration for banks as they’re engaging in these partnerships and really understanding in sort of the risks of engaging with any third party presents to them and their particular customer base or the customer base of the fintech firm. I mean, I think about any of the breakdowns that we’ve seen in these partnerships, they can almost always be traced back to problems with third party risks. Either the entities engaged didn’t fully understand them going in, or they just didn’t quite have the right controls in place to manage them. And oftentimes it’s related to the technology as well. Things are moving faster and they’re happening differently in these new digital partnerships. And so this guidance becomes even more important. And as we’ve worked with institutions on both sides of the fence here, there’s three particular areas that I think get a little bit challenging as you’re thinking about this. One is what does that initial due diligence look like for less established technology vendors? They’re different. They don’t have the same history. And how do you think about understanding the risks that a younger firm presents when you don’t have the length of time to assess their work in the industry? The other piece is, as you mentioned, Kavita, that there’s oftentimes many players in the stack, so there may be three, four, five, or six different third parties, if you will. And so how do you think about the due diligence on the subcontractors if your main relationship is with one firm, but they’re subcontracting on down the line and how far do you go to really understand what risk you’re taking on as a financial institution? And then the final piece we’re seeing more and more of this pop up, which is to what extent can banking institutions rely on third parties to do the due diligence of the vendors or the firms that banks want to collaborate with? And that’s requiring sort of us as regulators to think about things a little bit differently. ‘Cause oftentimes those third parties have a level of expertise that perhaps a bank wouldn’t have, and it can be a useful way to engage in the due diligence. So it sort of all comes back to understanding, needing to understand the range of risk and controls anytime you enter into one of these new partnerships. And here, again, I think the ones that we seen most successful are those where, in particular, the bank engages with the regulator early on often brings in the third parties that they’re engaging to meet with the regulators. And we all understand the risks as the program is being developed. And I guess another piece of information I’ll share is that every banker I’ve personally spoken to that has developed these relationships, whether it’s the backend or the front end, will tell me afterwards that they just initially completely underestimated what it takes to set up a successful partnership. So from that, I just can’t understand or overstate the need for really thinking this through and engaging your regulators along the way.

Yeah, great point. I mean, so as a fan of analogies, you know, the other one that I think about in this space is the example, the Boeing Dreamliner, which is a very famous case study out there where, you know, they were outsourcing so many of their parts to many different manufacturers to the point where the operational complexity of all was so high and they ended up building the plane, but over budget and not on time. And so it does sort of shift the emphasis from maybe some of the other risks that you traditionally have in insourcing these things to more operational type risks when you think about outsourcing. So all great points.

Yeah.

Yep, go ahead, Kavita.

I was just going to jump in. I totally agree. Third party risk management will continue to be the linchpin between the valuable innovation that’s provided by fintech firms, and the trust and stability that’s expected of a charted financial institution. And so this continues to be an area of focus for the Federal Reserve, particularly given kind of this increased reliance on third parties now, and then the changing and evolving nature of these relationships. So they’re traditionally, third party risk management was anchored in conducting due diligence of vendors that provided services to banks, right? So the flow of service was very one bilateral in one direction. Sorry, not bilateral, but in one direction. But the vendor was providing service to banks and some of these newer third party relationships, the banks, maybe the entity provider that’s providing the services. So financial institutions, I think may want to review their risk management and compliance frameworks to confirm that there, those frameworks are updated to reflect these emerging partnership models and the risks that they may pose. Another thing to emphasize is that a bank’s decision to partner with a fintech or a non-bank entity does not diminish the responsibility of the bank to ensure that all the banks activities are performed in compliance with the applicable rules, laws, rules, regulations, and it really, and Tracy, I hear your point about how difficult or how due diligence is changing as new types of vendors and new types of partnerships are being developed. But I think that the bank, the financial institution really bears the burden of ensuring that all the activities are performed in a safe and sound manner. And maybe I’ll just note, one final point on that, Mitch. Governor Bowman talked about this in her remarks earlier this year. She referenced work that the Federal Reserve is doing with the OCC and the FDIC to consider potential revisions to third party risk management guidance. I think in the speech, he also highlighted the importance of such partnerships for community banks and their ability to innovate. Our guidance today is risk-based and does allow for being adapted to the changing nature of third party relationships. But nevertheless, we’re continuing to evaluate what the changing landscape and we’re cognizant of potentially look, you know, we’re looking at our third party risk management guidance to see if any revisions maybe warranted to accommodate for this evolving landscape.

Great. I’m sure a lot of people are looking forward to that. Great. I’ll make one last point, ’cause this has been on my mind quite a bit and we can move on to the next topic. And you know, I come from the stress testing space and that’s a space where you focus a lot on financial risk and we’ve built up a lot of capital levels since the crisis. And you could debate what the right level of capital is these days, and there is a debate going on, but I think it’s, I think everyone would agree that we’re probably in a much better shape than we were, you know, before the crisis, before the previous crisis. But I think the next phase of topics that we probably have to focus and spend more time on is this idea of operational resilience. And, you know, I’m from Florida, grew up there, and there’s hurricanes that hit Florida all the time. And when I was growing up, my parents and I were probably not as responsible about thinking about hurricane risk and sort of hoping, and thankfully we never got hit directly by any major hurricanes, but you know, times have changed. And I was just reading last week that hurricane season is going to be more active than it’s ever been before. And you better believe my parents now have invested in shutters, are much more prepared than they’ve ever been before. And I think the game has sort of changed. And when I think about the connectedness of operational activities that are out there today in our financial system, the more that’s occurring, the more we’ve got to sort of find and invest in those shutters and think about, you know, what do we need to do to make sure that our financial system is resilient from that angle. So I did want to shift over to another topic, this one on artificial intelligence and machine learning. And I think this is another area that’s particularly been important during COVID-19. Before I get into questions, I did want to remind folks on the call that we are taking questions from Slido. So slido.com. And just as a reminder, the password there is SFFED0811, which is today’s date. So please feel free, if you’ve got some questions based on this conversation that you want us to address, go out there and submit those. So in the AIML space, Kavita, while at FINRA, you and team had actually released a paper on this topic specifically focused on the securities industry, but I am kind of curious, are there any key themes that you think about that carry over into the banking sector?

Yeah, Mitchell, I love the analogies, by the way. So I’m waiting for one on, I’m waiting to hear for one on AI and machine learning. Yeah, so you mentioned the paper that I coauthored while I was at FINRA, that was earlier this year. It really was a summary of the uses artificial intelligence in the securities industry and regulatory considerations and challenges that sort of, so broker dealer firms should bear in mind. So the report was focused on the securities industry, but to your point, I see a lot of perils regarding the use of AI in the securities industry and the banking industry. I think the first thing I would say is that there is no common definition of AI. So you ask 10 people to define AI, you’ll probably get 15 definitions. I just view it as a broad spectrum of technologies that look to, or that imitate, what would typically be considered as human cognitive behavior. The second thing I would say is there’s a lot of hype. In reality, the industry is cautiously exploring which use cases will reap the highest return with the lowest risks. So that being said, I would say two key areas where I’ve seen or heard from the industry talk about where there’s a lot of exploration around customer service and surveillance and fraud monitoring. So customer service essentially refers to things like chatbots, call centers, really ways that the technology can be used to enhance customer experience. So, you know, going as far out as the use of virtual assistants, like Alexa and Google Home and then surveillance and fraud monitoring, and I use this term broadly to really cover how the technology is being leveraged to monitor for financial crime, trading, even internal conduct monitoring. And the technology really allows for pulling in of data from a variety of sources, both internal and external, both structured and unstructured data to bring it all together, to look for anomalies or things that may stand out as suspicious. And then in the report, the second half of the report, we highlighted key challenges and areas of regulatory considerations. Again, that I think will apply probably just as much in the banking sector. So we talk about the importance of tech governance, really having a comprehensive tech governance framework to make sure that it’s reflected to, or updated to reflect the nature of these emerging technologies, like AI, to make sure that different players across the organization are brought at the table. So but, traditionally, it may just have been the business person and the IT person, we’re starting to see where firms are bringing together as part of the tech governance structure, legal, folks from compliance, audit, really just to get a broad perspective right from the get go. Another area that firms are really revisiting and enhancing and updating relates to model risk management, to really account for unique aspects of machine learning, such as explainability. And tied into that is the importance of data governance, right? So data is the foundation of any AI tool. So making sure that the data is valid, it’s robust, it’s accurate. And then, again, flowing from data, our concerns around customer privacy, how the data is being used, how the firms are ensuring that the privacy requirements are met from regulatory perspective. Obviously there’s potential reputational risks if data were to be compromised, but then also making sure that the appropriate customer consent is received where that data is being used. So this AI and machine learning is an area that the board is also giving some serious thought to. My team’s working really hard, trying to understand how the banking industry is using AI. We’ve heard anecdotally from the industry that there may be areas where the industry is seeking clarification as they explore machine learning tools. And so we’ve initiated an interagency outreach effort to just engage with the industry and hear directly from them, what areas of AI machine learning they could benefit from just getting additional guidance. So we’re going to continue with our learning in that area.

Great. I think this is a good pivot to Tracy actually, because you know, our team recently released a paper, Kaitlin Asrow did, on data rights and data privacy. And I think, Kavita, your paper calls data the lifeblood of AI, I believe. And so I think that’s a pretty good analogy there, but Tracy, so you’ve hosted, as well, a data symposium and you spent a lot of time thinking about these topics. Can you provide any perspectives you have on the role of data in financial services and its impact on consumers?

Yeah, no, I think Kaitlin laid the business case out for why we thought data was so important that we have spent the last couple of years really focused on the range of policy issues. And Kavita’s paper called it the lifeblood, I’ve heard it called the oil, that it’s sort of the engine that makes everything else happen. And that’s the reason we thought that really sort of trying to understand what the policy related issues are, is foundational to how you can think about everything else that flows from there, and like everything else, and I think Kavita touched on some of these, there’s both a wide range of potential benefits and then a number of risks as well. So, you know, some of the benefits are, you know, the way in which data is being used is really showing that it can improve the efficiency and the quality of financial services. It helps firms tailor those products to individual consumer needs, and it really has the potential to help improve the quality in financial services. So with those potential benefits, we’re also seeing that, you know, we’ve got vast amounts of data that’s often concentrated in a few locations that raises questions about potential systemic risk. And if you think about cyber risk being one of our top risks in banking today, and then you have large concentrations of data, that just sort of exacerbates that particular risk. And it’s causing us to have questions around where the regulatory parameters should lie, given the potential impact that this data is having on the financial system. If we don’t mention the privacy risks, those are being debated and legislated across the country and around the world with different jurisdictions taking different types of actions with regard to privacy. And then there’s the risk on how the data are used. Are they used for inclusive or exclusive purposes? Do they help provide services that improves one’s financial health versus exacerbating? And then the one that I think becomes the most challenging is their transparency and explainability in how the data are used. And so that’s the backdrop under which we decided to have our symposium last year and really focus on what was the role of the consumer in these data policy discussions. And I think you can see, it becomes, I like to refer to it as a multidimensional Rubik’s Cube, and you’ve got so many different issues that are often sort of like tugging at one another. You’ve got the issue of open banking and data portability, data privacy and consumer protection, cybersecurity, business liability is a big issue with the transmission of data. What opportunities does it provide for innovation or effectiveness of business models and all of these tensions exist and when you pull one lever, it often tugs on another. And so policymakers are really in a place where they’re trying to make, they’re having to make difficult trade off decisions. And our view was that the consumer’s perspective, perhaps, wasn’t always considered in some of these discussions ’cause there’s such a wide range of issues. So we were looking to really explore that aspect of it. And one of the things that we threw out there at the beginning is that, even when you look at the role of the consumer in this, their own actions are often at sort of conflict with what they want. And in some ways they say they want privacy, but then you look at their social media activity, or they want privacy but you look at all of the cool frictionless fintech services they signed up for that required them to give away their banking credentials. So even when you’re looking at what role the consumer should play, there’s inherent conflict in how they’re behaving. But we did come into this with the belief that the use of data in the consumer space should really help consumers improve their lives. And we wanted to better understand what roles are really effective for them in managing or controlling their data, what roles they want to have, and the implications of the different choices that are made for disadvantaged populations on perhaps the ability of financial institutions to evaluate and understand risks and financial services and any broader societal risks that are presented by some of the choices that are made here. Mitchell, you mentioned the paper that Kaitlin published earlier this year on the role of individuals in the data ecosystem. I would just double down on recommending that paper. I think that what she’s done is a really nice job of laying out the issues and the potential policy options, so that we can have further discussion and exploration here. I really liked the way she lays out the argument for reframing the conversation away from data rights and talk to data rights and away from data ownership while acknowledging that there’s all kinds of challenges and limitations when you think about individual consent in this complicated space. And I also really like how she highlights the really important distinction between enabling a consumer to manage their data and then expecting them to take action for their own protection. And so I really think that it’s well worth a read if you’re interested in this space. I also, you know, we’ve talked a little bit on some of these others, how this current health crisis is exacerbating some things. There’s a nice forward in the paper that speaks to the impact that COVID is having on this space and really sort of highlighting some of these policy issues and bringing them front and center. And the last comment I’ll make here is that to further this work, later this year we’ve been asked to cohost a Central Bank of the Future Conference in November of this year. We’re doing that with Michael Barra and Adrienne Harris from the University of Michigan’s Gerald R. Ford School of Public Policy. So we’re going to further explore some of these concepts around the role that data and innovation can play in financial inclusion.

Great, thank you, Tracy. I’m really looking forward to that conference. And I think you touched on something that even is a tension in my life, which is, I love data privacy, but also love my Google Maps to be free at the end of the day, right? So I did want to pause here ’cause we’ve got about 10 minutes left. I want to make sure we get to some of the questions that are out there. One question that popped up, and I think this relates to some of our conversation about data is, do you see increased interest in digital identity tech? It seems very necessary to enable online banking without fraud and or extremely high KYC AML costs.

So I can kick it off, Mitchell. So I think yes, to answer the question, there is definitely a lot of exploration going on in the digital identity space, right? So it starts, I think the conversation really goes, runs this spectrum of privacy and data rights to security and facilitating easy onboarding. So oftentimes, you know, I’ll use the analogy of when you go get a drink, you have to show your ID. And the ID shows information about who you are, where you live, what your birth date is, whether you’re an organ donor or not. And really all they need to know is whether you’re 21 or not, right? So you’re giving away a lot more information than really is needed. And then, so that’s one driver. The other driver is just to further facilitate customer onboarding and KYC. So in my conversations with the industry participants in this space over the last couple of years, there have been, there’s ongoing exploration, I would say, at least in the U.S., because it presents all these benefits, but it also presents some risks, right? So the first biggest risk is you create a central database with a PII. I mean, you’re really just creating a honeypot, right, for fraudsters. And it just, there’s just a huge risk of cyber test over there. The second risk is, so we’ve heard people, some industry players talk about potentially leveraging blockchain, where blockchain technology, where the owner of the identity retains the right to, you know, share the identity. And it’s really, the information is distributed, which could potentially work, but then you also have to think of other types of considerations, right? The considerations of operational resiliency of such a network. And again, we’ve seen these networks being exposed to cyber risks. So all that to say, yes, this is an idea, that it was gaining some traction, but I think that it’s long ways to go. In some underdeveloped countries where there is no existing system, they have rolled out digital identity efforts, Successful to a certain degree, but they too have encountered, you know, concerns and risks and issues with their digital identity platforms.

Yeah, that’s a great summary. I think it really illustrates that in some cases, the challenges in that space is less about the technology per se, but almost the coordination that you have between all the various sources of people’s identity. So I want to turn it over to a second question that was out there and, Tracy, this one might be good for you. As more fintechs are seeking entry to the banking system, what are some of the obstacles that they must first overcome?

Well, that’s a great question. And I think in some ways it’s no different for a fintech firm than from any non-banking firm that wants to get into the banking system. And I think the biggest hurdle usually is around the expectations around what the risk management infrastructure looks like, what the compliance infrastructure looks like in a banking organization, and they’re typically much higher. If you think about, you know, entities whose liabilities are ensured by the federal government, our expectation’s to protect those liabilities and for the entity to remain safe and sound are pretty high. So that’s usually a big hurdle that I think a lot of non-bank entities underestimate. There’s also what’s come up a number of times, I think with these fintech firms are the issues of ownership and control. Particularly if they still have venture backing in some way, shape, or form. Those have had a tendency to create some type of challenges as they look to get their ownership structure to a point where they would qualify for a particular banking charter. So I would highlight those two as the two most significant that come up when fintech firms are looking to enter the banking system.

Great, thanks, Tracy. So I do, there’s this other question here about any thoughts on decentralized finance, and maybe this is something that I can try to address here. So, I think this is a space that’s really exciting in many ways, because the way I kind of view it is what’s happening is that there are a lot of folks out there that are trying to, in many ways, recreate a financial system, but one that exists just purely digitally in some cases, based on smart contracts that are out there. The area that I always sort of advise people to think about is the history of financial innovation and the history of maybe some of the problems that they’re trying to solve. And I go back to thinking about just a few years ago, the whole conversation about Stablecoins and, you know, how can we create a global reserve currency, which some folks were working on. And I think there was a benefit to kind of exploring, well, what was the history of central banks in this case? And why do we exist in the first place? And I think there’s a lot of problems and a lot of experimentation that’s happened over the past hundred plus years on some of these things and certainly a lot of lessons that could be learned. And so I think instead of trying to recreate the wheel, in some cases, there’s probably some things that can be learned from those experiences. I think we’re also finding that a lot of the folks that work in this space, as you’re trying to sort of create this decentralized finance ecosystem, but then trying to get it to become mainstream and trying to fit it into our sort of regulatory, in some cases, political jurisdictions, it becomes something that looks a lot more like our traditional financial system. But again, it’s an area that I’m really excited to hear from folks because it’s great to hear from folks that are trying to build out some of this stuff that don’t come from traditional financial services backgrounds, ’cause there’s a lot of great ideas that can come out of that. So with that said, I think we’ve run out of time here. Just got three more minutes left. I don’t know if there’s any other last remarks, Kavita or Tracy, you’d like to make. I think there was a question out there about how do you even keep, personally, keep up with all the financial innovation that’s occurring?

I talk to my teenage son a lot. No, I mean, it’s a great question, especially with so much hype that’s out there, you know, and just so many different types of innovations that are just going on. I think for me, really, first and foremost, engaging with the industry and various players in the ecosystem really helps me kind of separate the wheat from the chaff. So events like these help me and you know, all of us, I guess, keep informed of what is top of mind of the industry. And then secondly, and Tracy, you can probably talk more to this. We tried to just gather ongoing intelligence from our supervisory and exam staff from across the system because they see things that are kind of front and center that are happening out there in the field. And then just personally, I just try to stay abreast of innovation and developments, not just in the banking industry, but more broadly in the financial services industry, in the healthcare space, in the tech world, because innovation really cuts through all industries.

Yeah, I think you’ve highlighted, Kavita, why it’s so challenging. I think one of the things that we learned early on when we formed our fintech team is that we could be attending a fintech conference sort of every day of the week, if we wanted to. I mean the amount of information that’s out there is just vast. And so it is challenging, but I think you’ve touched on key ones. For us it’s our engagement with the industry, it’s our engagement with our supervisors, are the two big ways internally, or inside the Fed. And then personally, the same as you. You try and stay engaged across a wide range of things. I also try personally to use a lot of the tools, just so that sort of, I have an understanding of how they work and I’m not the one who doesn’t understand it when it comes up in a conversation, whether it’s professional or personal. But it does present its own challenges. And to the point we were having about the risks that we’re taking, I think that, you know, every time I sign up for one of these services, I’m asking myself, is this really what I want to do in terms of the credentials that I’m giving up to participate?

Great. Well, I want to thank the two of you for being part of this conversation. And I also want to just quick shout out to the folks that really made this event come to life as well as the broader innovation hours. Tayeba Maktabi, Paul Tierno, Dan McGonagall, Jeff Ernst, Lynette Meister, Vivian, Sam. I know there’s a few others as well that have helped make this happen. So with that said, I want to thank everyone, the audience, for participating. Again, this conversation is recorded so we’ll probably make this available broadly. And I hope everyone has a great rest of the day.