The US Department of Treasury has posted the annual Financial Stability Oversight Council (FSOC) report and financial innovation is a prominent part of the document.
FSOC was established by the Dodd-Frank Act and is charged with three primary purposes:
- To identify risks to the financial stability of the United States that could arise from the material financial distress or failure, or ongoing activities, of large, interconnected bank holding companies or nonbank financial companies, or that could arise outside the financial services marketplace.
- To promote market discipline by eliminating expectations on the part of shareholders, creditors, and counterparties of such companies that the U.S. government will shield them from losses in the event of failure.
- To respond to emerging threats to the stability of the U.S. financial system.
Members of FSOC include the leading financial regulators in the US. The report was unanimously approved by the Council.
Of course, digital transformation in the financial services sector has picked up pace during the ongoing health crisis. Fintech innovation clearly offers benefits to consumers and businesses but risks always remain.
To quote the document:
“Financial innovation can offer substantial benefits to consumers and businesses by meeting unfulfilled or emerging needs or by reducing costs, but it may also create new risks and vulnerabilities. For example, there has been an increase in the number and type of digital assets with many increasing in value. Much like traditional assets, digital assets can also be subject to operational and counterparty risks that could prove disruptive to users and the digital asset ecosystem as a whole. In addition, financial firms’ rapid adoption of fintech innovations in recent years may increase operational risks associated with financial institutions’ use of third-party service providers; if critical services are outsourced, operational failures or faults at a key service provider could disrupt the activities of multiple financial institutions or financial markets.”
Regarding digital assets, FSOC recommends “responsible innovation” that complies with applicable laws. Clear guidance will support the development of a payment system something that is grown in importance given Europe’s draft framework for cryptoassets and stablecoins.
Digital assets are said to be a good example of innovation that is beneficial but holds potential risks.
“… if a stablecoin became widely adopted as a means of payment or store of value, disruptions to the stablecoin system, as with any payment or value system, could affect the financial system and the wider economy, warranting greater regulatory scrutiny. A decline in the value of assets involved in a traditional or new payment or value system can result in the transmission of risk to the financial sector through financial institution exposures, risks to the payment system involved, wealth effects and confidence effects. Risks to payment systems, if not properly managed, can present financial stability risks, given the importance of a well-functioning payments system in facilitating commercial activities.”
FSOC consistently recommends that federal and state regulators support responsible innovation by examining the benefits of, and potential risks to the financial system posed by innovation in financial services. This includes digital assets and distributed ledger technologies. Regulators are recommended to review existing and planned digital assets.
Overall, the Council voices its support for responsible financial innovation and competitiveness while promoting consistent regulatory approaches.
The FSOC Annual report is available below.
FSOC 2020 Annual Report