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March 19, 2012
Balancing payments risk management and regulation with innovation
Government must be careful not to overreact to, or stifle, new innovations that can greatly benefit the consumer and the American economy. Government should take advantage of marketplace solutions to issues where appropriate. To do this, and at the same time to be in a position to act appropriately, it is important for government to maintain expertise in electronic money and payments development, and to consider carefully major questions presented by these developments. (Excerpt from 1996 paper prepared by the Department of Treasury on emerging electronic money and banking innovations.)
This quote appeared in a presentation given last week by John Carlson, executive vice president at BITS, a nonprofit group that fosters communication around technology issues that affect the financial services industry. John used this quote to demonstrate that, even in 1996, the Treasury Department recognized the need to not over-regulate at a time when financial institutions were beginning to experiment with Internet banking.
In the presentation "Hardening Payments for the Next Generation," which he gave at the BAI Payments Connect conference, John stressed that we still have to exercise care as financial institutions continue to innovate. The industry must still consider how it will balance the benefits of innovation in payments with the need to manage changing risks and ensure that regulators keep up with the changes. John warned that, despite the myriad of new threats, the temptation to overreact to these with regulation and legislation may stifle payment innovations. He emphasized that, instead, payment stakeholders must collaborate and share information.
Following are a few other noteworthy points from the presentation.
Rise in fraud and security issues in payments
John noted that as more nonbanks enter the marketplace and new innovative alternative products are introduced, payments fraud is evolving alongside. We need to keep looking at emerging payment issues involved with EMV-enabled payments, for example, as well as mobile payments, cloud computing, and payments conducted via social media. At the same time that these products are entering the marketplace, fraud is evolving in new and unexpected ways. And as global crime rings increasingly engage in cross-border activities, for example, a rise in cyber-security threats will likely continue.
We are also seeing some conflicting trends in consumer trust of security issues, according to John. While many consumers respond conservatively in surveys on payments security, for example, consumers generally are becoming increasingly willing to share personal information with "friends" in social media sites like Facebook and LinkedIn. And while consumers are gradually warming up to alternative payments in the mobile channel, most fail to employ general protections such as mobile device password locks.
A challenging regulatory environment
John mentioned that U.S. financial institutions are subject to independent regulatory oversight by a host of federal and state agencies, but the regulatory environment for nonbanks is not well understood. This lack of clarity around the nonbanks results in unclear liability for financial institutions and their customers alike. Consumers are likely to go to financial institutions for error resolution because of trust and familiarity, even when the risk and liability belong to the nonbank partner.
Third-party risk will continue to be a significant concern going forward, said John, as banks recognize the economic benefits they can get from outsourcing. As a result, regulators will focus on banks' vendor management programs to ensure that banks exercise comprehensive due diligence when they engage with vendors, and that they continue to provide oversight of the vendor throughout the duration of the relationship.
John noted that while there is a great deal of discussion on regulation of the emerging mobile channel, it is likely that such regulatory guidance will be embedded in vendor oversight guidance, of which there have been many iterations over the years.
Trust is necessary element of a successful payment system
John's presentation concluded in saying that "trust is central to everything we do." Financial institutions and other stakeholders with access to payment data and personally identifiable information have a growing responsibility to protect that data as the risk grows for network and device compromise. With more personal information exposed via social media, we will need to consider incentives for stakeholders to safeguard information by banks and other competitors in the payments space. Furthermore, those nonbank competitors and outsourcing partners need to be held to similar business practice standards for security and safety and soundness.
By Cynthia Merritt, assistant director of the Retail Payments Risk Forum
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