Chairman Hill, Ranking Member Lynch, and members of the subcommittee, thank you for the opportunity to discuss supervision and regulation as it relates to innovation in the financial system.
The
However, innovation can also lead to risks, some of which are familiar and others more novel. The
Our approach to supervising and regulating innovation in banking is based on the following overarching principles. First, 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. If, in other words, a novel product or service raises the same risks as a traditional activity, it should be subject to the same regulation, even if it is based on new technology or described using different terminology.
Second, the
Third, we have sought to be transparent about our expectations and approaches to novel activity supervision and regulation to provide a pathway for responsible innovation. We articulate those expectations through a variety of channels, including guidance, statements, and other resources.
Finally, we recognize that we also must continue to learn, which is why we engage in regular outreach.
In keeping with these principles, the
As I noted previously, distributed ledger technology and crypto-asset-related activities are a focus of the novel activities supervision program. Distributed ledger technology offers the potential to increase efficiencies, lower costs, and increase access to financial products and services. Crypto-assets leverage the technology and are generally issued on open, public, decentralized networks. Both crypto-assets and the technology underlying them also present risks, including those related to governance and risk management of the network, and legal uncertainties around issues such as settlement finality and ownership rights. And crypto-assets' pseudonymous nature can create heightened illicit finance risks. As with all of their activities, banks engaging with the crypto-asset sector are expected to do so in a manner that is safe and sound. For example, banks with a high concentration in crypto-asset-related deposits may face heightened liquidity risks, given the significant volatility and interconnectedness in the sector, and should appropriately manage such risk.2
Beyond crypto-assets, some banks have expressed interest in more directly engaging in distributed ledger technology and tokenization of traditional assets, such as currency or securities, to expedite and automate payment, clearing, and settlement services.
Digital tokens that aim to maintain a stable value relative to a government-issued currency-often referred to as 'stablecoins' or 'dollar tokens'-have rightly garnered significant attention, given their implications for payments and financial stability. To provide clarity for banks interested in engaging with dollar tokens, we recently issued guidance on the process by which a
Novel banking activities involving complex partnerships between banks and technology-intensive third parties have also been an important area of focus. Third-party relationships can offer banks, particularly community banks, access to new technologies and innovation but can also introduce risks that need to be managed, such as, for example, operational risks and consumer compliance risks. As I mentioned, the novel activities supervision program will be helping to oversee complex technology-driven bank partnerships with nonbank financial technology companies.
The federal bank regulatory agencies have also recently issued guidance on third-party risk management, which lays out the agencies' supervisory expectations for all types of third-party relationships, including relationships with financial technology companies.4 In addition, the agencies have released a guide designed to assist community banks to assess risks in constructing and considering relationships with fintech companies.5
Another technology that holds potential is artificial intelligence (AI). Banks are leveraging AI for a variety of applications, such as fraud monitoring and customer service. While the technology offers several benefits, it also poses risks, including data challenges, explainability, bias, cybersecurity, and consumer protection. Given these risks, it is important that banks using AI are doing so in a safe, sound, and compliant manner.
Finally, it is important to note that innovation is not confined to the private sector. The
Conclusion
The
Thank you. I look forward to your questions.
1.Board of Governors of theFederal Reserve System , 'Creation of Novel Activities Supervision Program,' SR letter 23-7 (August 8, 2023 ). Return to text
2.Board of Governors of theFederal Reserve System ,Federal Deposit Insurance Corporation , andOffice of the Comptroller of the Currency , 'Joint Statement on Liquidity Risks to Banking Organizations Resulting from Crypto-Asset Market Vulnerabilities (PDF),' news release,February 23, 2023 . Return to text
3.Board of Governors of theFederal Reserve System , 'Supervisory Nonobjection Process for State MemberBanks Seeking to Engage in Certain Activities Involving Dollar Tokens (PDF),' SR letter 23-8 (August 8, 2023 ). Return to text
4. Interagency Guidance on Third-Party Relationships: Risk Management, 88 Fed. Reg. 37,920 (June 9, 2023 ), available at https://www.federalregister.gov/documents/2023/06/09/2023-12340/interagency-guidance-on-third-party-relationships-risk-management. Return to text
5.Board of Governors of theFederal Reserve System ,Federal Deposit Insurance Corporation , andOffice of the Comptroller of the Currency , 'Conducting Due Diligence on Financial Technology Firms: A Guide forCommunity Banks (PDF)' (October 2023 ). Return to text
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