Brian Knight
Associate Director, Financial Policy, Center for Financial Markets
Banking and Business and Capital Access and Capital Markets and Finance and Financial Innovations and FinTech and Global Economy and Job Creation and Public Policy and Regulation and U.S. Economy
Brian Knight is an attorney with significant experience in new sources of capital, financial technology, and entrepreneurial issues. He is interested in the interplay between technological, regulatory, and market innovation and how best to improve access to capital for businesses of all sizes.
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(Financial) Regulation Without Representation

By: Brian Knight
November 25, 2015

As Ian McKendry’s article in American Banker points out, this has prompted concerns that New York, given its importance to the banking industry, will de facto set the regulatory standard for the rest of the country. This concern is heightened by the fact that the proposed framework appears to be fairly proscriptive as to what banks must do, including requiring that banks create certain positions within their organizations and include certain security methods like multifactor identification in their contracts with venders.

The dynamic is one we see elsewhere, such as the DFS’ Bitlicense (the New York virtual currency licensing regime), or California’s unique auto emission standards. While we may not like to admit that not all states are created equal—for market purposes and situations where regulation of interstate markets are handled at both the state and federal level—some states are going to exercise outsized influence, effectively settingstandards for the rest of the country. It seems to me there are three potential problems posed by this: one democratic, one policy driven, and one economic.

The democratic problem is that market participants, both companies and customers, will be governed by rules they had no way to influence: “regulation without representation.” A bank of any size or ambition will likely need to be able to operate in New York, which means complying with DFS’ requirements, even if it isn’t headquartered or has its primary place of business there. Further, if you are a customer or partner of such a bank, even if you have no ties to New York, the requirements and costs of complying with New York regulation will affect you. Unlike federal regulation, where all states have two senators and proportional representation in the House of Representatives,* if you don’t live in New York you have no formal representation or way to exert control over the path or content of regulation that affects you. While New York’s control over how other states gain access to services may be market driven rather than de jure, it is still very real and may prevent people from being able to control, or at least democratically influence, the rules they live under. While, to its credit, New York’s DFS is seeking harmonization, if it or another influential state’s regulatory body wants to go against the grain of other regulators, its decisions may still govern the business of non-residents.

While such control may be a problem as a matter of political philosophy, it also creates the risk that if a powerful state creates bad policy, or if its policy becomes obsolete, it could hold back the industry nationally. The DFS proposal looks like it might trend toward being very proscriptive. If its requirements are ineffectual or become outdated, and the DFS doesn’t change (whether because it mistakenly believes its rules remain appropriate, or it spent resources on other issues) it could limit companies’ and consumers’ options on a national level. Further, while any one regulatory framework may make sense from a policy perspective, the cumulative and duplicative effects of multiple overlapping regimes may actually be self-defeating: market participants may end up bearing the expense of having to address the same issue multiple ways.

This cumulative regulation issue can also create an economic problem. Financial regulation is frequently a tradeoff between allowing market participants to operate relatively free to direct their resources toward providing services and building their business and limiting their behavior to protect customers. The cost benefit analysis for any one regulatory system may make sense, but companies forced by market concerns to comply with multiple overlapping regimes may find themselves, and their customers, bearing too many costs for too little benefit. At a minimum, this will create a loss that is likely to be passed on to consumers in the forms of higher prices or lower innovation, and may prevent entry into the market and competition.

This isn’t to say that regulation at the state level isn’t sometimes appropriate, especially in cases where unique state considerations exist and the “spillover” into other markets is limited—after all, considerable market power often goes hand-in-hand with expertise. Rather it means that we should be mindful of the costs of this regulatory dynamic—whether hybrid regulation is appropriate for emerging interstate markets, and whether the costs of regulation without representation justify consistent and exclusive federal standards.


 No regulatory regime is that onerous, and there may be significant convergence among regulations. But a company that has to comply with the rules of its home state, federal regulation, and the regulation of states with sufficient market power (or international regulations) has to bear a cumulative regulatory burden much higher than that imposed by any one regime.

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*The District of Columbia and various U.S. territories do not have voting representation in Congress.


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