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3 Possible Worms in the Fintech Apple

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A law professor is encouraging policymakers in Washington to take a skeptical approach to evaluating regulatory proposals from supporters of insurance technology systems and other financial technology systems.

Insurtech systems and other fintech systems can promote competition in financial services and create new financial services options for consumers, Frank Pasquale testified earlier this week, at a fintech hearing organized by the Senate Banking, Housing and Urban Affairs Committee.

Fintech can also create new problems, Pasquale testified, according to a written version of his testimony posted on the committee website.

(Related: Lawmaker Fears Unfair Fintech Biz Lending Practices

The committee has posted a video recording of the hearing and copies of the written versions of the witnesses’ testimony here.

Here’s a look at three of the possible fintech concerns Pasquale discussed at the hearing.

1. Claims that fintech algorithms are too complex to regulate.

Pasquale said some fintech companies use proprietary “algorithms,” or rule sets, and data sources to make decisions affecting consumers’ finances, without giving the consumers or regulators ready access to either the algorithms or the data.

In some cases, he said, the fintech companies say the algorithms are too complicated for regulators to regulate, or even to understand.

He cited recent press reports that some health insurers have thought about using publicly available photos of faces to assess applicants’ health.

“Regulators need to be able to audit machine learning processes to understand, at a minimum, whether suspect sources of data like these are influencing fintech firms,” Pasquale said.

Pasquale also warned against accepting statements that fintech machine learning processes are beyond the scope of human understanding.

Even if a machine learning process is complex, “we may still want to know what data was fed into the computational process,” he said.

2. Claims that private data is already readily available from commercial sources.

Commercial companies already do sell lists of impulse buyers, people with sexually transmitted diseases and people with Alzheimer’s disease, but that does not mean regulators should be quick to let fintech companies use those commercial data sources in financial decisionmaking processes, Pasquale said.

The commercial lists are often inaccurate, and consumers may have little ability to check or correct the information given, Pasquale said.

Even when the information is accurate, letting some of the information, such as whether an individual has been a victim of a crime, should not necessarily be in the hands of fintech companies, Pasquale said.

3. Claims that concepts such as blockchain technology will “change everything” quickly.

Some enthusiasts are speculating about the use of “futuristic fintech,” such as contracts based on blockchain technology, or “smart contracts that enforce themselves,” to revolutionize financial processing, Pasquale said.

In some cases, Pasquale said, the technology may eventually live up to the hype.

In the short term, futuristic systems could suffer from technology failures, hacking, and conflicts between what users think systems will do and what the systems actually do, Pasquale said.

In the area of smart contracts, for example, “there are many contractual relationships that are too complex and variable, and require too much human judgment, to be reliably coded into software,” Pasquale said. “Code may reflect and in large part implement what the parties intended, but should not itself serve as the contract or business agreement among them.”

— Read Banks vs. Disruptors: Who Will Win? on ThinkAdvisor.

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