Fintech Action Cools in U.S., Soars Elsewhere

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Looking back over the last year, it is apparent that the fintech industry has become mainstream just as fintech investing cools. What I mean by this is that fintech has matured in the last five years, going from something that was embryonic and disruptive to something that is now mainstream and real. You only have to look at firms like Venmo and Stripe to see the change. Or you only have to consider the fact that regulators are now fully awake to the change and have deployed sandboxes and innovation programs. Or that banks are actively discussing their fintech innovation and investment programs. Or that institutions are being created around fintech like Innovate Finance or the Singapore Fintech Festival. Fintech and innovation is here to stay.

For me, the biggest impact has been how busy 2016 has been. Each year is busy, but this year has been amazing. A great example is that I travelled to four continents in six days recently. That’s unprecedented and, a century ago, wouldn’t have been possible. Today, it’s easy. We just jump on and off aircraft and go. What is particularly intriguing for me—and telling—is where I go. After all, as someone at the center of fintech, where I go shows where the action is. In 2016, I’ve been to Singapore, New York and, most recently, London, which are the three fintech hubs for Asia, America and Europe, respectively. But I’ve also been to Nairobi, Hong Kong, Washington and Berlin, all key fintech focal points. Nascent centers in Abu Dhabi, Dubai, Bangkok, Kuala Lumpur also are on the radar. So, too, are are Mexico City, Sao Paolo and Mumbai.

In fact, what intrigues me the most is the fact that fintech has bubbled over in 2016. The latest figures show that U.S. investing in fintech slowed in 2016, while Chinese investments went up. And that is probably the most sobering thought as we head towards the holiday season. Fintech reached its zenith in the U.S. in 2016. Prosper and Lending Club started to have to answer some hefty questions about their operations, and there is no major new digital bank in the U.S. Meanwhile, Chinese fintech investments soared in 2016, and Ant Financial, which operates the Alipay payment platform for the Chinese Alipay Group, has become one of the most talked about IPOs of the year.

In other words, China, India and Africa are where we are beginning to see the most amazing transformations through technology with finance. China has more fintech buzz than anywhere at the moment thanks in large part because of Ant Financials’ innovations. India is doing amazing things with technology, and Africa has seen the rise of mobile financial inclusion that is changing the game for everyone.

The key here is to keep your eyes and ears open to change. Too often, I encounter people—senior banking people—who believe that developments in economies they see as historically poor being irrelevant. They don’t recognize that those historically poor economies are becoming presently wealthy and future rich. They are missing a trick.

In fact, I would go as far as to propose that the economies that were historically poor are the ones that are reinventing banking and finance through technology. They have no legacy and have no constraints, so they are rethinking everything. Eventually, their ideas will become things we all use so ignore them at your peril.

Happy New Year!

Is Trump Good for Fintech, or Bad?

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There has been an enormous sense of anticipation flooding through the community and regional banks since the election. President-elect Donald Trump’s opposition to the Dodd-Frank Act, which has created a stifling regulatory environment, is well known and bankers feel that relief is on the way. By contrast, the election results have produced a sense of consternation and concern among the financial technology companies that are trying to partner and compete with community and regional banks. The regulatory picture is much more confusing under a Trump Administration for these enterprises.

One reason for this is that fintech regulation was far from a settled issue before the election. The regulatory framework for fintech is not in place to any significant degree. In many cases, it will take new regulations to allow many of the fintech lenders and payment companies to expand their operations, and that’s a problem. Trump is opposed to new financial regulations of any sort, and it may be difficult to get the new framework in place during his term in office. Rather than pass new federal legislation, he is likely to leave the matter in the hands of the state legislatures and that will not benefit fintech companies.

The creation of a limited purpose national fintech charter as proposed by the Office of the Comptroller of the Currency is an attempt to make it easier for these companies to operate and not have to deal with regulatory agencies on a state-by-state basis. But in my opinion, there won’t be that many fintech companies that are willing and able to handle the responsibilities of a national charter, so this will provide limited relief to the industry. I also will not be shocked to see the concept of a limited purpose charter unwound early in a Trump Administration as bankers have been huge supporters of the incoming president and in my experience, the average bank is not shy about asking for favors.

Fintech firms are also big supporters of net neutrality since it gives them open and even access to bandwidth to offer services to users. Trump is not a supporter, and neither are the ranking members of the GOP in the Senate and the House of Representatives. Republican lawmakers have already put forth a bill to end net neutrality that I think will pass early in the next session of Congress and I expect Trump to sign it when it reaches his desk.

Immigration policies will also be a potential negative for fintech companies. Immigrants make up a significant percentage of the skilled workforce within the financial technology industry, and anything that makes to harder for them to get here and stay here is going to create a talent challenge for the companies in that space. Fintech companies that focus on payments could be hurt as well since many of the people that Trump wants to deport use these systems to send money to family back home, and that volume could drop substantially.

The biggest threat to fintech firms from the new administration will likely come from the repeal or reduction of Dodd-Frank. A lot of the opportunities that fintech companies are pursuing were created by the handcuffs placed on banks by that legislation. If the handcuffs come off under the Trump Administration, then fintech lenders and payment companies will find that they now have to go head to head with the likes of JP Morgan Chase & Co., Citigroup and Bank of America Corp., and that will be no easy task.

The regulatory environment for financial technology was murky before the election, and it is even more so today. While we can expect the combination of a Trump Presidency and GOP-controlled Congress to be pro-business, we can also expect them to be very pro-traditional banking. That will be a big negative for fintech companies that had hoped to compete with the banks in the future.

While many expect fintech to be a major disruptor of the banking industry and some even think it will replace banking, I don’t expect that to happen—especially if banks end up with a more favorable regulatory environment. The fintech firms that prosper under a Trump Administration will be those that can partner with a bank to offer financial products and services to bank customers in a more efficient and profitable manner.

What to Know About the New Fintech Charter

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fintech-12-13-16.pngDon’t expect an onslaught of fintech companies rushing to become banks. The recent announcement that the Office of the Comptroller of the Currency would begin accepting applications for special purpose national bank charters from fintech companies was met with gloom from some in the banking industry, and optimistic rejoicing from others.

For now, the impact on banking and innovation seems unclear, but the hurdles to obtaining a national banking charter will be significant, and include compliance with many of the same regulations that apply to other national banks, possibly dissuading many startup fintech companies from even wanting one. On the other hand, larger or more established players may find it worth the added regulatory costs to boost their marketing and attractiveness to investors, says Cliff Stanford, an attorney at Alston & Bird. Plus, fintech firms can avoid the mélange of state-by-state banking rules and regulations by opting for a national banking charter instead. So don’t be surprised if a Wal-Mart, Apple or Google decides to get a banking license, along with some other, less well known names. The online marketplace lender OnDeck has already said it was open to the possibility of a national bank charter.

The OCC is offering fintech companies the same charter many credit card companies and trust companies have. Basically, the institution has to become a member of the Federal Reserve, and is regulated as a national bank with the same capital standards and liquidity requirements as others. The company has to provide a detailed plan of what products and services it intends to offer, a potential hurdle for a nimble start-up culture more accustomed to experimentation than regulation. “They will have a high bar to meet and they might not be able to meet those requirements,” Stanford says.

However, if the special purpose bank doesn’t accept deposits, it won’t need to comply with the same regulations as banks insured by the Federal Deposit Insurance Corp., which means it is exempt from the Community Reinvestment Act (CRA). Although nondepository institutions would not have to comply with the CRA, the OCC described requirements to make sure the fintech companies follow a plan of inclusion, basically making sure they don’t discriminate, and promote their products to the underserved or small businesses. This has caused some consternation among community banks.

“Why should a tiny bank have to comply with CRA and a big national bank across America does not have to comply?’’ says C.R. “Rusty” Cloutier, the CEO of MidSouth Bancorp, a $1.9 billion asset bank holding company in Lafayette, Louisiana. “If they want a bank charter, that’s fine. Let’s just make sure they play by the same rules.”

The Independent Community Bankers of America, a trade group, put out a press release saying it had “grave” concerns about what it called a “limited” bank charter. “We don’t want a charter that disadvantages one set of financial institutions,’’ says Paul Merski, an executive vice president at the ICBA. “We aren’t against innovation. But we want to make sure some institutions aren’t put at a disadvantage.”

Richard Fischer, an attorney in Washington, D.C., who represents banks, says he doesn’t think a fintech charter is a threat to banks. The Wal-Marts and Apples of the world will do what they want to do, whether or not they have a bank charter. Wal-Mart, which abandoned attempts to get a special purpose banking charter in 2007, already has a sizeable set of financial services, although it partners with banks that do have a charter, such as Green Dot Corp. in Pasadena, California.

Could a new fintech charter lead to fewer bank partnerships with fintech companies, as the fintech companies can cut out the need for a bank? Possibly. But it could also lead to more bank partnerships, as some banks, especially small or midsized banks, become more comfortable with the risk involved in doing business with a fintech company that has a national banking charter.

Jimmy Lenz, the director of technology risk at Wells Fargo Wealth and Investment Management, a division of Wells Fargo & Co., says he’s optimistic that a charter could create more products and services.

“I don’t see this cutting the pie into smaller slices,’’ he says. “I think they will be cutting a bigger pie. I don’t see the banks coming out on the short end of this.” Others said that the competition to banks coming from fintech companies already exists, and won’t go away if you don’t offer a federal charter for fintech companies. “The competition is already there,’’ Stanford says.

What To Know About the New Fintech Charter

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Don’t expect an onslaught of fintech companies rushing to become banks. The recent announcement that the Office of the Comptroller of the Currency would begin accepting applications for special purpose national bank charters from fintech companies was met with gloom from some in the banking industry, and optimistic rejoicing from others.

For now, the impact on banking and innovation seems unclear, but the hurdles to obtaining a national banking charter will be significant, and include compliance with many of the same regulations that apply to other national banks, possibly dissuading many startup fintech companies from even wanting one. On the other hand, larger or more established players may find it worth the added regulatory costs to boost their marketing and attractiveness to investors, says Cliff Stanford, an attorney at Alston & Bird. Plus, fintech firms can avoid the m?©lange of state-by-state banking rules and regulations by opting for a national banking charter instead. So don’t be surprised if a Wal-Mart, Apple or Google decides to get a banking license, along with some other, less well known names. The online marketplace lender OnDeck has already said it was open to the possibility of a national bank charter.

The OCC is offering fintech companies the same charter many credit card companies and trust companies have. Basically, the institution has to become a member of the Federal Reserve, and is regulated as a national bank with the same capital standards and liquidity requirements as others. The company has to provide a detailed plan of what products and services it intends to offer, a potential hurdle for a nimble start-up culture more accustomed to experimentation than regulation. “They will have a high bar to meet and they might not be able to meet those requirements,” Stanford says.

However, if the special purpose bank doesn’t accept deposits, it won’t need to comply with the same regulations as banks insured by the Federal Deposit Insurance Corp., which means it is exempt from the Community Reinvestment Act (CRA). Although nondepository institutions would not have to comply with the CRA, the OCC described requirements to make sure the fintech companies follow a plan of inclusion, basically making sure they don’t discriminate, and promote their products to the underserved or small businesses. This has caused some consternation among community banks.

“Why should a tiny bank have to comply with CRA and a big national bank across America does not have to comply?’’ says C.R. “Rusty” Cloutier, the CEO of MidSouth Bancorp, a $1.9 billion asset bank holding company in Lafayette, Louisiana. “If they want a bank charter, that’s fine. Let’s just make sure they play by the same rules.”

The Independent Community Bankers of America, a trade group, put out a press release saying it had “grave” concerns about what it called a “limited” bank charter. “We don’t want a charter that disadvantages one set of financial institutions,’’ says Paul Merski, an executive vice president at the ICBA. “We aren’t against innovation. But we want to make sure some institutions aren’t put at a disadvantage.”

Richard Fischer, an attorney in Washington, D.C., who represents banks, says he doesn’t think a fintech charter is a threat to banks. The Wal-Marts and Apples of the world will do what they want to do, whether or not they have a bank charter. Wal-Mart, which abandoned attempts to get a special purpose banking charter in 2007, already has a sizeable set of financial services, although it partners with banks that do have a charter, such as Green Dot Corp. in Pasadena, California.

Could a new fintech charter lead to fewer bank partnerships with fintech companies, as the fintech companies can cut out the need for a bank? Possibly. But it could also lead to more bank partnerships, as some banks, especially small or midsized banks, become more comfortable with the risk involved in doing business with a fintech company that has a national banking charter.

Jimmy Lenz, the director of technology risk at Wells Fargo Wealth and Investment Management, a division of Wells Fargo & Co., says he’s optimistic that a charter could create more products and services.

“I don’t see this cutting the pie into smaller slices,’’ he says. “I think they will be cutting a bigger pie. I don’t see the banks coming out on the short end of this.” Others said that the competition to banks coming from fintech companies already exists, and won’t go away if you don’t offer a federal charter for fintech companies. “The competition is already there,’’ Stanford says.

Should You Do Business With Marketplace Lenders?

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Lenders-12-9-16.pngThe shift away from the traditional banking model—largely due to technological advances and the growing disaggregation of certain bank services—has contributed to the rise of the marketplace lending (MPL) industry. The MPL industry, in particular, offers consumers and small businesses the means by which to gain greater access to credit in a faster way. MPL, despite its increasing growth, has managed to stay under the radar from regulatory oversight until recently. However, in a short span of time, federal and state regulators—the Department of the Treasury, Office of the Comptroller of the Currency (OCC), Consumer Financial Protection Bureau (CFPB), the Federal Deposit Insurance Corporation (FDIC) and California Department of Business Oversight, for example—have begun to weigh the benefits and risks of MPL, with the OCC, for example, going so far as to announce its intention to grant special purpose national bank charters to fintech companies.

Given the evolving nature of the industry and its regulation, in this article, we discuss three key issues for MPL participants to consider. First, we discuss the regulatory focus on the third-party lending model. Second, we consider the potential fair lending risks. Third, we focus on considerations related to state usury requirements. We conclude with a few thoughts on what to expect in this changing landscape.

Third-Party Lending Model
The MPL model traditionally operates with three parties: the platform lender, the originating bank and investors purchasing the loans or securities. Based on the reliance on originating banks in the MPL structure, the FDIC, CFPB and others increasingly have considered the risks to banks from these third-party relationships. In particular, regulators appear to be concerned that banks may take on additional risk in these relationships, which are potentially similar to the lending model rejected by a U.S. District Court judge earlier this year when deciding CashCall was the real lender in dispute, not a tribal lender set up in South Dakota. Thus, the FDIC, for example, in its recent Guidance for Managing Third-Party Risk, asks institutions engaged in such third-party relationships to appropriately manage and oversee these third-party lenders before, during and after developing such a relationship. In addition, certain originating banks have also taken to retaining some of the credit risk to mitigate concerns that the MPL may be considered the true lender.

Fair Lending
Another potential area to consider relates to fair lending risks regarding extensions of credit in certain geographical areas, underwriting criteria and loan purchase standards. For example, the potential for fair lending risk may increase particularly with respect to the data collected on borrowers for underwriting purposes, for example, where the use of certain alternative criteria may inadvertently result in a disparate impact to protected classes. In addition, restrictions on lending areas or the types of loans sold to investors similarly could pose such issues.

State Usury Requirements
The recent Second Circuit decision in Madden v. Midland Funding LLC also highlights potential uncertainty regarding the MPL model. In Madden, the Second Circuit determined that a debt collection firm, which had purchased a plaintiff’s charged-off account from a national bank, was not entitled to the benefit of the state usury preemption provisions under the National Bank Act, despite originally being available to the originating national bank. Madden was appealed to the Supreme Court, which declined to hear the case. Thus, Madden has the potential to limit the ability for MPL firms to rely on their originating banks to avoid complying with state-by-state interest rate caps, as federal preemption would no longer apply to those loans later transferred to or acquired by such nonbank entities. Further, Madden increases the uncertainty regarding the originated loans that MPL firms may later sell to (or issue securities for) investors. While some lenders have chosen to carve out the Second Circuit (New York, Connecticut and Vermont) for lending and loan sale purposes, there is the continued risk that the decision may set a precedent in other circuits.

Conclusion
Even with the increasing scrutiny of the MPL industry, regulators appear to recognize the benefits of access to credit for borrowers. For example, the OCC, CFPB and the Treasury have indicated that any increase in regulation should be balanced with fostering innovation. This may be a potential signal on the part of regulators to adopt a framework by which financial innovation is incorporated into the traditional banking model. Thus, looking forward, we think the regulatory uncertainty in this space provides the opportunity for MPL participants to take a proactive approach in shaping regulatory policy for the industry.

Taking a Chance on the Unbanked

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Financial inclusion is a hot topic in our community, and for good reason. The banking industry faces a real challenge serving those people who don’t have access to traditional banking services.

According to the Federal Deposit Insurance Corp.’s latest annual survey on underbanked and unbanked, 7 percent of Americans didn’t have access to banking services in 2015. That represents nine million U.S. households. The number gets even bigger when you consider underbanked households, which are defined as those that supplement their bank accounts with nonbank products such as prepaid debit cards.

Some banks look at this market and only see the risks; others deem it outside of their target audience demographic. In either instance, the outcome is avoidance. Fintech leaders, by contrast, see an emerging opportunity and are proactively developing innovative solutions to fill the gap. Which poses the question: Is it possible for banks to do the same?

Deciding to move forward with this type of initiative must start with the data. One of the areas that we pay close attention to is application approval rates. We’ve been opening accounts via our digital platform since 2009, and we were initially surprised by lower-than-anticipated account approval rates. Why was this happening? As the number of consumers who want to open a bank account online increases, there are inherent risks that must be mitigated. From what we’ve learned, identity verification and funding methods for new accounts, for example, pose heightened challenges in the anonymous world of digital banking. As such, we have stringent controls in place to protect the bank from increasingly sophisticated and aggressive fraud attempts. This is a good thing, as security is not something we are willing to compromise.

However, we realize that not everyone we decline is due to potential fraud, and that therein lies a major opportunity. A large portion of declinations we see are a result of poor prior banking history. Here’s the kind of story we see often, which may resonate with you as well: A consumer overdrew their bank account and for one reason or another didn’t fix the issue immediately, so they get hit with an overdraft fee. Before long those fees add up and the customer owes hundreds of dollars as a result of the oversight. Frustrated and confused, the customer walks away without repaying the fees. Perhaps unknowingly, the customer now has a “black mark” on their banking reports and may face challenges in opening a new account at another bank. Suddenly, they find themselves needing to turn to nonbank options.

I am not excusing the behavior of that customer: Consumers need to take responsibility for managing their finances. But, shouldn’t we banks be accountable for asking ourselves if we’re doing enough to help customers with their personal financial management? Shouldn’t we allow room for instances in which consumers deserve a “second chance,” so to speak?

At Radius we believe the answer to that question is “yes,” which brings us back to my earlier point around opportunity. Just a few weeks ago we released a new personal checking account, Radius Rebound, a virtual second chance checking account. We now have a way to provide a convenient, secure, FDIC-insured checking account to customers we used to have to turn down. In doing so, we’re able to provide banking services to a broader audience in the communities we serve across the country.

Because of the virtual nature of the account, I was particularly encouraged by the FDIC’s finding that online banking is on the rise among the underbanked, and that smartphone usage for banking related activities is rapidly increasing as well. Fintech companies are already utilizing the mobile platform to increase economic inclusion; we believe that Radius is on the forefront of banks doing the same, and look forward to helping consumers regain their footing with banks.

Let me be clear, providing solutions for the unbanked and underbanked is more than a “feel good” opportunity for a bank—it’s a strategic business opportunity. A takeaway from the FDIC report is that the majority of underbanked households think banks have no interest in serving them, and a large portion do not trust banks. It’s upon banks to address and overcome those issues. At the same time, nonbank alternatives are increasing in availability and adoption. Like anything worth pursuing, there are risks involved and they need to be properly scoped and mitigated. But while some banks still can’t see beyond the risks, I think ignoring this opportunity would be the biggest risk of all.

CFPB Assumes ’Catalyst’ Role in Fintech Innovation

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In 2012, the Consumer Financial Protection Bureau (CFPB) recognized that the industry we now call fintech was starting to accelerate the delivery of cutting edge technology products to the financial services marketplace. The CFPB was aware that many of these offerings would make banking faster and easier for consumers and might also allow banks to perform their operations far more efficiently. At first blush, that seems like a win-win situation for consumers and the industry alike. However, the bureau was also aware that rapid growth of the largely unregulated fintech sector created the potential for abuse and fraud. The result was Project Catalyst, a program in which the bureau works with fintech firms to encourage the development of new consumer-friendly products while making sure these companies color inside the regulatory lines.

The CFPB released it first look at the achievements of the program in October. In “Project Catalyst report: Promoting consumer-friendly innovation,”the bureau outlined it efforts to work with fintech companies to develop consumer-friendly programs while avoiding potential regulatory pitfalls. In his preamble to the report, Director Richard Cordray noted that “As these efforts reflect, the Bureau believes innovation has enormous potential to improve the financial lives of consumers. At the same time, however, the Bureau recognizes that innovation cannot skirt the need for sufficient oversight and consumer protection.” While the CFPB wants to encourage financial innovation, it has endeavored to do so in a manner that keeps consumers and their money safe. So far the bureau would seem to be succeeding.

The report also outlines areas where the bureau has high interest and concerns. For example, payday lending products has been a concern for the CFPB from day one. These high-cost, short-term loans exploit lower-income and underbanked consumers who have cash flow issues. To reduce the need for these products the bureau has been encouraging the development of alternatives that help consumers better manage their finances to avoid the cash crunch that creates the need for a payday loan in the first place.

Underbanked and “credit invisible” consumers are a particular concern of the bureau. These individuals tend to be less sophisticated and are often easy prey for less scrupulous fintech companies. While they may not have a bank account, they do have smartphones and are targeted for payday loans, car title loans and other high-cost consumer loan products. Project catalyst has been actively working with fintech companies to find ways to deliver reasonably priced loans to the underbanked market on terms that are also favorable for the lender.

Building savings is also a key focus for the bureau. Project Catalyst is interested in working with companies that develop products that encourage savings and make it easier for customers to get and keep money in a savings account. Building tools that help consumers understand and utilize the budgeting and savings process is a key goal of the project and has been since the beginning. One of Project Catalyst’s first collaborations was with the personal finance website Simple to develop a program that helped consumers understand their spending habits and patterns.

Project Catalyst also highlights the need for improvements in mortgage servicing platforms. The bureau notes that many banks have just loaded new mortgage servicing platforms on the back of their current legacy system and that is not the optimum solution. The report comments that “These workarounds can be costly and are sometimes plagued by programming errors, failures in system integration or instances of data corruption. These failures cause consumer harm and increase the risk of data inaccuracies during loan transfers.” The CFPB is working with fintech companies to build new, more efficient technology platforms that will make the process easier and more consumer friendly.

Credit reporting and clarity are also a focus of the CFPB. Many credit users have no idea what is on their credit report and any technology that makes it easier to check credit scores and profiles is of interest to the bureau. It is also working with companies to develop products that help understand what types of behavior might improve or worsen their score.

Project Catalyst is also looking to improve the peer-to-peer payments process. The bureau is working with fintech providers to help people send money overseas, pay their bills or make purchases on a cost effective basis. It has also met with firms that are working on providing easily accessed price comparisons when sending money overseas so that people can find the cheapest and most convenient way to transfer cash to relatives back home.

While the CFPB’s mission is to help and protect all consumers, it is evident from the report that the bureau is very sensitive to the needs of the underbanked and less affluent consumers. This segment of the market has always been the target of fraud and predatory practices, and the introduction of mobile technology has made them more so than ever before. Fintech companies that develop programs to serve and protect this market will find the CFPB more than willing to help get their products to market.

The Future of Banks: Platforms or Pipes?

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future-banking-11-9-16.pngMuch has been written about the future of banking. In the end, it all seems to come down to one question: Will banks become platforms or pipes?

In reality, there’s no question at all. Platforms are the winning business model of the 21st century and the banking industry is well aware. In fact, banks have been platforms for decades—fintech companies are merely creating the latest set of bank platform extensions. Earlier incarnations include ATMs and online bill pay for consumers.

That said, what’s happening today is forcing banks to rethink how fast they extend their platform to avoid becoming just the pipes. The advent of the cloud and the software revolution in fintech with billions of capital being invested every quarter has brought more innovation to banking in the past two years than it has seen in the past 20. Still, the current David taking down Goliath narrative surrounding the future of banking and finance ultimately fails to account for the reality of the situation.

While it often goes unnoticed, a great many fintech startups today rely heavily on banks to enable their innovative services. The success of financial innovations like Apple Pay for instance is happening with a great deal of participation and cooperation between technology companies and financial institutions.

This relationship between banks and fintech underscores the reality of the financial services industry’s future. Yes, finance is evolving alongside the accelerating curve of technology, and yes, fintech is driving much of this change, but banks are—and will remain—squarely at the center of the financial universe for quite some time to come.

Why is this? For one, banks have been the backbone of the modern economy since its inception. They are far too ingrained in the financial system to be removed within any foreseeable time frame. Banks also have deep pockets, infrastructure and experience. Large market caps and long track records are clear signals to customers that banks can weather the inevitable downturn. Startups, on the other hand, are more susceptible to turbulence and market volatility—things banking customers, especially business customers, would rather avoid.

Big data is yet another boon to banks’ staying power. Banks have been collecting data on customer transactions and behavior for decades. This creates major advantages for banks. When used in the right way, this data can be leveraged to do things like identify customers that are ripe for new payment services or to mitigate and underwrite risk in innovative ways.

But despite all this, there is one hazard currently menacing banks: disintermediation. Starting with the ATM, technology has been distancing consumers from banks for quite some time. Today, their relationship with the consumer is slimmer than ever.

Meanwhile, fintech is picking up the slack. While traditional banking experiences can feel clunky, fintech products and services are designed to work with people’s lives and deliver value in new and unexpected ways. These upstarts pride themselves on delivering superior customer experiences—banking that is intuitive, mobile, cloud-based, responsive, available 24/7, you name it.

Fintech companies are also agile and built for rapid iteration—skill sets banks don’t yet have internally. This allows fintech companies to focus heavily on usability and keeping their user interfaces modern. At Bill.com, for instance, we upgrade our onboarding experience every two weeks. By comparison, most banks have outsourced many key functions to third-party service providers like Fiserv and Jack Henry, severely limiting their ability to make product changes outside of rigid, long-term release cycles.

The comparative lack of innovation by banks is no surprise. For decades, banks have spent most of their resources driving to meet quarterly earnings targets, delivering consistent results and ensuring compliance—the key objectives most highly-regulated, publicly-traded financial institutions must focus on to meet obligations to shareholders. That leaves fewer resources and funds for experimentation, learning and new product development. This makes it difficult for banks to keep up with shifts in customer preferences and behavior the way that fintech can. Banks know this and it is exactly why they are starting to shift their strategies to reflect being a platform and not just the pipes.

When banks become platforms for their customers and fintech partners, they increase the value of what they have built over the past several decades and disintermediation on the consumer front becomes irrelevant. Instead, as banks fuse their platforms with fintech, innovation will accelerate, creating tremendous value for everyone in the food chain.

Online Lenders: Finding the Right Dance Partner

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An increasing number of banks are conceding that innovations introduced by online lenders are here to stay, particularly the seamless, fully digital customer experience. Also, online upstarts have grown to understand that unseating the incumbents may well be heavy-going, not the least because of the difficulties of profitably acquiring borrowers. The result is that both sides have opened up to the potential for partnership, viewing one another’s competitive advantages as synergistically linked. We see five types of partnership emerging.

1) Buying loans originated on an alternative lender’s platform
In this option, alternative lenders securitize loans originated on their platform to free up capital to make more loans while removing risk from their balance sheets. Banks then purchase these securitized loans as a way to diversify investments. This type of partnership is among the most prolific in the online small business lending world, with banks such as JPMorgan Chase, Bank of America and SunTrust buying assets from leading online lenders. The benefits of this option include the ability to delineate the type of assets the bank wants to be exposed to, and potential for a new source of balance sheet growth. However, the downside include may include the difficulty of assessing risk, as alternative lenders are less likely to share details of proprietary underwriting technology. Moreover, the lack of historical data on alternative lenders’ performance means limited access to data on how these investments will fare in a downturn.

2) Routing declined loan applicants to an alternative lender or to an online credit marketplace
Banks decline the majority of customers who apply for a loan. This partnership option allows such banks to find a home for these loans by referring declined borrowers directly to an online lender or credit marketplace like Fundera, which may be more capable of approving the borrower in question. The advantages of this approach include the ability of the bank to provide their customers with access to a wider suite of products through a vetted solution, a reduced need to expand the bank’s credit box and increased revenue in the form of referral fees. Examples of this type of partnership are few and far between in the United States. Thus far, OnDeck has partnerships of this nature with BBVA and Opus Bank. In our view, a big reason why more banks haven’t followed suit is the loss of control over a borrower’s experience, since agreements typically require a full customer handoff to the alternative lender. In addition, regulators have become increasingly reticent to endorse such agreements, with guidance from the Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. being particularly restrictive.

3) Making the bank’s small business product line available through an online marketplace
Marketplace players, like Fundera, aim to empower borrowers with the tools needed to shop and compare multiple credit products from a curated network of reputable bank and non-bank lenders. They can be natural partners for traditional banks, as they can be lender agnostic, offering banks an opportunity to compete head-to-head with online lenders to acquire customers. Banks can choose to make any and all of their small business product lines (e.g. term loans, SBA loans, lines of credit, credit cards) available. Examples of this include partnerships with Celtic Bank, LiveOak and Direct Capital (a division of CIT Bank) currently have with Fundera. This option allows a bank to explore digital distribution of products within their lending portfolio, as well as the opportunity to acquire a high-intent, fully packaged borrower that comes from outside the bank’s existing footprint. In addition, this option enables banks to offer products only to the customers which meet eligibility criteria set by the bank (e.g., industry, state, credit box). The downsides of this option can be the upfront investment in technology required by banks to integrate with a marketplace lender.

4) Utilizing an alternative lender’s technology to power an online application
In this option, the alternative lender or lending-as-a-service provider powers a digital application, collecting all the application information and documentation that a bank requires to underwrite a small business loan. Capital, however, is still deployed by the bank. Examples of this partnership type include the collaboration between lending solutions provider Fundation and Regions Bank. This improves the usability of a traditional lender’s products by giving business owners the flexibility to apply online. This partnership also provides access to technology that is difficult and costly for a bank to develop. It may also reduce dependency on paper documents while reducing time to complete a loan application. The downsides of this option are that it can require deployment of significant resources for compliance and due diligence.

5) Utilizing an alternative lender’s technology to power an online application, loan underwriting and servicing
In addition to powering a digital application, the alternative lender can provide access to its proprietary technology for pricing, underwriting and servicing. As with option four, however, capital is still deployed by the bank. The example that comes closest to this type of partnership is the partnership between OnDeck and JPMorgan Chase. This option gives a bank access to underwriting technology that may be costly for them to develop on its own. By leveraging this technology, the bank may also be able to address segments of the market that would have been deemed uncreditworthy by its existing, more conventional underwriting process. Banks should only move forward with this option if they trust an alternative lender’s underwriting criteria, and the bank believes that the alternative lender can meet their compliance requirements.

Is Your Loan Origination Process Too Slow?

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loan-origination-11-3-16.pngOne of the biggest disruptors to the banking industry in the past several years has been the rise of technologically based financial technology, or the fintech industry. Fintech has brought a new wave of competition by finding more efficient ways to offer many of the same services as banks, including—most recently—lending. As the OCC points out in a recent whitepaper, banks and credit unions need to start thinking seriously about incorporating technology into more of their processes if they are to compete and effectively service customers. As fintechs continue to encroach on core banking services, banks will need to begin to find ways to strengthen and quicken loan origination processes.

According to a 2015 study from McKinsey & Company, 9 percent of fintech companies tracked in the study were making headway in the commercial lending space, an area which made up 7.5 to 10 percent of global banking revenues in 2015. For banks to keep pace, bank management has to ensure that their back-office systems and procedures for loan origination are designed for efficient growth and risk mitigation.

Speed
Technology is shortening processing time for loans, and banks and credit unions, in response, need to speed up their loan origination. Fast turnaround time is the currency of the digital age. Perhaps the most striking example of speed in the lending world is Rocket Mortgage, a Quicken Loans app that launched in a splashy 2016 Super Bowl TV ad that boasted minutes-long pre-approval decisions for mortgages.

In order to increase speed in lending, institutions should start by identifying the biggest bottlenecks in their current origination process. For many institutions, it is data collection and entry. Implementing technology like an online client portal for borrowers to upload documents makes it easier to track down all the required paperwork and allows the loan officer to work in digital instead of paper files. Technology can automatically read tax returns and reduce the time loan officers spend on manual data entry.

Of course, getting the data is only half the battle. The loan still needs to be analyzed, risk rated, priced and reviewed by a loan committee, and by using integrated software and standardized templates, the entire process is streamlined, which means getting back to the customer more quickly.

Defensibility
Another competitive disadvantage that banks and credit unions must overcome is the level of regulatory scrutiny placed on loan decisions. When building a competitive loan origination system, banks should focus on implementing processes that accurately identify credit risk and enable defensible, well documented credit decisions. Three key components of a defensible origination solution include:

  • Automated data entry and calculations to avoid manual error
  • Comprehensive documentation at each step
  • Templates for processes and calculations to ensure consistency and objectivity

Scalability
If an institution wants to process 100 more loans each year, they could hire more staff. Yet, a technology-based origination process also equips the institution to grow without increasing overhead costs and by better deploying staff to high-value activities. Platforms are available that realize time savings and better information flow, giving staff the tools needed to scale the institution.

The rise of fintech in recent years is indicative of the great potential efficiencies offered by technological innovations in banking, and progressive institutions are finding ways to lead this charge. To stay competitive with other institutions as well as fintech, banks and credit unions need to re-examine their back-office processes for loan origination to find ways to increase efficiency in loan origination. Banks can automate data entry and calculations, create consistency through templates for credit analysis, risk rating and loan pricing and prepare for audits and exams more easily with thorough documentation at each step. It prepares the institution to grow, remain competitive and better service its customers.

To learn more about technological solutions for your lending process, download the whitepaper “Tapping Growth Opportunities in the Business Loan Portfolio.”