Can Opposites Attract? Fintech Companies Look to Partner Up With Banks


partnership-5-24-16.pngThe charts look dire indeed. Economic growth as measured by gross domestic product has been anemic. Net interest margins, a main profitability figure for banks, have been under increasing pressure, with only a slight uptick in the fourth quarter of 2015 from a median of 3.08 percent to 3.13 percent. Loan yields also are down. Compliance and regulatory expenses are going up, according to Steven Hovde, chairman and chief executive officer at investment bank Hovde Group, and a presenter at Bank Director’s Growing the Bank conference in Dallas yesterday.

“Fintech and banks are going to end up marrying up,” he warned the crowd. “It’s the only way you are both going to survive. If you think you can do it on your own, you are sadly, sadly mistaken.”

Not long after that, the doors to the ballroom opened and about 140 bank executives and board members were invited to snack on breakfast burritos, as well as mingle with each other and nearly 100 executives from technology companies along with various leaders from professional service firms.

The tech companies have something many banks lack: innovative products and simple, customer-friendly digital solutions for a changing world. Meanwhile, the banks have some things many of the tech companies lack: actual customers and a more stable funding base.

In a sign of increasing acceptance of the transformative power of technology for the banking industry, the conference drew a crowd hoping to learn ways to grow their banks. The vendors were selling everything from data analytics to simplified mortgage platforms and a core system that gives a star rating to customers based on their profitability to the bank.

An executive who spoke at the conference—Eric Jones at core processor Fiserv—said his company has a two-way alert system where customers can take action digitally to respond to alerts by moving money between a savings and a checking account when they get a low-balance notice. Another vendor, Blend, automates the mortgage lending process complete with an application you can fill out on a mobile phone.

Even a representative from Lending Club, the marketplace lender, showed up hoping to lure in some business, although he declined to talk about the company’s recent woes, including internal controls troubles and the abrupt departure of founder and Chief Executive Officer Renaud Laplanche. (Lending Club partners with banks by selling loans to them generated through its online platform, or marketing consumer loans to the bank’s own customers, particularly if the bank doesn’t want to bother with consumer lending.)

Tom Ashenbrener, a director at First Federal Savings Bank of Twin Falls, Idaho, a $575 million asset bank, said his bank was a fairly conservative lender, but looking to grow nonetheless. He wouldn’t rule out the idea of his bank working with online lenders to grow loans. “There are partnerships that could allow us to stretch,’’ he said. “One of the ways we’re going to be prepared is by transforming ourselves.”

Joe Bartolotta, an executive vice president at Eastern Bank, spoke at the conference and had a more urgent tone. He mentioned the destructive impact the start-ups Uber and Lyft have had on the taxi business. “If the taxi business was ripe for disruption, where is banking?’’ he asked.

Address Your Commercial Clients’ Technology Needs


mobile-offerings-5-23-16.pngBy now, practically every traditional bank or credit union understands that they have to find ways to either compete with or embrace financial technology to attract and keep customers.

But it’s not just about retail customers, or millennials in particular, who have been raised to expect that technology should put just about every need at their fingertips. Fintech firms also have their eye on business customers, including a plethora of alternative financial services startups backed by investors and venture capitalists, lending money to small businesses that traditional institutions turn down–small businesses who then leave those institutions for good.

A 2015 World Economic Forum report estimates that marketplace lenders granted $12 billion to U.S. small and medium-sized businesses by the end of 2015. By 2020, annual U.S. volume could reach $47 billion, according to Morgan Stanley and Goldman Sachs.

How can a traditional bank or credit union compete? It can compete by providing products and services to make commercial customers’ lives easier, particularly using the mobile channel. This not only means offering mobile merchant services and treasury management solutions, such as remote cash deposit services, Check 21 compliant check images, expedited payments and interconnected vaults at merchant locations, but also an increasing array of cloud-based solutions.

Traditional banks and credit unions can even capitalize on the alternative lending movement. You name it, institutions can leverage any fintech solution that a business customer could possibly need. But how can institutions below the top 30 money center banks and large regionals—institutions with limited resources—offer solutions like that?

Let’s just look at one example at how challenging adopting fintech solutions on a piecemeal basis can be for one of those institutions: offering a mobile app for remote deposit capture. It’s seemingly a relatively simple app to offer, but to get that solution to market, an institution typically has to rely on its core processor to allow a third-party app developer to connect its solution to the core system. However, most core vendors do not want to open up their systems in real time for posting those deposits because they don’t want the third-party accessing the core—that’s a problem.

Then an institution has to figure out how to handle potential security issues that remote deposit capture poses. For example, a fraudster could take a picture of a fake check, or take a picture and deposit a real check remotely, but then immediately try to cash the check at the institution’s branch or at another institution. That’s another challenge. Working with a third-party app provider presents other problems as well. There could be issues importing images, and not getting upgrades delivered. On top of that, an institution has so much already on its plate that it can’t even imagine also handling sales and marketing of these third-party apps.

This example pales in comparison with what a bank or credit union has to do to provide its own solutions to commercial customers. While an institution’s niche may be primarily banking merchants and corporate entities, its focus may be just on commercial lending. However, to increase the stickiness of commercial customers, institutions should strongly consider offering a much fuller array of non-lending products, and those solutions must be cloud-based and easily accessible via mobile.

Therein lies the most daunting challenge of all: Contending with the financial industry’s own version of the Four Horsemen of the Apocalypse— operations, compliance, IT and sales. Banks and credit unions have options how to best overcome these challenges. They could invest in technologies to launch fintech solutions on their own and pay for the required expertise to appropriately manage those Four Horsemen themselves. They could also choose to partner with fintech vendors for each separate solution and try to coordinate management of the various operations, compliance, IT and sales duties that come with each solution. Alternatively, they could work with “concierge” partners that have wider menus of fintech solutions, as well as the expertise to help institutions manage the entire process.

Whichever approach banks and credit unions choose to compete in the new world, one thing is certain: They ignore fintech at their peril, as they risk losing business customers altogether.

How One Bank Invests for Innovation


innovation-investment-1.png

“You don’t invest to stay where you are. You invest to go where you want to be in the future,” says Chris Nichols, chief strategy officer of CenterState Banks Inc., a $4.9 billion asset bank headquartered in Davenport, Fl. The term is everywhere–innovation. But what does it mean relative to banks? In an industry burdened with compliance and regulatory pressures, it is rare for bank leadership to have the bandwidth to also think creatively. And when it comes to financial technology, many bankers feel that they don’t really understand this new world they are trying to enter. Nichols was the keynote speaker at a recent conference put on by the law firm Bryan Cave–Crossroads: Banking and Fintech Conference. The following is an edited conversation between Nichols and FinXTech Head of Innovation Kelsey Weaver.

When it comes to innovation, who at the bank is or should be responsible?
Nichols: Everyone should be responsible for innovation. Anyone can lead the charge. Every banker needs to understand the basics of how a bank works–credit, deposit gathering, compliance, finance—and the same is true for innovation. Everyone within the bank should be on the lookout for how to improve a process and how to incorporate new technology. The mistake that many banks make is leaving innovation to their IT group. Technology and process improvement is democratized at CenterState so any business leader can spearhead an effort with the support of IT, compliance, management and other line staff.

What area of fintech do you think has had the most profound impact for your bank?
Nichols: Figuring out how to add value to our customer’s lives and figuring out how to become more efficient in delivering our services are two areas that all banks need to have a relentless focus on. As a metric, we want to become part of our customer’s lives once per day and want to cut our efficiency below 40 percent over time. Neither effort will be easy, but it is getting easier over time with new processes and technology.

What advice would you give to other bankers when it comes to innovation?
Nichols: Be intentional. Proactively develop a culture of innovation so experimentation is the norm and failure is just part of the process. Next, commit to improving a process. Start with creating a vision, incorporate that into an action plan, approve a budget and hold someone accountable for execution. Improving your loan process is an excellent place to start in order to deliver credit faster and cheaper. Next to cutting branch delivery costs, loan processing is the second largest functional cost for a bank. Operational leverage in these two areas is easy to obtain and can make a huge difference on the bottom line in addition to the lives of a bank’s customers.

What advice would you give to fintech companies looking to work with banks?
Nichols: It is no wonder banks have a hard time working with fintech companies. There is a disconnect on both counts. Banks need to understand the urgency and mindset of the entrepreneur while fintech need to understand the compliance and reputational risk that the bank has to be responsible for.

I can’t tell you how many times a fintech company just wants to connect to our core system or have us send over “sample customer information” as if these are simple tasks. Fintech companies need to understand that these types of requests are huge undertakings and don’t happen lightly. Vendor compliance for a start-up alone is daunting let alone entering into a beta test. At Centerstate Bank, like most banks, our customer is our most valuable asset and we are fiercely protective of both their data and their experience.

Further, we run into many fintech companies that just have not thought through their business model. We get pitched many models that just cannot work from a pricing or customer care standpoint. We will never let another fintech company aggregate our customer base or our brand value.

What other banks in your opinion are doing things right when it comes to innovation?
Nichols: We stand in awe of many banks that excel in different areas. USAA, C1 Bank, Commercial Bank of California, Citizens of Edmonds, Triumph Bank, Live Oak, Texas Bank & Trust, Austin Capital are just some of the many banks that make equal or greater progress around being innovative. We follow and learn from a great many banks.

What Banks Need to Do to Address Technological Change


technology-4-27-16.pngIn the past few years the fintech industry has grown exponentially. According to a recent Forbes article, the existing number of fintech start-ups globally are between 5,000 and 6,000, all seeking to take a slice of the financial services marketplace. The fintech industry broadly includes any new technology that touches the financial world, and in many ways, this industry redefines forever the notion of traditional banking. More specifically, fintech includes new payment systems and currencies such as bitcoin, service aggregators such as robo advisors, as well as mobile applications, data analytics and online lending platforms. The fintech industry can also be divided into collaborators and disruptors, those businesses that provide services to banks and those that are competitors for services and looking to displace banks. As new technologies and approaches to delivering financial services are adopted, community banks will be challenged to meet the future expectations of their customers as well as to assess the additional risks, costs, resources and supervisory concerns associated with providing new financial services and products in a highly regulated environment.

The largest commercial banks have recognized the future competitive impact on their business as fintech companies create new and efficient ways to deliver services to their customers. Bank of America, for example, recently announced a fintech initiative and plans to target the start-up market for potential acquisitions. The large banks have the advantage of scale, deep pockets and the luxury of making bets on new technologies. If not by acquisition, other banks are partnering with new players that have unique capabilities to offer products outside of traditional banking. While community banks are not new to the benefits of fintech, the advancement and number of new technologies and potential competitors have been difficult to keep up with and integrate into a traditional bank’s business model. On top of that, the fintech industry remains largely unregulated at the federal level, at least for now.

Competition, compliance and cost are the three critical factors that bank management and board members must assess in adopting new technologies or fending them off by trying to stick with traditional banking values. Good, old-fashioned service based on long-term banking relationships may become a thing of the past as the millennial generation grows older. Contactless banking by the end of this decade or sooner could rule the financial services industry. While in some small community banking markets, the traditional relationship model may survive, it is far from certain as the number of brick-and-mortar bank branches in the United States continues to decline.

Also falling under the fintech umbrella is the rapidly escalating online marketplace lending industry. While most banks may rationalize that these new alternative lending sources do not meet prudent credit standards in a regulated environment, the industry provides sources of consumer, business and real estate credit serving a diverse market in the billions. While the grass roots banking lobby has been around forever, longtime banks should take note that the fintech industry is also gaining support on Capitol Hill, as a group of Republicans are now preparing legislation coined the “Innovation Initiative” to facilitate the advancement and growth of fintech within the financial services industry.

Fortunately, the banking regulators are also supportive of innovation and the adoption of new technologies. The Comptroller of the Currency in March released a statement on its perspective on responsible innovation. As Comptroller Thomas Curry noted, “At the OCC, we are making certain that institutions with federal charters have a regulatory framework that is receptive to responsible innovation along with the supervision that supports it.” In an April speech, he confirmed the OCC’s commitment to innovation and acceptance of new technologies adopted by banks, provided safety and soundness standards are adhered to. The operative words here are responsible and supervision.

Innovation will come with a price, particularly for small and midsize community banks. Compliance costs as banks adopt new technologies will increase, with greater risk management responsibilities, effective corporate governance and advanced internal controls being required. Banks may find it necessary to hire dedicated in-house staff with Silicon Valley-type expertise, hire chief technology officers and perhaps even change the board’s composition to include members that have strong technology backgrounds. In the end, banks need to step up their technology learning curve, find ways to be competitive and choose new technologies that serve the banking needs and expectations of their customers as banking and fintech continues to converge.

Small Business Lending: Partnering Your Way to the Top


small-business-loans-4-25-16.pngSmall business (SB) lending is a large and yet still underserved market in which community banks are generally well positioned to compete. The SB commercial loan market represents approximately $1 trillion in outstanding loans, of which banks hold over $500 billion. Approximately one-third of these assets are currently held by community banks. Despite those impressive figures, the existing small business market is smaller than it could be as large numbers of creditworthy small businesses needing smaller loans are not able to access the credit for which they likely could qualify, largely due to the costs of accessing and underwriting those loans.

Critically, it is the smaller SB loans—i.e. those below $250,000—that constitute the majority of the potential market of borrowers: a recent Federal Reserve survey suggests that applicants seeking less than $250,000 represent approximately 70 percent of total small business applicants. But most banks struggle to make such loans profitable, due to the fixed costs of traditional underwriting and processing relative to the smaller revenue opportunities.

On the other side of the equation, the lending market is undergoing a transformation driven by technology and new competition that is rapidly increasing the investment and scale necessary to compete. This technology is designed to reduce underwriting costs, shorten approval timelines and provide a more user-friendly customer experience. Larger banks and new, nonbank lenders are aggressively using this technology to expand share in SB lending, especially in the underserved smaller balance loan space that is so important to community banks.

Community banks are already gradually ceding SB market share—first to the larger banks and more recently to new technology-enabled nonbank lenders, commonly referred to as fintech lenders. Unfortunately, each community bank alone typically lacks the individual scale required to invest in technology that is now required to compete.

Banks, and particularly the largest banks, appropriately see the emergence of fintech lenders as a potential threat. But, since many community banks lack the resources to build or buy a technology platform on their own, the emergence of fintech lenders who can partner with community banks provides a new and attractive option for community banks to serve these important SB customers and to gain market share.

Federal Reserve Governor Lael Brainard summed up the opportunity for community banks as follows:

“Some view the growth of online platforms as a challenge to community banks in their traditional core businesses. But it is also possible that the very different strengths of community banks and online lenders could lead to complementarity and collaboration in the provision of credit to small business….”
… By working together, lenders, borrowers, and regulators can help support an outcome whereby credit channels are strengthened and possible risks are being proactively managed.”

Fintech partnerships designed to empower community banks should demonstrate the following characteristics:

  • Enable banks to offer a product that is otherwise not widely available through that bank and/or to replace a costlier or inefficient product with a better solution;
  • Enable banks to provide a “yes” to more of their customers, facilitating access to credit even if the customer is not yet able to meet bank credit standards;
  • Ensure banks retain control of the customer relationship and the customer’s experience;
  • Increase fee income and earning assets; and
  • Ensure banks are able to meet regulatory expectations and best practices.

In its January 2015 paper on collaboration by community banks, the Office of the Comptroller of the Currency (OCC) states: “As a group of like-minded institutions, community banks may find the benefits of collaboration outweigh competitive challenges and could strengthen the future viability of community banks. The OCC supports community banks in exploring opportunities to achieve economies of scale and the other potential benefits of collaboration.” The OCC goes on to note that community banks that collaborate must manage the risks inherent in such a collaborative arrangement but states “there are risks to collaborative relationships, but there are also risks to doing something alone without the proper expertise or in an inefficient or ineffective manner.”

I couldn’t say it any better. In connection with SB lending, therefore, community banks should assess the extent to which a collaborative approach may offer benefits of collective scale, expertise and efficiency in a controlled and compliant manner. They may just find that the benefits readily outweigh the risks, and that fintech offers a powerful opportunity for community banks to regain share in a number of product lines that have come to be dominated by the largest banks.

Beyond M&A: Staying Relevant Through Innovation & Transformation


Banks of all sizes are facing a fiercely competitive environment, reduced interest margins and regulation. While many in the industry are leveraging acquisitions to address these pressures, some are thinking outside the box. In his presentation at Bank Director’s 2016 Acquire or Be Acquired Conference, Andrew Wooten of PricewaterhouseCoopers LLP reveals how leading banks are adapting their business models, and the role technology plays in that transformation.

Highlights from this video:

  • Forces Shaping Banking
  • Fintech Landscape
  • Becoming Digital: Build, Buy Or Partner?

FinTech Day Recap: Rapid Transformation Through Collaboration


Over the next few years, the financial services industry will continue to undergo a major transformation, due in part to the speed of the technology movement. With continuous pressures to innovate, how can banks leverage these new technologies to stay relevant and competitive over the next five years? Filmed during Bank Director’s annual FinTech Day in New York City at the Nasdaq MarketSite, industry leaders in the banking, technology and investment space share their insights and perspectives on the challenges and opportunities facing traditional banks.

FinTech Day Recap: The Times They Are A-Changin


Over the next few years, the financial services industry will continue to undergo a major transformation, due in part to the speed of the technology movement. With continuous pressures to innovate, how can banks leverage these new technologies to stay relevant and competitive over the next five years?

Filmed during Bank Director’s annual FinTech Day in New York City at the Nasdaq MarketSite, Al Dominick, president and CEO of Bank Director, shares his thoughts on how banks who are looking for partnerships and opportunities to develop new technologies, may find fintech companies eager to collaborate.

How Regulators Could Foster the Fintech Sector


fintech-innovation-3-30-16.pngRegulators can’t afford to wait any longer in developing a framework for their oversight of the fast-rising fintech sector. The number of fintech companies, and the amount of investment in them, is growing too rapidly for regulators to hope that they can supervise the sector by applying existing regulations for banks to fintech companies on an ad-hoc basis. That will only create gaps in regulators’ monitoring of the sector, and confusion among fintech companies trying to grasp the complexities of financial regulation in the U.S. Such gaps and confusion are already evident: Many fintech companies are failing to implement best practices in securing customer data, and many of them are also unaware of how existing regulations apply to them.

I addressed the security issue in a previous article, but regulators should be just as concerned with clearing up the confusion in the market. That’s because the government has a legitimate interest in encouraging fintech growth, which would be boosted by a clear regulatory framework. Some fintech companies serve customers that have been ignored by banks in recent years, bringing them into the financial system. For instance, companies like OnDeck Capital, Kabbage, Lendio, Square, and others are filling the credit needs of small businesses that banks have been hesitant to lend to ever since the Great Recession. Regulators should be careful about imposing standards that gash this new source of credit for underserved small businesses. Also, some new technologies that fintech startups are working on, like the blockchain, can improve regulation and compliance throughout the financial services industry.

Build Relationships Early
How can regulators help foster innovation without sacrificing security and integrity in the financial system? For one, they should start their interactions with fintech companies as early as possible to encourage innovation while also safeguarding customers. This means providing guidance to companies while they are still developing and experimenting with their solutions, so companies can incorporate compliance into their products early on. If regulators wait to offer guidance until after products have already been developed or released on to the market, then regulators will become an unnecessary obstacle to innovation.

U.K. regulators are taking steps to develop relationships with fintech startups early on to offer guidance on their solutions. At the end of 2014, the U.K.’s Financial Conduct Authority (FCA) announced it would launch a regulatory “sandbox” where fintech companies could test new solutions. When companies use the sandbox, the authority waives some of the compliance requirements normally applied to pilot tests for new products. Banks can also use the sandbox, and the authority guarantees that it won’t take enforcement action at a later date regarding any tests that the banks run. The sandbox experiment will go live later this year, and U.S. regulators should watch it carefully and explore similar initiatives.

Eliminating Confusion
Regulators also need to give fintech companies a hand in navigating the complexity of the U.S. financial regulatory system. There are so many different regulations and so many different agencies enforcing them, it creates a landscape that can easily overwhelm a small startup. Banks can sympathize with this issue; but fintech companies don’t have the compliance budget, knowledge and experience that banks do.

One way to eliminate all of this confusion would be to create a separate regulatory agency for fintech companies, but there are such a wide variety of fintech companies now offering solutions in almost every category of financial services, one agency couldn’t deliver effective oversight with such a broad scope of coverage.

Instead, existing regulators need to be more proactive in their outreach with fintech companies. Engaging with new startups as early in their development as possible will help with this. Regulators could further eliminate some of the confusion in the market by creating a central registry for newly formed fintech companies before they launch their products. The registry would collect some information about the company and its work. That information could then be used to determine which regulatory agencies it should report to, and provide some guidance on which requirements it must be mindful of.

Some fintech companies will certainly be averse to more regulatory oversight. However, a more refined regulatory framework that ensures security and eliminates confusion will be a blessing for the fintech sector. Right now fintech regulation is a big question mark, and a critical risk for fintech investors. Removing that risk will improve investors’ confidence in the fintech sector, helping fintech companies gain the venture capital they need to get off the ground.

How Regulators Could Foster the Fintech Sector


Fintech-innovation.png

Regulators can’t afford to wait any longer in developing a framework for their oversight of the fast-rising fintech sector. The number of fintech companies, and the amount of investment in them, is growing too rapidly for regulators to hope that they can supervise the sector by applying existing regulations for banks to fintech companies on an ad-hoc basis. That will only create gaps in regulators’ monitoring of the sector, and confusion among fintech companies trying to grasp the complexities of financial regulation in the U.S. Such gaps and confusion are already evident: Many fintech companies are failing to implement best practices in securing customer data, and many of them are also unaware of how existing regulations apply to them.

I addressed the security issue in a previous article, but regulators should be just as concerned with clearing up the confusion in the market. That’s because the government has a legitimate interest in encouraging fintech growth, which would be boosted by a clear regulatory framework. Some fintech companies serve customers that have been ignored by banks in recent years, bringing them into the financial system. For instance, companies like OnDeck Capital, Kabbage, Lendio, Square, and others are filling the credit needs of small businesses that banks have been hesitant to lend to ever since the Great Recession. Regulators should be careful about imposing standards that gash this new source of credit for underserved small businesses. Also, some new technologies that fintech startups are working on, like the blockchain, can improve regulation and compliance throughout the financial services industry.

Build Relationships Early
How can regulators help foster innovation without sacrificing security and integrity in the financial system? For one, they should start their interactions with fintech companies as early as possible to encourage innovation while also safeguarding customers. This means providing guidance to companies while they are still developing and experimenting with their solutions, so companies can incorporate compliance into their products early on. If regulators wait to offer guidance until after products have already been developed or released on to the market, then regulators will become an unnecessary obstacle to innovation.

U.K. regulators are taking steps to develop relationships with fintech startups early on to offer guidance on their solutions. At the end of 2014, the U.K.’s Financial Conduct Authority (FCA) announced it would launch a regulatory “sandbox” where fintech companies could test new solutions. When companies use the sandbox, the authority waives some of the compliance requirements normally applied to pilot tests for new products. Banks can also use the sandbox, and the authority guarantees that it won’t take enforcement action at a later date regarding any tests that the banks run. The sandbox experiment will go live later this year, and U.S. regulators should watch it carefully and explore similar initiatives.

Eliminating Confusion
Regulators also need to give fintech companies a hand in navigating the complexity of the U.S. financial regulatory system. There are so many different regulations and so many different agencies enforcing them, it creates a landscape that can easily overwhelm a small startup. Banks can sympathize with this issue; but fintech companies don’t have the compliance budget, knowledge and experience that banks do.

One way to eliminate all of this confusion would be to create a separate regulatory agency for fintech companies, but there are such a wide variety of fintech companies now offering solutions in almost every category of financial services, one agency couldn’t deliver effective oversight with such a broad scope of coverage.

Instead, existing regulators need to be more proactive in their outreach with fintech companies. Engaging with new startups as early in their development as possible will help with this. Regulators could further eliminate some of the confusion in the market by creating a central registry for newly formed fintech companies before they launch their products. The registry would collect some information about the company and its work. That information could then be used to determine which regulatory agencies it should report to, and provide some guidance on which requirements it must be mindful of.

Some fintech companies will certainly be averse to more regulatory oversight. However, a more refined regulatory framework that ensures security and eliminates confusion will be a blessing for the fintech sector. Right now fintech regulation is a big question mark, and a critical risk for fintech investors. Removing that risk will improve investors’ confidence in the fintech sector, helping fintech companies gain the venture capital they need to get off the ground.