Should You Do Business With Marketplace Lenders?


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


unbanked-1.png

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


catalyst-1.png

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?


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


lenders-1.png

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?


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.”

What the Fintech Revolution is Really About


revolution-1.png

I often hear about how slow and ineffective banks are to adapt to the technological world of the internet age. It is true that banks are challenged in the virtual space of the internet. Their systems were built for the 20th century, where trade was focused upon buildings and humans in trading rooms and branches. However, the idea that banks are going to let fintech just steamroll their current operations is just an illusion.

Banks have millions of customers, billions of capital and centuries of history. This is their strength. They have poured billions of dollars into technology over the years, and still do. Admittedly, their systems are often cumbersome and out-of-date, but that is their challenge. How do they overhaul their systems so that they reflect the modern new age of distributing financial services as data through a network of software and servers, rather than as paper through a network of branches and humans?

Meanwhile, the fintech sun is rising and most of its beam is focused upon areas left dark by the incumbent financial institutions. Much of fintech is about banking the unbanked through mobile wallets. The peer-to-peer lenders appear to be more focused upon small businesses and higher credit risk borrowers, rather than the mainstream consumers and smaller, Main Street companies. Robo advisors are offering advice to those who previously received none, and payments companies like Stripe and Square are purely adding an overlay of an app and an API to an existing payments process that is not fit for that purpose.

In other words, fintech is either servicing the unserviced or fixing the fixable, rather than disrupting, destroying or disintermediating banks. In Europe, there are new banks rising: Atom, Solaris, N26, Tide, Tandem, Fidor, Starling, Monzo and more. They are called challenger banks, and mainly for the reason that they are meant to challenge the large existing banks. But they will not. Their focus is upon building niches, as all new banks start with no customers, limited capital and zero history.

Therefore, to throw a little dose of harsh reality onto the fintech fairy tale, the new world of finance on technology is all about adding to the existing financial system. It is not replacing it or disrupting it. It is supplementing it. That is why we have so many bank hackathons, incubators, accelerators and venture capital funds. Banks want fintech to rise. Banks, insurers, regulators and investors recognize that the financial system is only servicing some of the markets, not all. That is why the times we live in are so exciting and why I often underscore the real change our world is seeing with technology. That change is the inclusion of everyone in the network and, by everyone, I mean every one.

A decade ago, the seven billion people on this planet had just two billion with fully functional bank accounts. Today, we are seeing all of the people getting some form of financial inclusion through mobile wallets. Seven billion people can access the financial network today. That is everyone. Just a decade ago, only one in three people could access the network. That is the real transformational moment that fintech is delivering, and that is far, far brighter than the conversation about disrupting, disintermediating or destroying banks.

So please take note: fintech is about a whole new world where everyone can trade and transact in real time for almost nothing one-to-one globally. This is the revolution we are living through and it is a fantastic change from servicing just those worth serving through a physical network with buildings and humans. Serving the world through software and servers to allow trade and commerce to flow like water is the fintech revolution and I love it. I hope you do too.

One Bank’s Digital Transformation Journey


transformation-1.png

Last week Chris Skinner, a FinXTech advisor and fellow contributor, talked about the difficulties of banks shifting to digital, and shared the following: “It is radically different thinking, and is a cultural outlook, rather than a tech project.”

As the head of Radius Bank’s Virtual Bank, I work with a team that has been through the digital transformation process. And I can attest to the above statement: The shift to digital is far more than a project. It’s a total reconstruction of a bank’s culture, organization and systems. It is no easy task but the upside opportunity is big.

Digital transformation is perhaps the most important challenge facing banks at the moment. The penetration of the financial services industry by financial technology and the proliferation of alternative banking solutions presents the stalwarts with a choice: change, or else. Banks are realizing that the adoption of sophisticated, personalized technologies is no longer a “nice to have,” but rather a “need to have.” Never before has the customer experience been more critical to a bank’s success than it is today. I feel lucky that the Radius Bank team understood this early on, and set on a course aligned with this new way of banking.

When I first joined Radius Bank at the end of 2008, we were a small, commercial-focused community bank with six branches in Boston and New York. Mike Butler, the Bank’s CEO and president (and a member of the FinXTech Advisory Board), asked me to join him to help build the virtual bank. We recognized that the traditional model wouldn’t be able to address changing consumer demands. In light of that, we set out to build a bank focused on the future rather than the past.

Over the past several years, our Virtual Bank has actually become our primary retail banking strategy. While we’ve maintained one flagship financial center in Boston, our focus on customer experience, product development and technology offerings all starts with and focuses on the digital channel. We’ve made significant investments in technology to build a forward-thinking and responsive virtual banking platform that has allowed us to onboard and serve many new customers from across the country without the need to visit a branch.

We also realized a while back the importance of fintech partnerships. Let’s face it: Consumers today have more choices in terms of managing their finances than ever before, and many of them are choosing to put their trust in nonbanks. For us it has been about finding the right fintech firms to work with, and over the last three-plus years we’ve launched strategic partnerships with fintechs in areas such as mobile payments, investment management, student loans and alternative lending.

We’re proud of what we’ve been able to accomplish, but the transformation to a digital bank is a journey that’s never complete. It requires ongoing support from top leadership, including our board of directors and management team, and a creative, nimble team that brings marketing, sales, risk and IT together to build an infrastructure focused on security and scalability.

I’m eager to share some of the knowledge I’ve gained throughout our digital transformation process. I’m also eager to learn from my peers in banking and fintech about what’s next. FinXTech asked me to participate to represent the banking perspective, but as I’ve outlined above we’re not your traditional community bank. We sit at the intersection of financial institutions and technology companies—an increasingly productive cradle of innovation and disruption.

I look forward to engaging in these important conversations with you.

Creating Regulatory ’Sandboxes’ to Protect Innovation


innovation-1.png

Fintech regulation has presented a confusing picture here in the United Sates for several years now. Various federal agencies have at least some measure of control over fintech companies, and it can be challenging for innovative new startups to figure out which regulatory authority they are supposed to be talking to at any stage of the game.

Because of this confusion, there is a risk that we could fall behind the rest of the world as nations including Singapore and the United Kingdom have taken steps to provide their fintech companies with the benefits of a looser regulatory environment. Both nations have developed what they are calling fintech “sandboxes” to encourage and accelerate the development of new ideas and products for the financial services industry. Emerging countries like Thailand and Abu Dhabi are also promoting their version of the fintech sandbox to attract new companies and investment dollars into their economy.

There are some signs that the U.S. is also moving to relax regulation and encourage fintech innovation. I talked recently with William Stern, a partner at alaw firm whose practice focuses on both banking and financial technology. Stern says he is seeing some positive movement among U.S. regulators on the fintech front.

Stern referenced the Financial Services Innovation Act of 2016, introduced by Rep. Patrick McHenry, R-N.C., in September of this year. The bill creates a program similar to that used in the U.K. and would allow innovative new companies to apply to one or more of the agencies that currently oversee the financial services industry for a waiver of certain regulations and requirements. It would also prevent other agencies from introducing enforcement actions against the companies while the agreement was in place.

Stern noted that for a smaller company facing the full brunt of all the rules and regulations from a multitude of agencies including the Federal Deposit Insurance Corp., the Consumer Financial Protection Bureau, the Securities and Exchange Commission and the Office of the Comptroller of the Currency, it can be incredibly discouraging for a young entrepreneurial company, particularly one with limited funding. Entering into a compliance agreement would allow the firm to move forward, test and introduce new products without falling under the full weight of the combined rules and regulations at various levels of government.

Stern believes there is support on both sides of the aisle in Congress for encouraging financial innovation, but he also points out that the banking industry isn’t necessarily a big fan of relaxed regulation for fintech companies. Allowing smaller fintech concerns to operate without complying with the same rules as banks would place the latter at a disadvantage. Concerns about maintaining a high level of consumer protection have also been expressed.

For his part, Rep. McHenry thinks the legislation is needed to keep companies from leaving the U.S. and taking their innovation to countries with a less onerous regulatory environment. “Innovation in financial services has created more convenient and secure ways to meet the demands of American consumers,” McHenry said in a statement when he introduced his bill. “For these to succeed, however, Washington must rethink its own laws and regulations to keep up with the growth and creativity in the private sector. This bill represents a mindset shift in the way we address financial regulation. Rather than the command-and-control structure of the past, my bill establishes an evolved regulatory framework that encourages financial innovation, all while maintaining our regulators’ commitment to the safety of consumers and our financial markets.”

The bill is still in the early stages of the legislative process and is highly unlikely to be passed this year. McHenry has acknowledged this but hopes it will spark discussions that will carry over into the next congressional session, which will begin in January. The bill will likely face substantial opposition from those who favor greater rather than reduced regulation of financial services—a position generally associated with the Democratic Party—so the outcome of the congressional races on Nov. 8 could have a huge impact on the prospects for passage.

Both the OCC and the CFPB have been encouraging innovators to work closer with them so the agencies can help them navigate the compliance waters. Back in March, the OCC released a paper titled “Supporting Responsible Innovation in the Federal Banking System: An OCC Perspective.” When the report was introduced, Comptroller of the Currency Thomas J. Curry said that “At the OCC, we are making certain that institutions with federal charters have a regulatory framework that is receptive to responsible innovation and supervision that supports it.” The paper outlined eight principles the agency thinks should guide financial innovation and was viewed by many as the first step towards making it easier for innovators to deal with regulators.

As other nations around the world develop and embrace the sandbox concept, there is some legitimate concern that the U.S. will see companies and jobs leave for a more relaxed environment elsewhere.

Does Your Bank Have What It Takes to Go Digital?


digital-10-12-1.png

I’m often askedwhat’s the best way to make for a bank to go digital. There’s never an easy answer to that question as every bank is different. Some will only make it by launching a whole new bank rather than trying to reinvent their current bank. Some will try and re-engineer their bank and fail. And a few may actually succeed, although true digital transformation is a long and tough road. Most existing banks were built for the management of paper notes and documents in a branch environment. All of the technology that has been laid over that structure has cemented a physical distribution focus into the bank’s core back office systems. Those core systems are often written in archaic code, and it’s all very complex and difficult to change. The most fundamental point here is that it is also proprietary to the bank.

What is happening now is that fintech startups are using open source architecture that relies on the internet for distribution. They have no history and therefore no constraints. They are using all the latest development environments and are incredibly agile. How can a traditional bank compete with that?

The answer is they can’t. However, what a bank can do is use the fintech ecosystem to re-engineer its operations to become faster and more efficient. That’s going to take time and it’s critically important to understand that this bank re-engineering is more than just a tech project. It’s re-thinking the bank’s business model into an open sourced marketplace ecosystem where the bank is just a platform for many players to play. The visionary banks get this and are building such capabilities as I write this post. However, those visionary banks are few and far between and, common to all of them, have a technologist in the driving seat.

When you think about that statement, it’s pretty obvious that this has to be the case. You cannot convert a traditional bank built around physical structures to a digital bank built around digital structures if you are a banker. This is because the bank is trying to transform itself from a financial institution using technology to a technology provider offering finance. It is radically different thinking, and is a cultural outlook, rather than a tech project.

How many banks are led by technologists? I can count them on one hand. The majority of banks have zero technology representation in the C-Suite. A 2015 study of the world’s largest banks found that 40 percent had no technology professionals in the C-Suite, and 33 percent had just one. Seventy-three percent of banks lack technology leadership and yet they are the very same organizations where the current leaders are shouting for change. JPMorgan Chase & Co. CEO Jamie Dimon’s comment at an investors day event in 2014 that “When I go to Silicon Valley they all want to eat our lunch” is right on the money, but what will most bankers do about it? This is where many hem and haw. They make it known within the bank that it intends to go digital—and then assign the task like it’s just another tech project.

Instead, the few banks that are really making the change are building a C-Suite where the majority of those executives have professional technology experience, and along with the CEO live, breathe and talk technology from the Boardroom to the Boardwalk. They don’t just talk the talk, they walk the walk.

This is something I see very rarely in incumbent financial institutions, so when someone asks me what’s the best way to make a bank digital, my answer is always the same: Get a digital leadership team to work the project from the Boardroom to the Boardwalk. Does your bank do that?