Open Banking — A U.S. Pipe Dream or Near-Term Reality?
December 18, 2018
Some alternative funders are anxious for “open banking” to become the gold standard in the U.S., but achieving widespread implementation is a weighty proposition.
Open banking refers to the use of open APIs (application program interfaces) that enable third-party developers to build applications and services around a financial institution. It’s a movement that’s been gaining ground globally in recent years. Regulations in the U.K., a forerunner in open banking, went into effect in January, while several other countries including Australia and Canada are at varying stages of implementation or exploration.
For the U.S., however, the time frame for comprehensive adoption of open banking is murkier. Industry participants say the prospects are good, but the sheer number of banks and the fragmented regulatory regime makes wholesale implementation immensely more complicated. Nonetheless, industry watchers see promise in the budding grass-roots initiative among banks and technology companies to develop data-sharing solutions. Regulators, too, have started to weigh in on the topic, showing a willingness to further explore how open banking could be applied in U.S. markets.
Open banking “is a global phenomenon that has great traction,” says Richard Prior, who leads open banking policy at Kabbage, an alternative lender that has been active in encouraging the industry to develop open banking standards in the U.S. “It’s incumbent upon the U.S. to be a driver of this trend,” he says.
The stakes are particularly high for alternative lenders since they rely so heavily on data to make informed underwriting decisions. Open banking has the potential to open up scores of customer data and significantly improve the underwriting process, according to industry participants.
“Open banking massively enables alternative lending,” says Mark Atherton, group vice president for Oracle’s financial services global business unit. What’s missing at the moment is the regulatory stick to ensure uniformity. Certainly, data sharing is gradually becoming more commonplace in the U.S. as banks and fintech companies increasingly explore ways to collaborate. But even so, banks in the U.S. are currently all over the map when it comes to their approach to open banking, posing a challenge for many alternative lenders. Many alternative lenders would like to see regulators step in with prescriptive requirements so that open banking becomes an obligation for all banks, as opposed to these decisions being made on a bank-by-bank basis. Especially since many consumers want to be able to more readily share their financial information, they say.
“It will create huge value to everyone if that data is more accessible,” says Eden Amirav, co-founder and chief executive of Lending Express, an AI-powered marketplace for business loans.
Some global-minded banks like Citibank have been on the forefront of open banking initiatives. Spanish banking giant BBVA is also taking a proactive approach. In October, the bank went live in the U.S. with its Banking-as-a-Service platform, after a multi-month beta period. Also in October, JPMorgan Chase announced a data sharing agreement with financial technology company Plaid that will allow customers to more easily push banking data to outside financial apps like Robinhood, Venmo and Acorns.
There are several other examples of open banking in action. Kabbage customers, for instance, authorize read-only access to their banking information to expedite the lending process through the company’s aggregator partners, says Sam Taussig, head of global policy at Kabbage.
Also, companies such as Xero and Mint routinely interface with banks to put customers in control of their financial planning. And companies like Plaid and Yodlee connect lenders and banks to help with processes such as asset and income verification.
Some banks, however, are more reticent than others when it comes to data sharing. And with no regulatory requirements in place, it’s up to individual banks how to proceed. This can be nettlesome for alternative lenders trying to get access to data, since there’s no guarantee they will be able to access the breadth of customer data that’s available. “As an underwriter, you want the whole financial picture, and if data points are missing, it’s hard to make appropriate lending decisions,” Taussig says.
The problem can be particularly acute among smaller banks, industry participants say. While the quality of data you can get from one of the money-center banks is quite good, “as you go down the line, it becomes a little less consistent,” says James Mendelsohn, chief operating officer of Breakout Capital Finance. For these smaller banks, the issue is sometimes one of control. There’s a feeling among some community banks, that “if I make it easier for my small business customers to get loans elsewhere, I’m done,” says Atherton of Oracle.
Absent regulatory requirements, alternative lenders are hoping that this initial hesitation among some banks changes over time as they continue to gain a better understanding of the market opportunity and as more of their counterparts become open to data sharing through APIs.
Open banking could be a boon for banks in that it would enable them to service customers they probably couldn’t before, says Jeffrey Bumbales, marketing director at Credibly, which helps small and mid-size businesses obtain financing. Open banking makes for a “better customer experience,” he says.
One challenge for the U.S. market is the hodgepodge of federal and state regulators that makes reaching a consensus a more arduous task. It’s not as simple here as it may be in other markets that are less fragmented, observers say.
Major rule-making would be involved, and there are many issues that would need attention. One pressing area of regulatory uncertainty today is who bears the liability in the event of a breach—the bank or the fintech, says Steve Boms, executive director of the Northern American chapter of the Financial Data and Technology Association. Existing regulations simply don’t speak to data connectivity issues, he says.
To be sure, policymakers have started to give these matters more serious attention, with various regulators weighing in, though no regulator has issued definitive requirements. Still, some industry participants are encouraged to see regulators and policymakers taking more of an interest in open banking.
A recent Treasury Report, for example, notes that as open banking matures in the United Kingdom, “U.S. financial regulators should observe developments and learn from the British experience.” And, The Senate Banking Committee recently touched on the issue at a Sept. 18 hearing. Industry watchers say these developments are a step in the right direction, though there’s significant work needed, they say, in order to make open banking a pervasive reality.
“We’re seeing the pace and interest around these things picking up pretty significantly,” Boms says. Even so, it can take several years to implement a formal process. “The hope is obviously as soon as possible, but the financial services sector is a very fragmented market in terms of regulation. There’s going to have to be a lot of coordination,” Boms says.
Another challenge to overcome is customers’ willingness to use open banking. Many small business owners are more comfortable sending a PDF bank statement versus granting complete access to their online banking credentials, says Mendelsohn of Breakout Capital Finance. “There’s a lot more comfort on the consumer side than there is on the small business side. Some of that is just time,” he adds.
Certainly sharing financial data is a concern—even in the U.K. where open banking efforts are well underway. More than three quarters of U.K. respondents expressed concern about sharing financial data with organizations other than their bank, according to a recent poll by market research body, YouGov. This suggests that more needs to be done to ease consumers into an open banking ecosystem.
The topic of data security came up repeatedly at this year’s Money20/20 USA conference in Las Vegas. How to make people feel comfortable that their data is safe is a pressing concern, says Tim Donovan, a spokesman for Fundbox, which provides revolving lines of credit for small businesses. Clearly, it’s something the industry will have to address before open banking can really become a reality in the U.S., he says.
Despite these challenges, many market watchers feel open banking in the U.S. is inevitable, given the momentum that’s driving adoption worldwide. Several countries have taken on open banking initiatives and are at varying states of implementation—some driven by industry, others by regulation. Here is a sampling of what’s happening in other regions of the world:
In the U.K., for example, the implementation process is ongoing and is expected to continually enhance and add functionality through September 2019, according to The Open Banking Implementation Entity, the designated entity for creating standards and overseeing the U.K’s open banking initiative.
At the moment, only the U.K.’s nine largest banks and building societies must make customer data available through open banking though other institutions have and continue to opt in to take part in open banking. As of September, there were 77 regulated providers, consisting of third parties and account providers and six of those providers were live with customers, according to the U.K. open banking entity.
In Europe, the second Payment Services Directive (PSD2) requires banks to open up their data to third parties. But implementation is taking longer than expected—given the large number of banks involved. By some opinions, open banking won’t really be in force in Europe until September 2019, when the Regulatory Technical Standards for open and secure electronic payments under the PSD2 are supposed to be in place.
In Australia, meanwhile, the country has adopted a phase-in process to take place over a period of several years through 2021. Starting in July 2019, all major banks will be required to make available data on credit and debit card, deposit and transaction accounts. Data requirements for mortgage accounts at major banks will follow by February 1, 2020. Then, by July 1 of 2020, all major banks will need to make available data on all applicable products; the remaining banks will have another 12 months to make all the applicable data available.
For its part, Hong Kong is also pushing ahead with plans for open banking. In July, the Hong Kong Monetary Authority published its open API framework for the local banking sector. There’s a multi-prong implementation strategy with the final phase expected to be complete by mid-2019.
Singapore, by contrast, is taking a different approach than some other countries by not enforcing rules for banks to open access to data. The Monetary Authority of Singapore has endorsed guidelines for Open Banking, but has expressed its preference to pursue an industry-driven approach as opposed to regulatory mandates.
Other countries, meanwhile, are more in the exploratory phases. In Canada, the government announced in September a new advisory committee for Open Banking, a first step in a review of its potential merits. And in Mexico, the county’s new Fintech Law requires providers to provide fair access to data, and regulators there are reportedly gung-ho to get appropriate regulations into place. Still other countries are also exploring how to bring open banking to their markets.
The U.S. meanwhile, is on a slower course—at least for now. More banks are using APIs internally and have been exploring how they can work with third-party technology companies. Meanwhile, companies like IBM have been coming to market with solutions to help banks open up their legacy systems and tap into APIs. Other industry players are also actively pursuing ways to bring open banking to the market.
As for when and if open banking will become pervasive in the U.S., it’s anyone’s guess, but industry participants have high hopes that it’s an achievable target in the not-too-distant future.
Thus far, there has been little pressure for banks to adopt open banking policies, says Taussig of Kabbage. But this is changing, and things will continue to evolve as other countries adopt open banking and as pressure builds from small businesses and consumers in an effort to ensure the U.S. market stays competitive, he says. Open banking “is going to happen in the near future,” Taussig predicts.
Finitive Appoints Neil Wolfson to Board
December 10, 2018
Finitive announced today that it has appointed Neil Wolfson to its Board of Directors. Wolfson also serves on the Board of Directors at OnDeck.
“Finitive has established an innovative platform to provide institutional investors with direct access to alternative lending investments,” said Wolfson. “Finitive’s platform brings further transparency to this asset class.”
According to an April 2018 AltFinanceDaily story, Finitive was founded in August 2017 and has two kinds of clients: institutional investors and alternative lending companies. Back in April, the company had only four alternative lender clients. Today, they have eight.
“We are very selective [with our lending clients],” Finitive founder and Executive Chairman told AltFinanceDaily. “We are not a list service.”
Wolfson spent the last decade as President and Chief Investment Officer of SF Capital Group, a private investment group for high net worth families. There, he invested in over 30 direct debt and equity investments in emerging technology companies with a focus on FinTech companies.
Prior to this, Wolfson spent five years as Chief Investment Officer and President of Wilmington Trust Investment Management, a $40 billion investment management firm, and before that, he was the National Partner in charge of KPMG’s Investment Consulting Practice, representing over $100 billion of assets.
“Neil’s experience investing in global technology companies, coupled with a deep understanding of alternative lending markets, makes him an ideal fit for Finitive’s board,” said Barlow.
Finitive is based in New York and has more than 10 employees.
The Largest Merchant Cash Advance in History
September 28, 2018
How would you like to be the funder to do a $40 million MCA transaction? According to the Securities & Exchange Commission, a deal of such magnitude was one of the many negligent acts that 1st Global Capital CEO Carl Ruderman did with investor money. Though the SEC refers to the merchant as an auto dealership in California, it’s roughly 9 dealerships with common ownership that collectively gross more than $550 million a year in sales. It’s the deal of a lifetime except that the ISO who brokered it has become the largest unsecured creditor to file a claim in the 1st Global bankruptcy. Records show they are owed approximately $3.9 million in unpaid commissions.
And its performance has not been without challenges, according to emails disclosed in the SEC case.
In April 2018, 1st Global employees discussed what to do about the dealerships’ lingering cash flow problems after becoming aware that the owner intended to either recapitalize the debt or sell the dealerships. The choice by then had come down to either continuing to fund them or to cut their losses, an email says.
“If they were to become insolvent, everyone loses,” wrote the Director of Accounting and Finance.
1st Global continued to fund them. The $40 million (approximate amount) was not disbursed all at once but in increments over the course of a year.
One week before 1st Global filed for bankruptcy, they signed a Binding Letter of Understanding with the dealerships acknowledging that the owner would be selling them. At that time the merchant had unpaid taxes of at least $9 million and had an outstanding receivable balance with 1st Global of $43 million. The Letter said that 1st Global would accept “whatever amount it receives [..] at this point as complete satisfaction” of the current RTR when the business is sold. 1st Global also agreed to forever release the dealerships’ owner personally from all legal claims. It was signed by Carl Ruderman 8 days before he resigned.
The merchant has not returned AltFinanceDaily’s inquiries. The banker named in the Binding Letter as having been exclusively hired to sell the dealerships, told AltFinanceDaily over the phone that he has never heard of 1st Global. 1st Global ceased operations on July 27th. The SEC filed a complaint against Ruderman and the company on August 23rd and an amended complaint on September 26th. The dealership transaction is used as an example of malfeasance in it twice.
New Record
No longer candidates for the largest merchant cash advance in history, two ancient deals that were famous during their eras for their size, ended up in default, and in doing so showed the industry that there was such a thing as too big.
One was a $4 million advance made by Strategic Funding Source in 2011 to a tourist attraction being produced at the Tropicana Hotel in Las Vegas. The Las Vegas Mob Experience, billed as the most technologically advanced interactive presentation of historical artifacts ever devised and set up in a 26,000 square foot total immersion facility, it was predicted to bring in 1.5 million visitors per year. But the deal quickly spiraled out of control, the exhibit shut down, and allegations of fraud were lodged in court. Though the Mob Experience was dubbed the largest merchant cash advance in history, it depends on whether or not you’re counting common ownership of multiple businesses as individual deals or one deal.
Dozens of advances made by Global Swift Funding in 2007 and 2008 to businesses controlled by the same west coast-based restaurateur, led to Global Swift’s demise. When the “restaurant king,” as he was known, filed for bankruptcy across all of his entities, Global Swift had outstanding future receivables with his businesses of approximately $8 million. Dan Chaon, a then representative of Global Swift, told a local newspaper at the time that the restaurateur was “a helluva sales-talk artist… he provided false financial statements, and everyone got caught up in that game.”
The Seven-Minute Loan Shakes Up Washington And The 50 States
August 19, 2018
It takes seven minutes for Kabbage to approve a small-business loan. “The reason there’s so little lag time,” says Sam Taussig, head of global policy at the Atlanta-based financial technology firm, “is that it’s all automated. Our marginal cost for loans is very low,” he explains, “because everything involving the intake of information – your name and address, know-your-customer, anti-money-laundering and anti-terrorism checks, analyzing three years of income statements, cash-flow analysis – is one-hundred-percent automated. There are no people involved unless red flags go off.”
One salient testament to Kabbage’s automation: Fully $1 billion of the $5 billion in loans that it has made to 145,000 discrete borrowers since it opened its portals in 2011 were made between 6 p.m. and 6 a.m.
Now compare that hair-trigger response time and 24-hour service for a small business loan of $1,000-$250,000 with what occurs at a typical bank. “Corporate credit underwriting requires 28 separate tasks to arrive at a decision,” William Phelan, president, and co‐founder of PayNet—a top provider of small-business credit data and analysis – testified recently to a Congressional subcommittee. “These 28 tasks involve (among other things): collecting information for the credit application, reviewing the financial information, data entry and calculations, industry analysis, evaluation of borrower capability, capacity (to repay), and valuation of collateral.”
A “time-series analysis,” the Skokie (Ill.)-based executive went on, found that it takes two-to-three weeks – and often as many as eight weeks—to complete the loan approval process. For this “single credit decision,” Phelan added, the services of three bank departments – relationship manager, credit analyst, and credit committee – are required.
The cost of such a labor-intensive operation? PayNet analysts reckoned that banks incur $4,000-$6,000 in underwriting expenses for each credit application. Phelan said, moreover, that credit underwriting typically includes a subsequent loan review, which consumes two days of effort and costs the bank an additional $1,000. “With these costs,” Phelan told lawmakers, “banks are unable to turn a profit unless the loan size exceeds $500,000.”
According to the National Bureau of Economic Research, the country’s very biggest banks — Bank of America, Citigroup, J.P. Morgan Chase, and Wells Fargo—have been the financial institutions most likely to shut down lending to small businesses. “While small business lending declined at all banks beginning in 2008,” NBER’s September, 2017 report announces, “the four largest banks” which the report dubs the ‘Top Four’—“cut back significantly relative to the rest of the banking sector.”
NBER reports further that by 2010—the “trough” of the financial crisis—the annual flow of loan originations from the Top Four stood at just 41% of its 2006 level, which compared with 66% of the pre-crisis level for all other banks. Moreover, small-business lending at the “Top Four” banks remained suppressed for several years afterward, “hovering” at roughly 50% of its pre crisis level through 2014. By contrast, such lending at the rest of the country’s banks eventually bounced back to nearly 80% of the pre-crisis level by 2014.
That pullback—by all banks—continues, says Kenneth Singleton, an economics professor at Stanford University’s Graduate School of Business. Echoing Phelan’s testimony, Singleton told AltFinanceDaily in an interview: “Given the high underwriting costs, banks just chose not to make loans under $250,000,” which are the bread-and-butter of small-business loans. In so doing, he adds, banks “have created a vacuum for fintechs.”
All of which helps explain why Kabbage and other fintechs making small business loans are maintaining a strong growth trajectory. As a Federal Reserve report issued in June notes, the five most prominent fintech lenders to small businesses—OnDeck, Kabbage, Credibly, Square Capital, and PayPal—are on track to grow by an estimated 21.5 percent annually through 2021.
Their outsized growth is just one piece—albeit a major one—of fintech’s larger tapestry. Depending on how you define “financial technology,” there are anywhere from 1,400 to 2,000 fintechs operating in the U.S., experts say. Fintech companies are now engaged in online payments, consumer lending, savings and investment vehicles, insurance, and myriad other forms of financial services.
Fintechs’ advocates—a loose confederacy that includes not only industry practitioners but also investors, analysts, academics, and sympathetic government officials—assert that the U.S. fintech industry is nonetheless being blunted from realizing its full potential. If fintechs were allowed to “do their thing,” (as they said in the sixties) this cohort argues, a supercharged industry would bring “financial inclusion” to “unbanked” and “underbanked” populations in the U.S. By “democratizing access to capital,” as Kabbage’s Taussig puts it, harnessing technology would also re-energize the country’s small businesses, which creates the majority of net new jobs in the U.S., according to the U.S. Small Business Administration.
But standing in the way of both innovation and more robust economic growth, this cohort asserts, is a breathtakingly complex—and restrictive—regulatory system that dates back to the Civil War. “I do think we’re victims of our own success in that we’ve got a pretty good financial system and a pretty good regulatory structure where most people can make payments and the vast majority of people can get credit.” says Jo Ann Barefoot, chief executive at Barefoot Innovation Group in Washington, D.C. and a former senior fellow at Harvard’s Kennedy School. But because of that “there’s been more inertia and slower adoption of new technology,” she adds. “People in the U.S. are still going to bank branches more than people in the rest of the world.”
Barefoot adds: “There are five agencies directly overseeing financial services at the Federal level and another two dozen federal agencies” providing some measure of additional, if not duplicative oversight, over financial services. “But there’s no fintech licensing at the national level,” she says. And because each state also has a bank regulator, she notes, “if you’re a fintech innovator, you have to go state by state and spend millions of dollars and take years” to comply with a spool of red tape pertaining to nonbanks.
At the federal level, the current system— which includes the Federal Reserve, Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC)—developed over time in a piecemeal fashion, largely through legislative responses to economic panics, shocks and emergencies. “For historical reasons,” Barefoot remarks, “we have a lot of agencies” regulating financial services.
For exhibit A, look no further than the Consumer Financial Protection Bureau created amidst the shambles of the 2008-2009 financial crisis by the 2010 Dodd-Frank Act. Built ostensibly to preserve safety and soundness, the agencies have constructed a moat around the banking system.
Karen Shaw Petrou, managing partner at Federal Financial Analytics, a Washington, D.C. consultancy, is a banking policy expert who frequently provides testimony to Congress and regulatory agencies. She wrote recently that the country’s banking sector has been protected from the kind of technological disruption that has upended a whole bevy of industries.
“The only reason Amazon and its ilk may not do to banking, brokers and insurers what they did to retailers—and are about to do to grocers and pharmacies,” she observed recently in a blog—“is the regulatory structure of each of these businesses. If and how it changes are the most critical strategic factors now facing finance.”
Cornelius Hurley, a Boston University law professor and executive director of the Online Lending Policy Institute, is especially critical of the 50-state, dual banking system. State bank regulators oversee 75 percent of the country’s banks and are the primary regulators of nonbank financial technology companies. “The U.S. is falling behind other countries that are much less balkanized,” Hurley says. “Our federal system of government has served us well in many areas in our becoming a leading civil society. It’s given us NOW (Negotiable Order of Withdrawal) accounts, money-market accounts, automatic teller machines, and interstate banking. But now it’s outlived its usefulness and has become an impediment.”
Take Kabbage, which actually avoids a lot of regulatory rigmarole by virtue of its partnership with Celtic Bank, a Utah-chartered industrial bank. The association with a regulated state bank essentially provides Kabbage with a passport to conduct business across state lines. Nonetheless, Kabbage has multiple, incessant, and confusing dealings with its bank overseers in the 50 states.
“Where the states get involved,” says Taussig, “is on brokering, solicitation, disclosure and privacy. We run into varying degrees of state legislative issues that make it hard to do business. Right now we’re plagued by what’s been happening with national technology actors on cybersecurity breaches and breach disclosures. We are required to notify customers. But some states require that we do it in as few as 36 hours, and in others it’s a couple of months. We’ve lobbied for a national breach law of four days,” he adds, which would “make it easier for everyone operating across the country.”
Then there’s the meaning of “What is a broker?’” says Taussig, who as a regulatory compliance expert at Kabbage sees his role as something of an emissary and educator to regulators and politicians, the news media, and the public. “The definitions haven’t been updated since the 1950s and now we have wildly different interpretations of brokering and solicitation,” he says. “The landscape has changed with e-commerce and each state has a different perspective of what’s kosher on the Internet.”
Washington State is a good example. It’s one of a handful of jurisdictions in which regulators confine nonbank fintechs to making consumer loans. In a kabuki dance, fintech companies apply for a consumer-lending license and then ask for a special dispensation to do small-business lending.
And let’s not forget New Mexico, Nevada and Vermont where a physical “brick-and-mortar” presence is required for a lender to do business. Digital companies, Taussig says, would have to seek a waiver from regulators in those states. “Many companies spend a lot of money on billable hours for local lawyers to comply with policies and procedures,” Taussig reports, “and it doesn’t serve to protect customers. It’s really just revenue extraction.”
All such restraints put fintechs at a disadvantage to traditional financial institutions, which by virtue of a bank charter, enjoy laws guaranteeing parity between state-chartered and federally chartered national banks. The banks are therefore able to traverse state lines seamlessly to take deposits, make loans, and engage in other lines of business. In addition, fintechs’ cost of funds is far higher than banks, which pay depositors a meager interest rate. And banks have access to the Fed discount window, while their depositors’ savings and checking accounts are insured up to $200,000.
The result is a higher cost of funds for fintechs, which principally depend on venture capital, private equity, securitization and debt financing as well as retained earnings. And that translates into steeper charges for small business borrowers. A fintech customer can easily pay an interest rate on a loan or line of credit that’s three to four times higher than, say, a bank loan backed by the U.S. Small Business Administration.
Kabbage, for example, reports that its average loan of roughly $10,000 typically carries an interest rate of 35%-36%. It’s credits are, of course, riskier than the banks’. The company does not report figures on loans denied, Taussig told AltFinanceDaily, but Stanford’s Singleton says that the fintech industry’s denial rate is roughly 50 percent for small business loans. “Fintechs have higher costs of capital and they’re also facing moderate default rates,” notes Singleton. “They’re not enormous, but fintechs are dealing with a different segment. Small businesses have much more variability in cash flows, so lending could be riskier than larger, established companies.”
Even so, venture capitalists continue to pour money into fintech start-ups. “I’ve gone to several conferences,” Singleton says, “and everywhere I turn I’m meeting people from a new fintech company. One of the striking things about this space,” he adds, “is that there are lot of aspiring start-ups attacking very specific, very narrow issues. Not all will survive, but someone will probably acquire them.”
Contrast that to the world of banking. Many banks are wholeheartedly embracing technology by collaborating with fintechs, acquiring start-ups with promising technology, or developing in-house solutions. Among the most impressive are super-regionals Fifth Third Bank ($142.2 billion), Regions Financial Corp. ($123.5 billion), and BBVA Compass ($69.6 billion), notes Miami-based bank consultant Charles Wendel. But many banks are content to cater to familiar customers and remain complacent. One result is that there’s been a steady diminution in the number of U.S. banks.
Over the past ten years, fully one-third of the country’s banks were swallowed whole in an acquisition, disappeared in a merger, failed, or otherwise closed their doors. There were 5,670 federally insured banks at the end of 2017, according to the Federal Deposit Insurance Corp., a 2,863-bank, 33.5% decrease from the 8,533 commercial banks operating in the U.S. in 2007.
It does appear that, to paraphrase an old expression, many banks “are going out of style.” In recent years there have been more banking industry deaths than births. Sixty-three banks have failed since 2013 through June while only 14 de novo banks have been launched. In Texas, which is known for having the most banks of any state in the country, only one newly minted bank debuted since 2009. (The Bank of Austin is the new kid on the Texas block, opening in a city known as a hotbed of technology with its “Silicon Hills.”)
One reason there’s so little enthusiasm among venture capitalists and other financial backers for investing in de novo banks is that regulators are known to be austere. “If you’re a company in the U.S.,” says Matt Burton, a founder of data analytics firm Orchard Platform Markets (which was recently acquired by Kabbage), “and you tell regulators that you want to grow by 100 percent a year – which is the scale you must grow at to get venture-capital funding – regulators will freak out. Bank regulators are very, very strict. That’s why you never hear about new banks achieving any sort of scale.”
But while bank regulators “are moving sluggishly compared to the rest of the world” in adapting to the fintech revolution, says Singleton, there are numerous signs that the status quo may be in for a surprising jolt. The Treasury Department is about to issue (possibly by the time this story is published) a major report recommending an across-the-board overhaul in the regulatory stance toward all nonbank financials, including fintechs. According to a report in The American Banker, Craig Phillips, counselor to Treasury Secretary Steven Mnuchin, told a trade group that the report would address regulatory shortcomings and especially “regulatory asymmetries” between fintech firms and regulated financial institutions.
Christopher Cole, senior regulatory counsel at the Independent Community Bankers Association—a Washington, D.C. trade association representing the country’s Main Street bankers—told AltFinanceDaily that, among other things, the Treasury report would likely recommend “regulatory sandboxes.” (A regulatory sandbox allows businesses to experiment with innovative products, services, and business models in the marketplace, usually for a specified period of time.)
That’s an idea that fintech proponents have been drumming enthusiastically since it was pioneered in the U.K. a few years ago, and it’s something that the independent bankers’ lobby, whose member banks are among the most threatened by fintech small-business lenders, says it too can support. Treasury’s Phillips “has said in the past that he’d like to see a level playing field,” the ICBA’s Cole says. “So if (regulators) are going to allow a sandbox, any company could be involved, including a community bank. We agree with him, of course, because we’d like to take advantage of that.”
In March, 2018, Arizona became the first state to establish a regulatory sandbox when the governor signed a law directing that state’s attorney general (and not the state’s banking regulator) to oversee the program. The agency will begin taking applications in August with approval in 90 days, says Paul Watkins, civil litigation chief in the AG’s office. Watkins told AltFinanceDaily that he’s been most surprised so far by “the degree of enthusiasm” from overseas companies. With the advent of the sandbox, he adds, “Landlocked Arizona has become a port state.”
The OCC, which is part of the Treasury Department, may also revive its plan to issue a national bank charter to fintechs, sources say (EDITOR’S NOTE: This had not yet been implemented before this story went to print. The OCC is now accepting such applications) – a hugely controversial proposal that was put on ice last year (and some thought left for dead) when former Commissioner Thomas J. Curry’s tenure ended last spring. At his departure, the fintech bank charter faced a lawsuit filed by both the New York State Banking Department and the Conference of State Bank Supervisors. (Since then, the lawsuit was tossed out by the courts on the ground that the case was not “ripe” – that is, it was too soon for plaintiffs to show injury).
Taussig, the regulatory expert at Kabbage, reports that the Comptroller of the Currency, Robert J. Otting, has promised “a thumbs-up or thumbs-down” decision by the end of July or early August on issuing fintechs a national bank charter. He counts himself as “hopeful” that OCC’s decision will see both of the regulator’s thumbs pointing north.
The Conference of State Bank Supervisors, meanwhile, has extended an olive branch to the fintech community in the form of “Vision 2020.” CSBS touts the program as “an initiative to modernize state regulation of non-bank financial companies.” As part of Vision 2020, CSBS formed a 21-member “Fintech Industry Advisory Panel” with a recognizable roster of industry stalwarts: small business lenders Kabbage and OnDeck Capital are on board, as are consumer lenders like Funding Circle, LendUp and SoFi Lending Corp. The panel also boasts such heavyweights in payments as Amazon and Microsoft.
Working closely with the fintech industry is a “key component” of Vision 2020, Margaret Liu, deputy general counsel at CSBS, told AltFinanceDaily in a recent telephone interview. CSBS and the fintech industry are “having a dialogue,” she says, “and we’re asking industry to work together (with us) and bring us a handful of top recommendations on what states can do to improve regulation of nonbanks in licensing, regulations, and examinations.
“We want to know,” she added, ‘What the main friction points are so that we can find a path forward. We want to hear their concerns and talk about pain points. We want them to know the states are not deaf and blind to their concerns.”
Former Lendio Executive Leaves for Enova/The Business Backer
August 8, 2018
Enova announced last week that Jim Granat has joined the company as its Head of Small Business Financing. This will include oversight of Enova’s small business brands: Headway Capital, which provides lines of credit to small business, and The Business Backer, which provides merchant cash advances, among other products.
Enova acquired The Business Backer in 2015 for $27 million and retained its president and co-founder, Jim Salters – until recently. An Enova representative confirmed that Salters no longer works at the company. As Head of Small Business Financing, Granat will be assuming at least part of Salters’ role. An Enova representative also said that Granat will be relocating from the Salt Lake City area to Chicago, where Enova has its headquarters.
Granat comes to Enova as the departing president of Lendio, a sizable funder that has been growing and establishing new regional offices throughout the U.S. Prior to his role as Lendio President, just one step below co-founder and CEO Brock Blake, Granat was Chief Operating Officer at Lendio as of 2014.
Enova is a global financial products company. The Business Backer and Headway Capital operate under the Enova umbrella, but as distinct brands. In addition to merchant cash advance, The Business Backer offers term loans from $5,000 to $350,000, SBA loans, factoring, equipment financing, commercial real loans up to $75 million and business lines of credit up to $150,000.
Enova started in 2003 as Check Giant LLC. After several name changes and acquisitions, the company now has more than 1,100 employees and operates internationally. The company went public on the New York Stock Exchange in 2014 and trades as ENVA.
Elevate Offers Prime-like Credit Card to Non-prime Consumers
July 23, 2018Last week, Elevate (NYSE: ELVT) launched the Today Card, a credit card for non-prime consumers with features typically included only on cards for prime users. Some of the features for the new card include credit lines up to $3,500, a mobile app where consumers can check their balance, pay their bills, zero liability fraud protection, fraud alerts, and a credit score monitor that allows consumers to view their credit score and monthly credit reports. Elevate’s Today Card is being issued by the Capital Community Bank of Utah and powered by Mastercard.
“We’ve found that non-prime consumers lacked credit card options that provide ease of use and functionality,” Jason Goldberg, Today Card General Manager, told AltFinanceDaily. “We saw a need to bring a product with a prime customer experience, features, and benefits, coupled with larger credit lines to this segment. Our experience in underwriting, product design, and marketing to non-Prime consumers allowed us to thoughtfully and quickly bring this product to market in partnership with Capital Community Bank of Utah and Mastercard.”
This partnership of a fintech company with a community bank and a credit card payment network is part of a growing trend which was the central topic of a PwC study published last year. The report found that 82% of large participants in the banking industry expect to increase partnerships with fintech companies over the next three to five years.
“We are proud to be partnering with Capital Community Bank of Utah and Mastercard for this new product as we believe fintech and bank partnerships are the way of the future and important for fintech’s long-term success,” said Ken Rees, CEO of Elevate.
Elevate’s focus is to provide non-prime consumers with greater access to credit. One of the company’s more popular products is RISE, led by Tony Leopold, which provides unsecured installment loans and lines of credit to consumers with low credit who are often turned away by traditional credit providers. Elastic is another popular product under the Elevate umbrella that is designed for unexpected expenses. Elastic is a bank line of credit that makes it easy to access money as soon as the following business day.
Elevate went public on the New York Stock Exchange in April of last year. The company was founded in 2014 and is headquartered in Fort Worth, Texas, with offices in Dallas and San Diego in the US and in London and Bury St. Edmunds in the UK. The company employs 650 people worldwide.
Interest in Equipment Finance M&A is Strong
July 19, 2018
Interest in mergers and acquisitions (M&As) in the equipment finance industry has been high in the first half of 2018, according to The Alta Group, a consultancy dedicated to equipment leasing and asset finance.
This follows a May 22 Reuters report announcing that global M&As reached $2 trillion in 2018, which at the time of publication, was a record for the value of deals in that period. This record was achieved in part by the $11.1 billion merger of GE’s (GE.N) transportation business with rail equipment maker Wabtec (WAB.N).
Echoing the robust global M&A climate, Cincinnati-based Verdant Commercial Capital, a large commercial equipment finance company, announced on Monday that it had acquired Intech Funding Corp., which does financing and leasing for manufacturing companies. (The Alta Group was involved in this acquisition). No financial terms were disclosed for this acquisition.
“Several of our clients had not considered selling their businesses yet,” said Bruce Kropschot, Senior Managing Director of The Alta Group, “but M&A market conditions are so favorable now they concluded they could not risk missing out on the opportunity to sell while prices were high and there were many interested acquirers.”
In a statement, Kropschot attributed this favorable climate for M&As to “the relatively high multiples reflected in the stock market and the M&A market, interest rates that are still quite low, substantial liquidity in corporations and financial institutions, and the recent tax legislation with its lower corporate income tax rates and 100% expensing on equipment purchases.”
The Alta Group has clients throughout the world and has been representing equipment leasing and finance companies since 1992. It is headquartered in Glenbrook, Nevada and employs 60 consultants worldwide.
Tech Changes Lending And Payments The World Over
June 25, 2018
On a business trip to China last summer, Matt Burton had plenty of money in his wallet but it was practically useless.
Case in point: He had a lengthy standoff with a Shanghai taxi driver who insisted on a mobile-phone payment. “I spent 20 minutes arguing with the cabbie,” says Burton, one of the founding partners at Orchard Platform, a leading provider of technology and software to the alternative lending industry. “You’d think that — out of all of the professions — a taxi driver would accept cash.”
The New Yorker finally convinced the cab driver to take the payment in renminbi, China’s paper currency. The incident, meanwhile, is illustrative of how deeply and widely mobile payments have penetrated the huge Chinese market. “No one in China carries wallets anymore,” Burton reports. “Everyone pays with their smart-phones. Even the elderly women selling vegetables on the side of the road accept mobile payments,” he adds. “Cash has become a hassle.”
Welcome to China’s financial technology revolution. Almost overnight, China’s population graduated from calculating with the 16th-century abacus to showcasing what is arguably the world’s most sophisticated system of mobile payments. Thanks to financial technology, China is fast becoming a cashless economy. China is just one place outside the U.S. where financial technology is catching on in a big way. As Americans remain, for the most part, wedded to suburban drive-in banks, walk-up automated teller machines, and plastic credit and debit cards, the rest of the world is rapidly embracing digital solutions. And nowhere is that happening more dramatically than in China.
According to the most recent figures released by China’s Internet Network Information Center, the country had 724 million mobile phone users at the end of June 2017. China’s Ministry of Industry and Information Technology reports, moreover, that consumers paying for everything from food and clothing to utility bills to movie tickets and – you guessed it, cab fare — engaged in 239 billion mobile payment transactions in 2017, a surge of 146 percent over the previous year.
Mobile payments have become a $16 trillion industry in China, the ministry adds, accounting for about half of all such transactions in the world.
And there’s ample room to grow. The World Bank discloses that there are now 772 million Internet users in China, more than double the entire population of the U.S. Yet that leaves 50% of China’s population – mostly in the countryside and rural areas – who are not yet plugged in to the Internet.
Two Chinese mobile-payment platforms dominate the industry. Ant Financial is the 800-pound-gorilla, its Alipay program boasting 520 million global users on its website. It’s an affiliate of publicly traded Alibaba Group Holding, an online merchandiser known as the “Amazon of China” which was founded by entrepreneur Jack Ma, reputedly the richest man in China.
Alipay not only has bragging rights to roughly 60 percent of China’s digital and online payments market but, in 2013, it overtook PayPal as the global leader in third-party payments. With deep roots in e-commerce, Alipay is the go-to payments option for online shoppers, who are steadily migrating from laptops to mobile devices.
WeChat Pay is the upstart in the duopolistic rivalry. Launched in 2013, nearly a decade later than its rival, it’s a unit of conglomerate Tencent Holdings, a social network and messaging platform often compared to Facebook. As WeChat continues to add subscribers, its Tenpay app has been growing accordingly, eroding Alipay’s market share as new users gravitate to the e-payments program. While WeChat records fewer payments than Alipay, Forbes magazine reports that it claims more users.
Whatever WeChat’s virtues, Ant Financial continues to chew up the scenery. It recently topped the charts as the world’s “most innovative” fintech in 2017, as reckoned by a research team formed by accounting giant KPMG and H2 Ventures. China scored a hat trick, moreover, as two additional homegrown fintechs — online property-and-casualty insurer ZhongAn and credit-provider Qudian Inc. — took second and third place, respectively, in KPMG/H2’s rankings. For good measure, China also claimed five of the top ten spots on the “most innovative” list, edging out the U.S., which had four.
Financial analysts recently surveyed by the Financial Times reckon Ant Financial’s market valuation at $150 billion, catapulting the company into the rarified status of not just a “unicorn,” but a “super-unicorn.” (Named after the rarely seen mythical one-horned horse, “unicorns” are start-ups valued at $1 billion). So robust is Ant Financial’s market valuation that the global investment community is salivating over its impending initial public offering.
(Ant’s progenitor, Alibaba, holds bragging rights as the largest IPO ever, according to the Financial Industry Regulatory Authority. It raised $21.8 billion in 2014; its NYSE-listed stock was trading at $194.36 in mid-May, essentially in the same league as Apple and Facebook, trading at $188.80 and 187.08, respectively, on Nasdaq.)
“Four of the largest fintech unicorns in the world are coming out of Asia,” notes Dorel Blitz, the Tel Aviv-based head of fintech at KPMG. “The companies are getting bigger and stronger,” he adds, “and you’re beginning to see more direct investment in public fintech companies as well.”
Adds Orchard’s Burton: “I think it shows you how massive the opportunities are outside the U.S.”
Ant Financial and WeChat are also serving as a world-class demonstration project on how fintechs can turn a tidy profit while opening up financial services to large populations who lack access to basic financial services, thereby providing entry to the middle class. The two platforms have provided “financial inclusion for tens of millions, if not hundreds of millions of people” who previously were on the periphery of the banking and financial system, says Kai Schmitz, a fintech lender at International Finance Corporation that lends to private businesses in the developing world.
Once people are making electronic payments on their mobile devices, Schmitz notes, it creates a “pathway” to a whole panoply of financial services, including personal and business loans, savings, insurance, and investments.
“You can create a user profile so that a large part of the population that could not be reached (by traditional financial institutions) are now making payments and can be followed on the data track,” he says.
The World Bank reports that two billion adults and 200 million businesses in the developing world are currently unable to access even basic financial services. Through IFC, the World Bank has invested $370 million in fintech companies operating throughout Asia, the Middle East, Africa and Latin America. The fintechs, an IFC communications manager told AltFinanceDaily, offer “a range of products and services — from e-wallets, virtual banks, lending, and online payments to retail payment points and exchanges.” IFC, she adds, also invests in fintech funds.
Anju Patwardhan is the U.S.-based managing director at CreditEase Fintech Investment Fund, a $1 billion Chinese venture capital firm that invests in fintechs delivering financial services to “unbanked” and “underbanked” populations. “They are living in Africa, Bangladesh, China and elsewhere on less than two dollars a day and have no access to financial services,” she says.
“But there are also a very large number of people who may be technically included in the financial system but still don’t have access to a full range of financial services at reasonable prices,” she adds. “If someone is borrowing from a moneylender or pawnbroker, it doesn’t count (as financial inclusion). In that case, the number of people is very much more than two billion.”
Once phone towers are built and a payments infrastructure is in place, fintechs promising more sophisticated financial services can operate similarly to the settlers who followed pioneers in the U.S.’s westward expansion. That’s been the story in Kenya and other African countries where M-Pesa (“pesa” is Swahili for money) and other mobile-phone payments systems set up shop a decade ago.
Branch International, based in San Francisco but doing business exclusively in emerging and frontier markets for only three years, is one of the settlers. It boasts that it now has the “No. 1 finance app in Africa.” In March, Branch raised $70 million in a second-stage round of debt and equity financing from a group of venture capitalists led by Trinity Partners that included Patwardhan’s CreditEase and the IFC. Patwardhan will serve as an advisor to Branch’s board.
Branch’s principal business is making loans and micro-loans ranging from as little as $2 to $1,000 in Nigeria, Kenya, and Tanzania. Despite its name, Branch touts itself as a “branchless bank”, all of the credit transactions taking place on mobile devices, says Matt Flannery, Branch’s chief executive and founder. Its average loan amount is $25.
Many of Branch’s customers are individuals and businesses who often had trouble obtaining credit from established financial institutions or were ineligible for loans. But, according to Branch’s website, it’s possible for a prospective borrower to obtain a loan in just a matter of minutes. “Branch eliminates the challenges of getting a loan by using the data on your phone to create a credit score,” the website says. Branch promises privacy, fees that are “fair and transparent,” and terms that “allow for easy repayment” with no “late fees or rollover fees”. “As you pay back on time,” the website also says, “our fees decrease, and you unlock larger loans with more flexible terms.”
The platform, CEO Flannery says, has lent out $100 million dollars to roughly that same number of people. “The formal financial system in African countries is generally composed of old-fashioned banks that are risk-averse and fairly slow to make lending decisions,” he says. “People really appreciate us,” Flannery adds. “I’d say we’re like Uber and they’re the horse-and-buggy.”
The company is growing by 20 percent month-over-month and expects to disburse more than $250 million in 2018. Asked to describe Branch’s typical borrower, Flannery says: “We have some rural users (of Branch’s finance app). But in general we’re serving the commercial middle-class — shopkeepers and entrepreneurs – in urban capitals.” Want to know precisely who Branch’s customers are? “Just go to downtown Lagos (the capital of Nigeria and the largest city on the African continent) and you’ll see all different kinds of businesses and single-owner merchants on street corners,” Flannery says.
Jeff Stewart, the founder and chairman of Lenddo (which recently merged with competitor EFL) asserts that his firm’s machine learning technology and risk modeling techniques, which are being deployed in emerging countries from Costa Rica to The Philippines, have the capacity to assess the “creditworthiness of everyone on the planet.” In the absence of credit history in much of the developing world, he explains, this can done by constructing a risk profile combining both “psychometrics” and a “digital footprint.”
Psychometrics is a behavioral assessment tool based on a prospective borrower’s “Big Five” personality traits: openness to experience, conscientiousness, extraversion, agreeableness, and neuroticism (OCEAN for short). “What we’ve been able to show,” Stewart asserts, “is that certain personality types have a positive and negative correlation with repayment. It’s not 100 percent accurate. But you can predict the statistical recovery ratio on repayment. You can say that, for a person with a high score, something like 88 out of 1,000 people (with his or her profile) would not repay.”
The digital footprint, which is the second “critical component,” Stewart says, analyzes a prospective borrower’s reliability by reconnoitering their smartphone usage. “We’ll look at everything on your phone,” he says, “How you use the phone. Whom you interact with. When you use your phone. There are thousands of features that generate a digital footprint. Everything from meeting someone at a sports bar to the apps on your phone to things like e-mailed receipts that show your financial activity.”
Such methods help build credit for those lacking credit history while rehabilitating those whose credit history is blemished. And all that’s needed is a smartphone. “We’ve turned the smartphone into a credit bureau,” Stewart says.
The acquisition of smartphones is taking place at a blistering pace, Stewart notes, now that cell phone costs are “at the bottom of the cost pyramid” in many countries. For example, a “low-end Android” now fetches as little as $25 in Africa. “One credible study I’ve seen shows that every 10% percent rise in access to smartphones translates into a 1/2 percent rise in a country’s gross domestic product,” Stewart says.
While the private sector is driving the trend to financial inclusion in China and Africa, India’s government-driven model “is setting a new global standard in using financial technologies to support financial inclusion,” declares Patwardhan of CreditEase, who also lectures at Stanford. “The country has become a giant testing ground for financial inclusion and innovation,” she argues in a recent academic paper, “and may become a role model for other emerging economies.”
India’s state-run effort includes a $1.3 billion digital identity program known as Aadhaar. Under Aadhaar (which means “foundation”), the state issues residents a 12-digit identity number that’s based on their biometric data –such as fingerprints and iris scans — and personal information. The ID number covers more than 1.19 billion residents. In just the first two years after Aadhaar’s 2009 debut, Patwardhan says, more than 250 million Indians were able to open bank accounts.
Jo Ann Barefoot, chief executive at Barefoot Innovation Group in Washington, D.C. and a senior fellow emerita at Harvard’s Kennedy School of Government, agrees. She notes that Aadhaar opened up access to both fintech services and bank accounts to women who were long treated as second-class citizens by the social and economic system. “India’s digital ID program means that wives and daughters have identity now,” she says.
“In the past,” she adds, “only (male) heads of households would have family identity documents and a government card — which would be the equivalent of having a Social Security number in the U.S. But the wife wouldn’t have her own card. So this is a massive door-opener to fintech growth. And it’s also opening up (all areas of) finance to millions and millions of people.”
India’s “digitalization” program, moreover, has entailed development of a national payments network called “unified payments interface,” or UPI. The combination of UPI and Aadhaar as well as other digital initiatives have resulted in “a surge of online lending platforms,” says Patwardhan, citing Capital Float, NeoGrowth, Faircent, LendingKart, Quiklo, IndiaLends, CreditExchange, and Onemi.
The homegrown fintechs, however, will be up against tremendous external pressure as India, with 1.3 billion people and poised to overtake China in population growth, is generating enormous interest from global fintechs. Among outside platforms piling into the country are China’s Ant Financial and WeChat. The former took a $1 billion stake in Paytm, an Indian mobile payments and e-commerce company. Similarly, competitor WeChat’s parent, Tencent, has invested in Hike, a mobile wallet valued at $1.4 billion last June, according to CNBC, exciting investor interest as a unicorn.
U.S. companies are getting into the act too. Google launched digital payments app Tez last September, which “is taking advantage of India’s infrastructure and has already gotten 30 million downloads,” Patwardhan says. In February, Facebook rolled out a peer-to-peer payments feature on WhatsApp. Even Branch’s Flannery has announced that his “branchless bank” plans to earmark part of its $70 million war chest to offer $2-to-$1000 loans on the subcontinent.
Having banned high-denomination paper bills as a way to rein in corruption and aiming at a cashless economy, India has been innovating in ways that “have gone the Chinese one better,” marvels Patwardhan. “Their payment systems going through the UPI network are interoperable,” she notes, for example. “You don’t have to be on the same app or with the same bank. India is now on the cutting edge.”
