The last couple of days at Fintech Meetup were intense and well worth the time to attend.  Like other fintech conferences, innovation was a theme brought out in the keynotes and the engaging discussions across the panels.  The aspect of this conference that stands out from any other is its 1:1 meeting program.  Conference attendees participate in back-to-back, carefully curated 15-minute meetings with people who want to collaborate.  This is a roll-up-your-sleeves conference where attendees come together to make things happen!  It was outstanding!

Here are some themes that emerged from the many conversations:

• Fintechs are continuing to modernize small business lending and provide access to capital for underserved businesses that have been traditionally overlooked by the banking system because of the cost to serve.  Using technology to automatically access accounting data is not new – but there have been advancements in technology to process disparate data and a wider ability for lenders to access business sales data by tapping into payment systems and ISVs.  This continuous and real-time sales data allows lenders to paint a more forward-looking and better picture of the financial health of a business to inform risk and underwriting.  The government is leaning in to support technology innovation in small business lending by modernizing SBA lending, including granting the first SBA license to a fintech (Funding Circle).  Partnerships and collaboration with fintechs, banks, payfacs, and ISVs will continue at a faster pace.  There is a lot of optimism for the future and a sense that we are still early in this journey – there will continue to be many opportunities for banks to work with fintechs to provide capital to small businesses, which will ultimately help small businesses better operate and grow.

• The current investment and funding environment for early-stage Fintechs has improved, while later-stage activity is still quiet while these companies focus on cash flow, profitability, and cash burn.  There is wide agreement that companies will be coming out stronger having managed through high and low market environments.  VC outlook is selectively optimistic.  Many are very excited by embedded finance and vertical SaaS where there is the potential for network and flywheel effects, and with cross-border payments given the size of that market.  While wealthtech presents automation opportunities, distribution seems difficult.  There are mixed opinions about B2C and crypto.  Most VCs believe lending is not attractive, however, Ryan Gilbert refuted those opinions with his statement that “credit is like oxygen and that we need it to live”.  He further stated that while valuations are lower due to the interest rate environment, their function is critical and there are exciting opportunities in this space. 

• Real-time payments have been slow to gain adoption, but bank implementations are accelerating.  Fintech software can be an enabling force to power banks and support bank and consumer adoption.  Payment routing (ACH, Same Day ACH, RTP, FedNow) ultimately depends on whichever method makes the most sense for the use case – criteria such as speed, credit push vs. debit pull, weekend settlement, and revocability all factor into the type of payment rail that could be used.  The outlook is exciting as we get closer to broad usage and develop new financial service products on the ISO 20022 layer that leverage increased speed, certainty, and availability as part of their value propositions. 

• There was a huge focus on best practices for bank and fintech partnerships and associated compliance considerations given recent regulator actions.  In this regulated industry, banks need to control their risk management obligations and they are the ones that own the compliance of their fintech partners.  Fintechs need to understand they are a service provider to the banks and *not* the other way around.  Regulatory controls, due diligence, trust, and ongoing oversight are needed to make it work.  As part of the relationship, banks should collaborate with fintechs on the messaging with the regulators, even though it is only the bank at the table.  Banks will take time to evaluate new fintech relationships and Fintechs need to get into the list of priorities the bank is working on.  Expectations, intentions, and timing should be made clear upfront without stringing anyone along – otherwise, the fintech should move on and search for another bank partner.   

• Compliance is a competitive advantage.   Data, tools, and technology are being developed to strengthen risk management and compliance functions for financial service providers and to support the compliance function between providers.  Financial service providers are not able to be nimble if they are stuck in compliance.  These technologies free people out of low-level compliance tasks, so the FIs can redeploy the same resources to understand the data, interpret the data, and work with the data faster.  This frees them to focus on product innovation for the benefit of the consumer.  For example, FairPlay and Upgrade discussed how FairPlay’s fair lending analytics software enables Upgrade to have customizable, real-time, continuous improvements and tweaks to their models which gives them confidence when there are changes in products, population, customer behavior, or data.  The analytics and feedback are iterative and they can adjust their models on the fly for continuous improvements. 

• There is rapid adoption of GenAI with companies actively experimenting and deploying this new technology, particularly in services and functions that require lots of reading and writing (insurance, legal).  We will likely see case studies on how GenAI is being used in the market and the impact within the next year.  The profit pools in retail banking will decline since consumers will be able to rapidly find the highest rates for savings and lowest rates for loans.  Retail banks should not rely on customer inertia – they will need to focus on other stickiness beyond price.

The conference was very optimistic and collaborative.  There are several reasons for this – we are at the start of a fresh year, the tone from leaders in the industry was positive about the opportunities in front of us *now*, the conference attendees are action-oriented and want to get things done, and the structure of conference absolutely supported meaningful connections and potential collaboration.  There will be partnerships and innovation as a direct result of this year’s Fintech Meetup, and I am so looking forward to seeing what is developed and built!

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The vast diversity of Small Businesses requires nuanced banking solutions and experiences

The American Banker Small Biz Banking conference took place this week, November 13 – 15, in Nashville TN. It was my first time at this conference and my first experience in Nashville. Both exceeded my expectations! I was impressed with the keynotes and panel discussions with leaders bringing unique perspectives and some conflicting opinions.

The mix of attendees across community banks, credit unions, larger banks, and digital-first small business fintech providers created some interesting conversations, particularly around digital innovation and the importance of human relationships. The small business banking market is vast with many different sectors and approaches—and it was fascinating to speak with a wide array of providers serving the industry.

Here are some themes that emerged from the many conversations:

• Advances in technology and access to external transaction data can allow banks to look beyond their internal data to better understand their customers. Banks now can augment internal data with external data to achieve a more holistic and real-time view of the health of a small business which could have a profound impact on marginalized customer segments and communities.  Despite its power, there will be challenges for the industry. Customers still need to gain comfort with sharing their transaction history, and data is not uniform across the lenders. Standards and a common framework are needed, including consistency, reliability of connections, and security.

• Marginalized customers have had difficulty accessing small business credit. This was highlighted during the pandemic when marginalized small business owners who needed support most were not getting it. Recent regulator activities, including Rule 1071, illustrate their position that small business aligns more with retail/consumer versus commercial, and this focus will continue.  Small business bankers need to strengthen compliance efforts to meet regulator expectations. Rule 1071 is a fair lending rule, not a data collection rule—and it is not going away. Banks need to keep their foot on the gas pedal and spend time preparing before their lending decisions and data are published for all to see. The CFPB will be looking for good faith efforts of banks to implement the rule into bank policies and procedures, validating the accuracy of data, developing effective training programs for data collection, and timely and accurate data submissions.

• Small business lending has slowed considerably. Banks have modified their risk appetite and small business owners are more hesitant to take on more credit given increased interest rates and market uncertainty—they are in a “wait and see” mode. As a result, banks are shifting some focus toward ancillary services and core small business banking needs such as receiving and making payments.

• Banks need to constantly innovate to stay in the same place or they run the risk of being left behind. Building from scratch takes time and is expensive. “Speed to market” requires partnering with fintechs. There is a need to work with them to enable better banker and customer experiences — anything to create ease, speed, ancillary service, or the ability to get to “yes” more often. Banks are partnering with fintechs to strengthen operational capabilities (e.g., analyzing alternative data for LMI lending opportunities, fraud decision engines, compliance support, etc.) and to provide complementary services and experiences to small business customers (e.g., small business cash flow visibility and forecasting through a visual platform).

• Generalization will not work any longer and banks should be approaching the market with unique specialization and product bundles to solve nuanced small business needs—for example, the banking needs of a doctor or dentist are very different from an agriculture business—further, size matters.  Banks are resetting their philosophies away from being “lenders” to being “bankers.” Some best practices include focusing efforts to deepen the relationship within the first six months of the relationship and forming integrated teams of the relationship banker and specialists (e.g., payments, wealth management) to have conversations with small business owners to uncover specific customer needs and goals to create a compelling value proposition for that customer. One small business account relationship can lead to new personal accounts, wealth management, mortgages, home equity loans, employee accounts, etc. Small business deposits are the most attractive compared to deposits for other customer segments, given their lower cost/interest rates. With the increase in customer churn because of bank failures this past Spring, product bundles can help improve the stickiness of small business deposits. 

• Digital is accelerating but the extent and perceived relevance differ greatly by customer segment. Many discussed the requirement for a human element (even with digital onboarding) to cultivate the relationship and support the business owner in specific situations (e.g., fraud events) and for overall advice. You can automate transactions, but not trust, and you need bankers where the people are. Even some digital-first providers discussed the need for bankers, whereas others are delivering on customer experience and not on relationships. These differing approaches can still succeed and work well for the intended customer segment.
• Significant opportunity exists for automation across many aspects of small business banking (onboarding, marketing/prospecting, underwriting, compliance). Technology investments are most commonly going towards mobile banking, security/fraud, and automation to serve SMBs.
• Digitization and e-signatures come with a cost of fraud, which has increased significantly in recent years. For example, there has been an increase in corporate identity theft of dormant companies, with fictitious tax returns or even payment of tax liabilities and penalties to put the business in good financial standing to subsequently take out loans across multiple banks.

Small businesses are incredibly diverse, and their owners have varied financial service needs.  They are passionate about their businesses, not necessarily specific bank products. The industry is working hard to better support small business owners’ needs and experiences —with the dizzying array of small businesses it makes sense there would be different approaches to solving their banking needs. This is a fascinating and complex market sector with the potential for great value creation as providers continue to dive deeper and deliver nuanced financial solutions and experiences.

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Here are some thoughts and observations: 

• There was and will continue to be much discussion about open banking, open data, and 1033.  1033 will be a massive change requiring the sharing of data historically enjoyed by the largest of banks.  Some benefits seem to be proven, agreed upon, and understood such as the ability to use account cash flow data to improve access to credit for consumers who lack credit bureau history.  In addition, the industry seems most excited about the potential ability to use real-time longitudinal data to create richer, more personalized, and customized products and services in the future.  While it is agreed that consistency and accuracy of data will benefit the industry, some argue that this will come with increased costs for implementation and ongoing compliance – the value should exceed the cost.  Technology will improve and it is expected that consumer adoption will continue, thus increasing benefits to product and service providers.  With 1033 it is now crystal clear that the consumer owns the data – but infrastructure needs to be put in place to hold the data and protect PII.

• There is bumpiness in the regulatory environment.  All eyes – from banks to fintechs – are on regulatory developments and enforcement actions.  Compliance should be at the forefront and serve as the foundation for businesses with constant engagement between business leaders and internal risk/compliance.  Understand the purpose of the regulation and the customer interest it is protecting instead of getting frustrated by its specific requirements. 

• There is an increased emphasis on partnerships – who has a seat at the table with you for mutual benefit such as value creation or enabling infrastructure.  Banks are becoming much more active in working with fintechs and it’s not just testing.  The ability to problem solve and increase performance helps to create a great partnership.  Bank and non-bank partnerships need to be aligned on a solid foundation of compliance. 

• There are significant data and automation opportunities to improve access to products and services in small business banking.   While banks typically provide a bank account, payments, and working capital, others in the market are providing more services that are needed including payroll, marketing, CRM solutions, and others.  Historically relationships with bankers and small businesses were done over a handshake.  This is being replaced with access to new sources of data that enable a holistic view of a business’s past and where they are headed – this includes cash flow and merchant services as a start.  Expanding into utility bills, supplier payments, lease payments, and other transactions is critical. 

• Banks are modernizing, but it is a massive effort that requires investment in time and resources.  A best practice is to integrate legacy system owners and the builders of the new architecture into a cohesive team to drive the change needed to support existing businesses and set up the tech stack to enable innovation. 

• Fintech has entered a new era with the advancements in technology and data used by good and bad actors.  Technology – cloud, the use of APIs, AI – are still rapidly evolving.  There will be continued growth in the areas of infrastructure, frictionless transactions and experiences, fraud, and security.

The industry has certainly been through much this year with bank failures, significant increases in interest rates, a pullback in investments, and more recently a war that has directly impacted families and business leaders across the world.  Despite these challenges, Money 20/20 was instead focused on the opportunities in the future while recognizing the need for solid foundations in business models and compliance.  Crypto was de-emphasized.  Businesses facing significant financial challenges were simply not in attendance.  It felt great to network and learn from others to get back to business and look toward the future. 

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Why Buy-Now Pay-Later is Growing so Quickly

Over several years there has been much interest and discussion around Buy Now Pay Later (“BNPL”) and its role within consumer credit.  The concept of paying for a purchase in installments is not a new concept at all—in the distant past however, it was incredibly inefficient compared to electronic ways to pay and finance at the point of sale, like credit cards. The use of technology to streamline the customer experience at the point of sale has brought the product back in popularity. While we are several years into its resurgence, there are still developments and shifts in the market that make it important to watch if not participate in.   

A BNPL product facilitates a purchase whereby the purchase amount is split into generally four payments over a six-week timeframe without an interest cost during the payment period.[1] The product was already on a growth trajectory, and then COVID propelled its growth as online purchases became more of the norm. The current BNPL market is sizable and will continue to grow significantly. BNPL purchases in the United States totaled nearly $100 billion in 2021, up from $24 billion the prior year.[2]  Worldwide BNPL volume in 2021 was $680 billion and is expected to grow to $1.1 trillion in 2025.[3] 

Benefits for both sellers and buyers help to drive the strong growth in the market:

• Benefits to Sellers: The strongest benefit is incremental sales. With advanced technology and data, BNPL providers can underwrite and approve more customers. Potential buyers complete their purchases through a compelling user experience along their purchasing journey. Sellers also benefit from fraud protection.

• Benefits to Buyers:  BNPL is an economically rational product compared to other forms of financing like credit cards. For users who do not own credit cards, the product enables users to access financing. BNPL financing is more economical compared to higher-cost credit cards[4] since financing is cost-free if all payments are made on time. BNPL has more transparency and predictability with its installments, helping consumers work with their budgets and manage their spending since they have known installment obligations.  Perhaps most compelling is that BNPL provides the benefit of credit while using money that consumers have on hand—in fact, many BNPL products in the market have been structured so users cannot go into perpetual debt.[5]  Further, BNPL appeals to Gen Z that has fully embraced the smartphone and generally has a lukewarm attitude towards credit.

While pure-play BNPL providers have suffered lower valuations recently (as with many fintech players), their recent top-line performance illustrates the relevance of the BNPL benefits to the market:

Risks, Resiliency, and Regulation

Given the exponential growth in BNPL and the emergence of new entrants, there has been much attention in the market, including that from regulators. The CFPB put forth an inquiry and obtained data from BNPL firms including Affirm, Klarna, and AfterPay, and through their research published a report in September 2022[6] voicing concerns around debt accumulation and overextension, data harvesting and monetization, and inconsistent consumer disclosures and protections (e.g., disclosed fees, dispute protections, customer service for handling returns and refunds, etc.).[7]  This investigation was justified since regulators need to understand significant market developments, potential risks created in the market, and their impact on consumers. 

Since BNPL transactions and their payments are currently not reported to the credit reporting agencies, there is limited visibility to the true volume of BNPL transactions, the overall market performance of these loans, impacts on consumer debt burden, shift in usage from credit cards to BNPL, and other analytics. This poses a great risk to lenders since they do not have full visibility into a consumer’s financial picture. Each of the credit rating agencies has put initiatives in place to begin the capture of these transactions,[8] and these efforts are still underway. 

The rising interest rate environment is also a risk in the industry for pure-play monoline BNPL providers; however, their earnings releases and the growth in volumes will represent growth in top-line revenue.  The profitability of these players and their sustainability are significant concerns.

The nature of BNPL requires instant underwriting decisions with the goal of high approval rates. These requirements seem in conflict and could lead to a misperception that the underwriting for risk is not robust. This is an incorrect generalization—many providers, lenders, and banks are using credit information, other sources of data, and proprietary risk models to assess the customer’s ability to pay—the same approach as with other unsecured credit products, except that BNPL typically has smaller sizes. 

How the Industry Structure is Changing

Traditional suppliers of consumer credit and other industry leaders have responded to the opportunity (and threat) of installment lending and BNPL:

• Credit card issuers have developed hybrid functionality. Programs like Amex Pay Later, Citi Flex Pay, and Chase My Plan enable cardholders to select specific purchases and pay overtime in fixed installments. 

• Banks are introducing BNPL quickly with technology partnerships. While banks have a long history of underwriting, they traditionally have lacked the ability to leverage technology to provide products to consumers that are accessible when it matters the most. Technology providers such as Jifiti, LiftForward, and others provide the technology infrastructure linking banks to merchants and enabling embedded finance solutions including BNPL. 

• MasterCard and Visa have each launched their own programs that enable lenders the ability to offer BNPL at checkout across their merchant networks.

• Big Tech is getting into the game in a big way. Apple Pay Later was launched in March 2023^[9] to select users.  The service will enable users to split purchases into four installments, and users can manage these loans in their Apple Wallet. This is particularly interesting in that Apple already has a wide reach into the iPhone customer base and is integrated into Apple Wallet—customer acquisition will be inherently easier for them compared to other providers, and authentication of the borrower is already built into the device.

A big question remains about the quantified impact of BNPL on other consumer credit products.  Consumer attitude is compelling towards BNPL in that the product is more flexible and better aligned with the customer’s financial needs and interests compared to credit cards.  

The growth of the market and the economic benefit of BNPL does indicate there this likely some displacement of credit card volumes to that of BNPL. This could be better quantified once BNPL transaction activity is fully reported to the credit rating agencies.

Looking Ahead and Implications

BNPL is young in its life stage and the market has been evolving rapidly.  This is what we can expect to see going forward:

1. There will be more regulation with clearer requirements for treating BNPL as credit—the industry will need to work with regulators during this journey. The regulators need to spend time having conversations and working with data so they can figure out how the industry works and where the true risks lie. It is imperative for the industry to work with the regulators during this journey. Expect more regulation, guidance, and rules for BNPL like that of credit cards (note:  a similar move was just enacted in Australia[10]).  This will include consumer protections, bureau reporting, supervisory examinations, disclosures, data privacy, etc. Regulatory pressure will create a rougher period in the near term, but the industry will be stronger on the back end.

2. BNPL will be included within credit bureau reporting—providing more visibility into BNPL and adding information to borrower credit reports. Each of the credit rating agencies is building infrastructure for BNPL reporting, which will take time for completion and use by lenders and furnishers. In the interim, some lenders will use alternative sources of data (e.g., cash flow data) to provide a clearer picture of the credit risk of their customers/applicants.  Once BNPL is fully integrated into the reporting, there will be more transparency on the BNPL performance, impact on other credit products (e.g., credit cards), and quantified impact on consumer debt burdens. From a borrower’s perspective, BNPL could be a path to establish a credit file, and these tradelines will add more information to existing credit files.

3. Consumer adoption will surge—keep your eyes on Apple Pay Later. JD Powers estimates that the percentage of U.S. consumers with a BNPL account was 22% in January 2023, up from 18% in October 2022 and 14% in July 2021.[11]  Strong adoption will continue as more users become familiar with the economic benefits of the product. Apple Pay Later will help to raise awareness of BNPL with its iPhone users, who will likely have delightful user experiences with the product. 

4. Additional use cases and merchant categories will expand.  BNPL will continue to go upscale with larger purchases such as travel. We will likely see BNPL that combines multiple purchases into an “experience” bundle—such as trip expenses (airfare, hotel, car, meals, event ticketing), back-to-school shopping across several retailers, holiday shopping, etc. BNPL products will be developed for B2B purchases, freeing up the cost of financings and improving cash flow for suppliers. B2B BNPL is already happening in international markets and is estimated to be a $200B opportunity in Europe and the U.S.[12]

5. BNPL providers will diversify or be acquired. BNPL as a stand-alone product is not a sustainable model since it is difficult to own a customer relationship or address their broader financial service needs. Pureplay BNPL providers will need to diversify their product offerings to enhance their revenue streams and build customer loyalty.  They need to drive to become profitable or will continue to suffer from low valuations and represent bargains for potential acquirers.

6. There will be more BNPL participation coming from traditional banks, including incumbents with existing merchant relationships.  Technology providers are building programs and solutions to make it easier for banks of all sizes to participate.  Larger institutions with existing merchant relationships (e.g., issuers with retail relationships for private label and/or cobrand portfolios), banks with merchant acquiring services) are likely to capitalize on these relationships and find more opportunities to serve them with their credit capabilities including BNPL.

7. Meet your customers where they are – evolve from product-centric strategies to customer-centric strategies based on customer needs.  Think about customer needs and their journey along the purchase process and how they prefer to pay.  If you are not already offering BNPL, you should research what your customers need to determine if you should participate.  Determine how important the Gen Z customer base is for your business and understand their payment preferences.  Offering more choices to customers can support their acquisition, loyalty, and retention.

8. Lenders, tech providers, and sellers will need to increase their focus on implementing strong risk management and compliance programs over their partner relationships.  On June 9, 2023, the Fed, OCC, and FDIC issued inter-agency guidance on the risk management of third-party relationships and includes discussions on governance, oversight, accountability, independent reviews, documentation, and reporting[13].  BNPL depends on connections between lenders, sellers, and in many cases technology providers.  Expect heightened focus from regulators in the risk management program, governance, and monitoring of these relationships.

Continuing the Conversation

BNPL is an economically rational product that provides many benefits to buyers and sellers.  BNPL is in a resurgence and is young in its life stage compared to other more mature credit products such as credit cards. Governance over BNPL—such as credit bureau reporting and regulation of BNPL as a form of credit—has not caught up to the popularity of the product. This will happen in the near term. 

Despite the regulatory uncertainty as the product matures, the supplier landscape is responding rapidly, including traditional banks which are able to participate quickly by partnering. Consumer adoption will accelerate, and Gen Z will represent a key market segment. While BNPL is relatively new in its evolution and guardrails still need to be put in place, current data does not clearly indicate that the product is inherently bad for the industry or for consumers. More will be proven over time, but in the meantime, we can fully expect the market to continue to grow and represent great opportunities to meet customers where they are.

Please contact me if you found this of interest and would like to continue the discussion!

[1] Other payment and financing mechanisms at the point of sale include installment loan financing (at an interest rate over a term), private label credit cards, other credit cards, etc., and are excluded from the definition of BNPL.

[2] Source:  Cornerstone Advisors, https://www.forbes.com/sites/ronshevlin/2021/09/07/buy-now-pay-later-the-new-payments-trend-generating-100-billion-in-sales/?sh=7f96781e2ffe

[3] Source:  CB Insights, https://www.cbinsights.com/research/report/buy-now-pay-later-outlook/

[4] A recent CFPB study estimates that a majority of BNPL borrowers would face credit card interest rates between 19 and 23 percent annually if they had chosen to make their purchase using a credit card.  Source:  Consumer Use of Buy Now, Pay Later: Insights from the CFPB Making Ends Meet Survey | Consumer Financial Protection Bureau (consumerfinance.gov)

[5] For example, the AfterPay product has been structured with responsible spending rules and consumer protections built into the service (e.g., payments via debit, late payment fees fixed/capped and suspended service, rewards for responsible spending).

[6] CFPB Study Details the Rapid Growth of “Buy Now, Pay Later” Lending | Consumer Financial Protection Bureau (consumerfinance.gov)

[7] Director Chopra’s prepared remarks on the release of the CFPB’s Buy Now, Pay Later report | Consumer Financial Protection Bureau (consumerfinance.gov)

[8] Everything You Need to Know about BNPL Credit Reporting (jifiti.com)

[9] https://www.apple.com/newsroom/2023/03/apple-introduces-apple-pay-later/

[10] https://amp-abc-net-au.cdn.ampproject.org/c/s/amp.abc.net.au/article/102368810

[11] https://www.jdpower.com/business/resources/battle-buy-now-pay-later-customers-being-won-point-sale#:~:text=According%20to%20our%20data%2C%20the%20total%20percentage%20of,in%20October%202022%20and%2014%25%20in%20July%202021.

[12] https://www.pymnts.com/bnpl/2023/demand-for-flexible-b2b-payments-fuels-eu-bnpl-growth/

[13] https://www.federalregister.gov/documents/2023/06/09/2023-12340/interagency-guidance-on-third-party-relationships-risk-management

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The keynote by Greg Palmer recognized that it will no longer be good enough for providers to simply outrun their direct competitors.  The industry is now at an inflection point with many external pressures and customers expect more; the next 5-10 years will be transformational as providers adapt and compete within this broader context. 

Here are some themes I observed at the conference:

1. AI and data should be harnessed to truly understand your customer and deliver personalized customer experiences.  Gone are the days of product-focused cross-selling efforts – a requirement is customer engagement along a customer journey, all supported by data and analytics.  Data is not valuable until it is processed to uncover insight and action.  Providers need to start with customer needs as they develop products and include strong feedback loops.  Apiture lead a fantastic discussion showing examples of how a bank can leverage data to build a symbiotic relationship with customers over time and over life stages, creating a relationship where the customer feels like the institution understands their challenges and objectives over the years. [Square, Apiture]

• Gen Z will have an enormous impact on the industry.  The generation is influenced by social media, TikTok, and video and trusts PayPal more than banks.  Providers will need to adjust to attract this generation as employees, customers, and suppliers in the coming years.  Climate and sustainability are of great interest to this generation and there has been a call to action for providers to substantiate climate in their products and services with integrity.  [Insider Intelligence, Carbon Zero Financial]

• Non-banks and Big Tech have achieved share of mind as there is a higher ability and lower barrier of entry to offer financial services.  Javelyn reported that 52% of consumers indicate that their financial relationship is with a non-bank, and this figure rises to 69% for Gen Z.  In the current and future landscape, traditional FIs will be competing against players that exist on someone’s phone.  Big Tech (Apple, Amazon, Meta) influence on financial services is massive as they continue to diversify their revenues, capture more data, and drive customer engagement.  Cornerstone Advisors estimate that embedded finance will be a $26B market in 2026.  Banks and fintechs need to integrate more, but existing infrastructure limits delivering the products and experiences that customers require.   70% of attendees think overcoming legacy thinking and legacy systems is the roadblock to achieving digital transformation.  [Javelyn, Cornerstone Advisors]

• The industry will need to incorporate new technologies that will fundamentally change the landscape.  Generative AI is the most promising of those, and banks will need to start small and begin experimenting internally and with non-sensitive data.  While the Metaverse was discussed, attendees do not view it as being truly transformational.  RTP in the US needs to happen, but it will take time.  [Celent, Cambrian Ventures, Lightspeed Venture Partners, Moov Financial]

• Many expect BNPL will continue to surge and place some pressure on existing consumer credit products such as credit cards.  Adoption will continue with consumers and merchants given the strong value proposition for the product.  Regulation is developing but this is perceived as good for the industry.   Credit bureau reporting is still being implemented, and will enable more data and insight on usage and performance. [Insider Intelligence, LendingClub, Tavant, FTV Capital]

• We have made progress with financial inclusion but there is more work to be done.  More underrepresented people have accounts and there are more digital payments since the pandemic.  However, the wealth gap needs to close through home ownership and savings, and consumers need to have a better ability to manage cash flow and gain access to cheaper and more efficient payments.  AI models are being used that leverage data beyond traditional FICO scores that enable more “yes” credit decisions and better prices across the board.  Cash flow transaction data is powerful to understand financial health and the ability to pay.  [CommonWealth, Accion Venture Lab, Interledger Foundation, LendingPoint, Pave.dev]

Over 32 fintech demos were presented, and organized around:

• Cash flow insight and analytics:  Pave.dev showcased their solution for consumer credit underwriting; upSWOT featured their solution for small business (for businesses and FIs that serve them)
• Lending solutions:  QuickFi showcased a compelling product that brings automated PoS lending to the manufacturing sector
• Investor dashboards.  A compelling product was demonstrated by Babbl
• Market analysis (vendor evaluation, competitor product evaluation).  Fintech Insights illustrated customer journey steps by providers and the ability of an FI to design and implement an optimized customer experience.
• Operational and/or processing efficiencies
• Features to enable FIs to differentiate products/services
• Tools to enable digital journeys
• Access to datasets (tax data, government funding programs)
• Assistance for FIs as they modernize and implement AI and/or cloud
• Customer verification (voice, biometrics)
• Document assessments, validation, and sharing
• Counterparty risk assessments
• Personalization and marketing

Overall, FinovateSpring gathered forward-looking industry participants with curiosity and energy to uncover future opportunities.  I’m looking forward to continuing this conversation this Fall in New York City!

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Here are some takeaways from this year’s conference: 

1.      The current environment is tough and one that we have not seen since the dot.com bust. Investor appetite has dramatically slowed since exits are unclear. This is a cycle, and growing companies need to manage their runway to survive and come out the other end. Focus should be on profitability and unit economics while adhering to regulatory compliance. Existing fintechs that come through the cycle will be very strong. Scale in revenues and customers matter—M&A activity is expected and will require creativity to find curated buyers, build relationships, and generate demand. Financial Technology Partners / FT Partners  Current

2.      Despite this, the fintech industry is poised for strong growth with companies that have proven and vetted their value propositions and business models. When our world went digital post-COVID there was a run-up in investor demand and some companies with unproven business models continued to raise funding through multiple rounds. The recent decline is a normalization from this hypergrowth. The outlook for fintech is incredibly promising with strong forecasted growth in revenue and margin—driven by cutting-edge innovation with products that start with the underlying customer problem to be solved. It is expected that venture capital will go back to basics and require proof of business models before further funding rounds—resulting in strong and resilient companies going forward. QED Investors

3.      Fintech lenders see an opportunity to finance small businesses in their time of need as they deal with economic headwinds. Fintech lenders see a great opportunity and responsibility to leverage data and analytics to drive underwriting efficiency, access a broader set of data to assess the financial health of a business at a fairer price, and provide transparency to help small business owners compare their options so they can make decisions that improve their financial standing over time as their business grows. Lendio Funding Circle US Credibly Nav Technologies, Inc. Intuit American Express

4.      Financial products and services for the traditionally underserved need to be built uniquely and meet customers where they are. This requires being customer-obsessed to understand the customer through significant research and feedback loops. There should be no preconceived notions when approaching product design—trust is built by creating true value for customers. Tala Commonwealth Block

5. More work is needed in the industry to address the root causes of disparities in the treatment of marginalized segments of the population. Segments of the population are not reflected in credit bureau data; housing appraisal values can differ between white and people of color; the number of black or women-owned banks has declined through the years. These issues need to be addressed and remediated since access to credit and homeownership are paths to prosperity. Experian FairPlay AI Ready Life

6.      Fintechs and banks are embracing collaboration to create win-win opportunities. Fintechs focus on cutting-edge product innovation and customer experience while benefiting from a bank’s compliance systems and lower cost of capital. A fintech can create a network of banks to manage asset/liability management, and banks can gain access to digital channels to grow deposits, loans, and customers. Embedded finance will create many opportunities with new kinds of providers, but execution will be very complex since significant cross-functional (marketing, loyalty, IT, product, strategy) coordination will be required at the partner with people who may not understand the complexities of payments and/or lending. Other requirements include top management buy-in, skill to navigate a large company, and strong due diligence at the beginning of the relationship. QED Investors  Upgrade Inc. Netspend  CardFree  Mastercard  Jifiti  LiftForward

7.      Many stakeholders are excited about the power of open banking, including the regulators. Open banking can enable financial service providers to see a more holistic view of the customer. The automated use of such data creates a better customer experience and reduces errors. These advancements could make it easier for a customer to switch providers leading to an increase in competition. The CFPB expects rules to be completed next year and is seeking engagement from market participants including fintechs and intermediaries. Privacy remains a concern as is the risk that detailed transaction data could be used for other purposes. Codat  Lili  Consumer Financial Protection Bureau

As we get through this rough patch, we will emerge stronger. I’m looking forward to seeing what is created and participating in Fintech Nexus again next year!

Fintech Nexus

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The Importance of Small Business Lending in the United States

Small businesses across our nation play a crucial role in the health of our economy. As of 2019, small businesses employed 46.4% of total employees in the United States and paid 39.4% of the nation’s wages.[1] Women and racial minorities own 43.2% and 19.4% of small businesses, respectively. 

Despite their significant contributions to the U.S. economy, many small business owners have difficulty accessing credit to launch and/or grow their businesses. Small businesses may not have sufficient revenue history or other information to qualify for credit, their financing needs may not fit within the credit box of banks, or other factors. Access to credit is particularly difficult for women and minority small business owners if their business and/or personal credit histories are not well-represented in traditional credit reporting datasets.

When it comes to small business lending, community banks have an advantage over large national banks given their deep understanding of the communities they serve. As such, community banks have played a key role in small business lending. Fintech lenders also are filling the gap, leveraging alternative data, predictive algorithms, and other technologies to not only provide a more detailed picture of the financial health of a small business but also to streamline the customer experience and lower operational costs.

The Consumer Financial Protection Bureau (CFPB) has recognized the need to support equitable access to credit for small businesses, and on March 30, 2023, issued its Final Rule under Section 1071 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Rule 1071”), which modified the Equal Credit Opportunity Act (ECOA) to include data collection and reporting requirements on small business lenders—including large banks, community banks, credit unions, and fintech lenders alike.

Access to credit and small business ownership are levers to build wealth. Fairer small business lending practices can enable more businesses to launch and grow, drive economic prosperity for our communities and the families of small business owners, and support greater equity within our nation.  Alternatively, the lack of fair small business lending can hamper potential growth and further create inequity for small business owners in marginalized segments of the population. 

Final Rule 1071

Final Rule 1071 was issued on March 30, 2023, with ~900 pages outlining data collection and reporting requirements for small business lenders to provide transparency into small business lending practices.  While the CFPB anticipates that it will initially release aggregate-level data, application-level data will eventually be released. The reported data will ultimately be used to enforce fair lending laws and identify business and community development needs for women and minority-owned small businesses. 

Rule 1071 applies to:

The data elements required for collection and ultimate reporting under Rule 1071 include:   

For data collected directly from an applicant, procedures must ensure that: 1) The initial request for applicant-provided data occurs prior to notifying an applicant of the final action taken on an application; 2) The request for applicant-provided data is prominently displayed and presented; 3) Applicants are not discouraged from responding to such requests; and 4) Applicants can easily respond to such requests.  Further, lenders are required to maintain procedures to identify and respond to indications of potential discouragement (e.g., low response rates for applicant-provided data).

The final rule has recordkeeping requirements, including a requirement to retain copies of small business lending application registers and evidence of compliance for three years.  

Rule 1071 also includes a requirement to maintain an applicant’s responses surrounding the applicant’s minority-owned, women-owned, and LGBTQI+-owned business statuses and regarding principal owners’ ethnicity, race, and sex separate from the rest of the application and accompanying information.

Timing of rollout varies depending on the volume of covered originations:[3]

Implications for Small Business Lenders

Small business lenders should assess Rule 1071 and the implications for their business given the risk of regulators and other entities using the publicly available data to raise fair-lending concerns. The implementation of Rule 1071 will require small business lenders to make substantial operational changes across their lending workflow and significantly increase their overall cost of compliance.[4] The effort required for data gathering, storage, analytics, reporting, and ongoing monitoring and testing will be more significant for lenders that are not accustomed to such requirements (e.g., those that do not offer consumer mortgages) and/or have manual small business lending processes with little automation. 

Here are some recommendations for you to consider as your organization gets ready for Rule 1071:

1. Don’t underestimate the level of effort required to be compliant.  Even if your organization has experience with the data gathering and reporting required for consumer mortgages, the nuances of small business lending are significant and the data supporting lending decisions can be more complex. It is likely that you will need cooperation and collaboration across various business groups and stakeholders unaccustomed to such data collection and reporting requirements. This complexity increases if your organization provides multiple credit products to your small business customers. 
2. Dedicate resources, develop processes, and leverage technology to capture, clean, and store accurate data. Some considerations:
   • Ensure data is complete and correct.  Modify your applications and other forms where necessary.  Limit applicant-provided “open text” data and consider the use of defined choices that the applicant can select where possible.
   • Craft demographic-data questions carefully and monitor response rates by division, location, loan officer, etc.
   • Establish and maintain strict firewall procedures to restrict access to certain data from employees involved in the credit decision. Maintain data records for at least three years, allowing for audits and regulatory reviews.
   • Update your internal policies and procedures to reflect the new data collection, reporting, and retention requirements.
3. Once you have the data collected in usable form, conduct preliminary testing to see if there are any potential fair lending concerns so you can remediate them in advance of public disclosure. This analysis should be conducted by product, division, industry vertical, location, loan officer, etc. as appropriate. Remediation of potential fair lending concerns could involve testing the specific variables used in the lending decision, automating more of the lending process, analyzing previously declined applications to determine if other models and/or information could have been used to approve the applicants at the same risk, and other strategies. 
4. Establish a robust compliance management system to oversee the implementation of Rule 1071 and monitor ongoing adherence to its requirements. This may include appointing a fair lending officer, conducting regular fair lending analysis, and remediating any identified issues on an ongoing basis. Ensure your existing reporting systems can accommodate the new data and reporting formats that will be necessary to support compliance. Automate and build the compliance process and supporting infrastructure the right way from the start, to allow your team to focus on what it does best—cultivating relationships and serving the financial service needs of small business owners.
5. Consider the development and/or extension of automated processes and models aligning with your credit strategy. Any part of the process or decision involving human intervention increases the risk of error or bias. Conduct fair lending testing during model development and iterate/refine before the models are put into production.  
6. Consider the use of new data and/or scores to allow for a more holistic view of the health of a small business since credit-worthy small businesses may not be adequately represented within traditional data sources/scores.  If you are considering the use of new data, leverage automated fair lending testing tools to understand the fairness of the data and its impact on women and minority business owners.
7. Develop strategies and documentation of your fair lending compliance approach (data evaluation, model development, testing, monitoring) that will stand up to regulator inquiries.
8. Develop training for staff who touch on any of the new processes related to 1071 compliance.  Communicate that fair small business lending practices help to support small business growth, community economic prosperity, and potential new business/ lending opportunities for your organization. 

Continuing the Conversation

Rule 1071 is important to help support fair access to credit for women and minority-owned businesses— creating more opportunities for business and economic growth and narrowing of the wealth gap. By strengthening small business lending practices as an industry, we can support access to credit and influence the success of small business owners, improve relationships and loyalty with these customers, and create incremental capital flow and new lending opportunities. 

However, the implementation of and ongoing compliance with Rule 1071 will require significant efforts from small business lenders. Rest assured that small business lenders do not have to navigate this journey on their own and there are industry resources to help along the way. As an industry, we will need to orchestrate the right people, data, processes, and technology to help manage the cost of compliance with Rule 1071. The effort we make in the near term is justified to support new opportunities for lenders and economic prosperity for all small business owners, regardless of their race, ethnicity, gender, or sexual orientation.

Please contact me if you found this of interest and would like to continue the discussion!

[1] https://advocacy.sba.gov/wp-content/uploads/2022/08/Small-Business-Economic-Profile-US.pdf

[2] https://www.consumerfinance.gov/about-us/newsroom/cfpb-proposes-rule-to-shine-new-light-on-small-businesses-access-to-credit/#:~:text=%E2%80%9CSmall%20businesses%20are%20the%20primary%20job%20creators%20and,means%20by%20which%20families%20and%20communities%20build%20wealth.

[3] https://files.consumerfinance.gov/f/documents/cfpb_sbl_info-sheet-regarding-compliance-dates.pdf

[4] A lawsuit has been brought forth by Texas-based Rio Bank and Texas Bankers Association asserting that the new reporting requirements will drive away smaller lenders in the space and therefore eliminate available products for small businesses, including those owned by women and minorities.  https://www.bankingdive.com/news/texas-bank-trade-group-rio-lawsuit-cfpb-small-business-data-collection-rule/648831/

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The inaugural in-person Fintech Meetup conference took place this week (March 19 – 22) in Las Vegas and is positioned to be a key event in financial services, banking, and Fintech. The gathering brought thought-provoking discussions and a slew of impactful 1:1 meetings for attendees.  Despite market volatility, there was still an air of excitement over opportunities and resilience that can be created in times of industry stress.      

Here are some takeaways related to Fintech Meetup from this week:

• There is a flight to safety, given market volatility and fragility.  Newer Fintech providers need to look inward, focus on themselves, and continue to innovate.  Larger Fintechs need to figure out how to leverage their scale to position to grow.  All need to refocus and figure out who they are and what they are good at so they can focus on these core strengths.

• Open banking is exciting but there is uncertainty as to its governance.  There is an increased willingness of customers to share their data, but the industry needs to deliver security, real-time functionality, and trust.  Ground rules are needed over furnishers, ownership of data, transparency, and use of data.

• Sponsor bank and Fintech partnerships drive innovation and are growing — as is regulatory scrutiny over these relationships.  Fintechs excel at customer acquisition and product innovation.  Sponsor banks excel at operations and regulatory compliance.  BaaS providers allow players to enter quickly but add complexity.  As the industry continues to evolve:
  • Executive leadership commitment is essential.
  • Partners need to formalize relationships the correct way up-front, with robust due diligence, ongoing relationship management, and a compliance management program to govern the relationship. 
  • Sponsor banks need to view Fintech partners as customers of the bank. 
  • Fintechs should have a deep understanding of compliance requirements (KYC/AML, customer protections) expected by regulators. 
  • Partners need to evaluate their product roadmap and assess whether the potential partner can scale and align.
  • Collaboration is critical for ongoing success and day-to-day operations.

• SMB lending is the next frontier for innovation and inclusion.  For consumer lending, alternative data outside of traditional credit bureaus has been instrumental in helping some lenders better understand risk, extend credit, and improve the fairness of credit decisions – but more work needs to be done in the industry.  Traditional data sources for SMB lending have been limited and out of date – but today lenders are able to tap into accounting, banking, commerce, and payments software through APIs.  This allows for a streamlined and richer view of the business beyond traditional credit bureau data and increases access to credit for traditionally underserved business owners.

• Globalization and digitization create opportunities for Fintechs to innovate and enable all form factors and in real-time.  Legacy payment systems do not effectively address these needs and as a result, the software market is very fragmented with many Fintech players.  Orchestration enables choice but creates complexity and risk when there are issues with a payment.  Accuracy and reliability are critical — if you lose your customer, they are not coming back.

• Significant opportunities exist to modernize B2B payments, but the transformation will continue to dramatically lag behind consumer payments.  B2B payment digitization lags consumer payments given legacy processes and systems and the complexity of B2B payment flows (multiple suppliers, multiple currencies, approval processes, etc.).  Automating AP/AR is compelling.  Real-time payments could become ubiquitous with the roll-out of FedNow.  However, B2B payment modernization requires significant effort and requires change across the entire workflow beyond the payment itself.  Providers support industry adoption by making it easier for small businesses to integrate.  For enterprises, providers crystalize the benefits, drive simplicity, and create a path with discrete milestones.  There will always be multiple methods of payment that need to co-exist; it is not the rail, but the user experience. 

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November 5, 2022

Money 20/20 is one of the biggest events in financial services, blending all things digital across banking and FinTech. Despite economic and market uncertainty, this year’s event held last week in Las Vegas, brought energy and optimism that could only be described as infectious.  

Over 11,500 registered attendees convened at the Venetian to explore new developments in the industry and challenge the status quo.  A major theme of the conference was the need for the industry to strengthen and prove the governance function between FinTechs and their Bank partners, coupled with the availability of automated tools and techniques to support these relationships and their overall risk management functions that benefit FinTechs and Bank partners alike.

Here are some takeaways related to this theme from Money 20/20 this year: 

1. FinTechs continue to need access to a Bank’s charter to move money and/or provide financial services under the watchful eyes of regulators who monitor compliance with KYC, AML, BSA, fraud monitoring, OFAC screening, UDAAP, fair lending, and other requirements.  While some FinTechs obtain their Charters through their own applications (Varo Bank) or through bank acquisition (Lending Club, SoFi), a more common approach is to form a relationship with a Bank that has experience in partnering with FinTech providers. 
   
2. There was an increased focus and discussion on the governance between FinTechs and their Partner Banks, and the coordinated compliance programs that need to be in place to protect industry stakeholders including FinTechs, Partner Banks, investors, and consumers.  The growth of BaaS and the number of FinTech partnerships has increased regulatory scrutiny in this sector, as evidenced by the recent order by the OCC against Blue Ridge Bank relating to third-party risk management, BSA/AML risk management, suspicious activity reporting, and information technology control and risk governance.
   
3. Given a backdrop of economic uncertainty and rising interest rates, FinTechs must now justify their business models and business practices, including complying with numerous regulations.
   
4. Partner Banks must demonstrate to regulators that they are monitoring FinTech activities and the overall relationship. FinTechs, meanwhile, need to stand up their practices to many constituents – to regulators, their Partner Banks, and investors.  Money 20/20’s agenda included panels where banks, FinTechs, and industry experts discussed the requirements for successful partnerships. These include strategic and product alignment, organizational resources and commitment, technology integration and formalized governance programs and frameworks to ensure ongoing regulatory compliance and consumer protection. Such programs are crucial since FinTechs are an extension of the Banks that they partner with, and introduce financial and reputational risk to Bank partners.
   
5. Kareem Saleh, CEO of FairPlay, took the stage to discuss how FairPlay works with its bank and FinTech customers to debias data and automate fairness testing and compliance (back-end reporting as well as front-end model development) of algorithmic models used across the customer lifecycle (e.g., marketing, credit decisioning, pricing, fraud screening, servicing).  FairPlay also optimizes decisioning systems for fairness and creates Second Look programs.  Through these analytics, FairPlay has been able to help its customers reduce their cost of compliance, increase confidence when dealing with regulators by evidencing commitment to fairness, increase application approvals, and ultimately provide fairer products and solutions to their customers.

Over time we expect to see governance models between FinTechs and Partner Banks continue to evolve and strengthen.  Forward-looking Partner Banks and FinTechs will invest in automated tools and in their compliance, legal, and oversight functions to support this evolution and create a competitive advantage.

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