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 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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