Fintech Eagles Soar with Consumer and Small Business Data

Article Topics:

How is data driving innovation and fueling the Fintech space?

What Risk Managers and Board Directors should worry about?

 

Blog Author Email: bphelan@riskdirector.com

LinkedIn Profile: http://www.linkedin.com/in/bob-phelan

Date: March 5, 2017

 

How is data driving innovation and fueling the Fintech space?

• The regulatory requirements for financial institutions requires a strict 3^rd party control environment for Privacy, Information Security, Compliance Disclosures, and Fair Credit Reporting (Federal Reserve). The Fintech control standard is generally weaker and usually relies upon a customer granting authority to the Fintech company to have access to their bank account data. The Payment Services Directive version 2 (PSD2) in the European Union as well as Dodd-Frank Section 1033 in the USA – allow consumers to access and convey rights to 3^rd parties to access their personal and business financial records. Therefore, checking account and other bank financial data can be transferred to Fintech companies to run surveillance and analysis of customer financial data, enabling Automated Clearing House payments, marketing, and credit decisions, which is fueling innovation.
• Why are the large data sets captured by Fintech companies stirring the strong interest of investors and financial institutions? Simply said, Fintech companies know how to use the social networks, bank, credit bureau, and other 3^rd party data better than traditional financial institutions. They have designed improved credit processes delivered through mobile, social networks, and cloud-services using BigData and machine-learning models.
• What are some examples of outcomes? Fintech has found a way to tap the finite pool of credit-worthy customers with accounts at banks, acquire them cheaply, and offer them a product that is either emotionally or rationally superior. No small feat given that the banks have been doing this for 50+ years. Please see the excerpt below from a letter written by Benjamin Franklin to his daughter that defines behavior of our national symbol, the Bald Eagle, that could be analogous to outcomes mentioned above by Fintech Lending companies. However, there are many other Fintech successes ranging from customer friendly mobile apps and wallets, crowd-sourced funding, peer-to-peer marketplace, and blockchain technology for digital authentication.

 

 

Excerpt from Benjamin Franklin’s Letter to His Daughter

 

“For my own part I wish the Bald Eagle had not been chosen the Representative of our Country. He is a Bird of bad moral Character. He does not get his Living honestly. You may have seen him perched on some dead Tree near the River, where, too lazy to fish for himself, he watches the Labor of the Fishing Hawk; and when that diligent Bird has at length taken a Fish, and is bearing it to his Nest for the Support of his Mate and young Ones, the Bald Eagle pursues him and takes it from him.”

 

“For the Truth, the Turkey is in Comparison a much more respectable Bird, and withal a true original Native of America . . . He is besides, though a little vain & silly, a Bird of Courage, and would not hesitate to attack a Grenadier of the British Guards who should presume to invade his Farm Yard with a red Coat on.”

 

What Risk Managers and Board Directors should worry about?

• I know that these days it seems that everyone wants less regulation. However, there are core regulatory practices in financial institutions that protect consumers and small businesses as well as the liquidity and sustainable credit worthiness of financial institutions. Financial institutions have built complete acquisition, underwriting, servicing, and collection systems, mostly on legacy platforms, but tested and refined through numerous macroeconomic conditions. They also have MIS that provides evidence of regulatory adherence for compliance, credit, and operational risk. Risk managers should evaluate risks when integrating a Fintech product with their systems. As part of oversight and due diligence, risk assessments should consider relevant risk exposures given the narrow specialization of most Fintech companies. Areas to consider include money laundering, fraud, payment and collection practices, disparate credit treatment/fair lending, truth in lending disclosures, 3^rd party management, privacy choices and data sharing, information security, and other operational risks.

 

• In addition to the usual risks covered above, Consider the following scenarios:
  1. The next economic downturn may be driven by changes in fiscal policy, monetary policy, or regulatory changes creating an unexpected credit impact to certain segments. The following are some examples:
     1. Consider the impact of non-deductibility of interest expense for small businesses. The firms that have low margins and high debt will clearly be at risk. Resellers of wholesale goods are the largest users of short term credit and the most vulnerable to a loss of interest deductions as they already have low margins.  In addition, consider the risk if cash advances are billed as fees and could these fees be recharacterized as interest and non-deductible. Either way, truth in lending will be a focus by the regulators.
     2. Since consumers cannot deduct credit card or loan interest today, a tax law change here may be no impact to consumers. However, watch out as mortgage interest deductions may be cut massively.  I will bet that very few financial institutions or Fintech companies have modeled the scenario where wealthy small business owners with large residential or commercial mortgages may not have enough income to offset the loss of deductions by the forthcoming tax cut. Historical analysis shows that if the small business owner defaults on their mortgage or consumer debt, there is a 70%+ chance their small business will also default.

• There may be certain segments seriously impacted by a border adjustment tax. There is so much financial uncertainty around retail given the threat from online and potential non-deductible imported cost-of-goods-sold. Can retail produce low margin goods and clothing in the US? Probably not.  And, there is no export offset as most retailers are generally NOT large exporters.

1. Funding – watch what happens when default rates and interest rates rise at the same time. Funding may dry up for Fintech lending portfolios but not for financial institutions.

 

1. Valuation of Fintech companies: The aggregate Fintech space consists of over 1000 companies with $105 Billion invested. The current estimated market valuation of the Fintech space is $867 Billion, which is larger than the combined market capitalization of Chase/JPM ($323B), Wells Fargo ($290B), and Bank of America($242B) on February 26, 2017 (Su).  Another interesting sign of potential Fintech exuberance is the success of the LendIt and Fintech Conference in NYC on March 6-7, where there are 20+ main speakers and over 200 speakers for the exhibitors. The number of sponsors of the conference is approximately 83 which is in addition to the exhibitors (LendIt USA 2017).

 

• Customer engagement happens through good communication, trust, service, financial security, and transparency. The current environment is enamored with technology innovation as evidenced by the large valuation and success of the social networks and technology companies.  The sharing of data across the technology ecosystem can have negative implications in cybersecurity, fraud, and privacy. Certain lending customer segments prefer long-standing business relationships, while millennials and other younger segments prefer the latest mobile technology and instant model-driven decisions that Fintech and leading financial institutions are providing.

 

The amount of data being captured today fuels faster decisions and better targeting, but certain customer segments want more transparency and control of their data in the future of risk management.

Disclosures

This blog reflects personal views, opinions and positions associated with my role in RiskDirector, LLC. and those providing comments on this blog are theirs alone, and do not necessarily reflect the views, opinions or positions of the companies discussed, current or former employer companies, nor of the authors in the works cited. I make no representations as to accuracy, completeness, timeliness, suitability or validity of any information presented and/or commenters on my blogs and will not be liable for any errors, omissions, or delays in this information or any losses, injuries or damages arising from its display or use.

I reserve the right to delete, edit, or alter in any manner I see fit blog entries or comments that in my sole discretion, deem to be obscene, offensive, defamatory, threatening, in violation of trademark, copyright or other laws, of a commercial proprietary nature, or otherwise unacceptable.

 

References

Department of Commerce. 2016 Top Markets Report Financial Technology (n.d.): n. pag. 2016 Top Markets Report Financial Technology. U.S. Department of Commerce, 2016. Web. Feb. 2017. <http://trade.gov/topmarkets/pdf/Financial_Technology_Executive_Summary.pdf&gt;.

Federal Reserve. “Fair Credit Reporting Act.” Consumer Compliance Handbook (2016): FCRA, SourceMedia. Nov. 2016. Web. Feb. 2017. <https://www.federalreserve.gov/boarddocs/supmanual/cch/200611/fcra.pdf&gt;.

“FinTech Landscape.” VB Profiles. Spoke Intelligence, 2017. Web. Feb. 2017. <https://www.vbprofiles.com/markets/fintech-landscape-56fa295534d34989ae001be9&gt;.

Franklin, Benjamin. “Turkey Quotes – The Eagle, Ben Franklin, and the Turkey.” Quotes Famous Quotes – Famous Sayings. WordPress.com, 22 Nov. 2008. Web. Feb. 2017. <https://quotes.wordpress.com/2008/11/22/turkey-quotes-the-eagle-ben-franklin-and-the-turkey/&gt;.

“LendIt USA 2017.” LendIt USA 2017. Lendit Conference LLC, 2017. Web. 03 Mar. 2017. <http://www.lendit.com/usa/2017&gt;.

“Ranking the Top Fintech Companies.” The New York Times. The New York Times, 06 Apr. 2016. Web. Feb. 2017. <https://www.nytimes.com/interactive/2016/04/07/business/dealbook/The-Fintech-Power-Grab.html?_r=0&gt;.

Su, Jean Baptiste. “The Global Fintech Landscape Reaches Over 1000 Companies, $105B In Funding, $867B In Value: Report.” Forbes. Forbes Magazine, 28 Sept. 2016. Web. Feb. 2017. <https://www.forbes.com/sites/jeanbaptiste/2016/09/28/the-global-fintech-landscape-reaches-over-1000-companies-105b-in-funding-867b-in-value-report/#3013f07b26f3&gt;.