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Podcast 316: Shri Santhanam of Experian

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Using artificial intelligence in lending decisions has gone from a curiosity to, I would argue, the mainstream over the last five years. Most lenders have either started a pilot program or are considering it seriously and some, led by fintech lenders like Upstart, have made it core to their business.

Our next guest on the Fintech One-on-One podcast is Shri Santhanam. He is the EVP and GM of Global Analytics at Experian. Shri has spent much of his career bringing big data and AI to bear on a myriad of business challenges. For the last two years, he has been leading the global analytics initiatives for Experian.

In this podcast you will learn:

  • Shri’s background with AI and data analytics.
  • The three big changes that have accelerated for lenders in the last 18 months.
  • What fintech lenders need to be successful in the competitive environment today.
  • How lenders are best driving impact from AI.
  • What Experian is doing to help lenders with their client journeys.
  • How they are helping lenders increase their speed to market.
  • The impact of regulatory constraints on AI underwriting models.
  • The three ways Experian is differentiating themselves today.
  • How lenders should be using AI today.
  • What it will take for all lending to be done via AI models.
  • The interesting trends in the AI space that will shape the future.
  • What Experian’s plans here are for the next five years.

You can subscribe to the Fintech One on One Podcast via Apple Podcasts or Spotify. To listen to this podcast episode there is an audio player directly above or you can download the MP3 file here.

Download a PDF of the Transcription or Read it Below

Welcome to the Fintech One-on-One Podcast, Episode No. 316. This is your host, Peter Renton, Chairman and Co-Founder of LendIt Fintech.

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Peter Renton: Today on the show, I’m delighted to welcome Shri Santhanam, he is the EVP & GM of Global Analytics and AI Products at Experian. Obviously, he is an AI expert and I wanted to get Shri on because we haven’t really delved deeply into AI in a long time and a lot has changed which we get into in some depth in this episode. You know, we talk about what lenders are doing today, what they need to do to be successful, how they’re using AI. 

We delve pretty deeply into how Experian is really helping some of the things they’re doing that is really unique in the field, we talk about how lenders should be using AI and what are the trends that Shri is seeing, both historically and going forward, and he also looks into his crystal ball and provides predictions for five years from now. It was a fascinating interview, hope you enjoy the show.

(music)

Peter: Welcome to the podcast, Shri!

Shri Santhanam: Thank you. Thank you for having me, Peter.

Peter: My pleasure. So, let’s get started by giving the listeners a little bit of background about yourself. Can you give us some of the career highlights before you got to Experian?

Shri: I spent a significant portion of my career at Oliver Wyman which is a strategy and operations consulting firm in the financial services space. I started my career with Oliver Wyman right out of school, I was actually getting a PhD at Stanford which I didn’t end up finishing, but what really attracted me to consulting was bringing an engineering approach to business problems and that’s been the theme of my time at Oliver Wyman. 

For the last seven or eight years at Oliver Wyman, I helped build a business called Oliver Wyman Labs where we saw the opportunity in about 2011/2012 to bring Silicon Valley style tech and AI into some of the challenges large banks and financial institutions faced post-crisis. That was a fun journey bringing Python, Big Data to AI tech into that sort of space and spent a bunch of time there. 

And then about two years ago, the senior leadership at Experian asked me to come over to play a role leading global analytics in AI, helping drive impact with Experian’s data in a simpler way so here I am.

Peter: Okay, So, before we get into the meat of the discussion, I’d love to kind of get a little bit of background about your experience with AI and analytics, how that journey has gone for you throughout your career.

Shri: For me, even before it was called all of the fancy names that it is now, AI/ML, I’ve always been attracted to pursuit of data-driven decision making. What attracted me to consulting is what was a group called Retail Value Engineering and the founder of that group was a man named Jacques Cesar who would often describe the work we do as “squeezing blood from the stone” that is sort of data, right. 

Actually, the initial work we did was with retailers and in the early 2000’s, they had an enormous amount of data largely captive in these huge monolithic systems and I was very attracted to the prospect of putting that data to work and helping their businesses run better, helping improve the lives of consumers and businesses. That, eventually, over the course of the first decade of this century translated into Advanced Analytics, AI and tech being tools in making that sort of mission a reality, like one of the interesting things we did in retail was, for instance, cannibalization analysis. 

Retailers, as they traditionally think about…. let’s say you’re promoting an item of toothpaste, you largely look at the sales of toothpaste, but it has an enormous amount of impact on other items in that week, bringing customers into that store and the impact of a simple thing like promoting Colgate toothpaste is actually profound and AI and analytics can help you understand that and make better sort of choices. So, that was my starting point, I think it eventually grew into my interest in driving financial services post-crisis and helping banks lend better. 

Now, historically, banks and lending institutions have mostly used rules or basic logistic regression models to make decisions, but to me, bringing AI and ML to really drive financial inclusion help consumers have better access to credit and sort of lenders make better decisions is an important part of the mission I see.

Peter: Okay. Well, let’s get right into it and talk about the lending space. You know, it’s been a very interesting last 18 months for all lenders, I would say, and obviously we’ve seen them move to digital that I think became mandatory pretty much for the entire world. But, I’d love to get sort of what you’re seeing at Experian as far as how this transformation is playing out. What are you seeing as far as, you know, the democratization of digital capabilities and that sort of thing.

Shri: It’s a great time to be talking about the lending revolution and even before COVID, I would argue that there was a very significant lending revolution underway where if you looked, historically, at how lending happened, it was with sort of pen and paper. Over the last decade and a half, really the notion of digital tools, digital decisioning, analytics and digital underwriting has come into play. Now, COVID has dramatically accelerated that and we’re seeing three big things which are different. 

First, when you looked at maybe even three/four years ago, you have the Capital One, some of the large, sophisticated banks really being at the forefront of leading this revolution in bringing either machine learning or digital tools to the entire lending process. Now, it’s almost becoming a necessity for the entire spectrum of lenders, large, medium and small, to operate digitally and make some of those decisions. 

The second thing we’re seeing with the lending revolution right is actually this deep focus on the customer experience. It was okay five/six years ago to wait several days, weeks to approve loans or make decisions on loans for consumers and businesses, now, that expectation has dramatically changed. We’re seeing lending institutions willing to make that decision in real-time instead of minutes, hours, that sort of dimension. 

Third, fundamentally, sort of product innovation and inclusion. You’re seeing the whole fintech space come in and really the operating challenge and the question of fintechs is, can I find an underserved niche of the market which I have unique perspective and how to think about that risk and I can improve them and lend to them. Is it student loans, is it sort of immigrants who’ve been in this country where our traditional credit and lending methods don’t do them in the same way. So, there’s a significant shift in how lenders are starting to look at the space and you’re seeing those three trends are what we’re seeing at Experian.

Peter: Right. And, I’d love to get your take too, because I know you work with both banks and fintech lenders and I think it’s a curious time for fintech lenders because they’ve had sort of the digital space wide open for them, I mean, some of them for longer than a decade and now that gap is closing. What do you think fintech lenders need today to be successful in the environment we’re in?

Shri: Fintech lenders, as I see it, are actually disrupting the market in a way which, net of net, really benefits the consumer because if I look at the four pieces of a fintech in this lending space that they’re coming in and saying, can I pick a segment of the market where I apply an underwriting sort of lends and I apply a customer experience lends which is very, very different, right. And you’re seeing a number of these fintechs like Affirm, Prosper, sort of start to be very successful in that space. 

So, I think in order for them to be successful, they need three big things. First is they need to embrace machine learning and advanced underwriting because the core of their business model involves in them being at the forefront of underwriting with a lens that slightly seems different. So, I think embracing machine learning, understanding how that works and that can improve financial inclusion should be part. 

I think the second thing that fintechs need to be able to succeed is really disrupt and reinvent the customer experience and decisioning around that. Lots of it is digital, but, essentially, interesting product innovation where you can get into the retail customer journey or much closer to the purchase occasion or the use case of all sorts of customers in a way that traditional lending still has friction.

Peter: Interesting. So then, can we just dig into the AI and analytics just for a bit here. What are you seeing as far as lenders, you know, how are they best driving impact from AI.

Shri: If you look at how, let’s say, the bulk of the middle market has lent, even four/five years ago, it’s been on the back of two simple things. It’s been a set of policy rules and it’s been some sort of underwriting model. That’s how a lot of the lending frameworks have actually sort of worked. And, in the main, the long tail of lenders that mostly use either standard scores which are available off-the-shelf or if they created specific custom models, they will mostly use self-logistic regressions. That was sort of how, historically, things have worked. 

Now, it’s been a challenge to change any of those things because the costs and the infrastructure required to stand up machine learning models, put them into production, have sort of decisioning rules and optimization tools and more sophisticated have been prohibitive, but that reality is fundamentally changing now So, custom scores, the ability to create optimized decision rules and the ability to do this in a tailored way on data sets which are actually relevant for you as a lender, that reality is changing the costs or are dropping, even as we speak, to do that. 

So, that holds to the adoption of a modern sort of lending decisioning structure is a big part of what AI and analytics replace. If you look at models which were logistic regressions now, there are gradient boosted tree models which can start to help outperform those. You have decisioning rules which start to help like significantly outperform and really get better approvals and lower sort of charge offs for lenders.

Peter: Okay. So, I want to switch gears a little bit and talk about what Experian is doing, specifically in the space. Maybe you can start with just talking about how is Experian helping lenders with their client journeys and that sort of thing today.

Shri: So, when I came in two years ago, one of areas we saw as a big opportunity was to help clients with some of the analytics and AI which they use, particularly in the mid-market, for building these models. So, there’s credit unions, there’s mid-market customers where, historically, what we’ve done is we’ve built custom models and projects for them. What we found was the typical time it took to build these custom models were somewhere between five/six months and the deployment of these models, again, was sort of complex and took another three months. 

So, for many of our customers in the space, we found that there was a clear need, but the time and the ability to deliver these things, there was a lot of overhead which was involved. So, one of the things we’ve done is we’ve built a platform to significantly disrupt the space, a platform called, Ascend Intelligent Services, which we believe significantly reduces the time to both build models, create decision rules and really put this into production. 

So, the whole build model and produce, we’re still in early stages with these products, but we have several tends of successful customers where we’ve significantly reduced the time for end-to-end build and the cost where we can put these things into production. One example is a public case study we have of a mid-market lender named, Atlas, where we’ve seen very, very significant cost of results with this sort of work with our platforms.

Peter: Interesting, interesting. So, can you dig a little deeper into that. I mean, I’d love to get sort of a sense, without giving away the secret sauce, but how were you able to make this a much faster process?

Shri: Yeah, great, happy to talk about that. So, if you look at the historical process, there have been probably four main points of friction which has added a lot of time. The first has been around data management and wrangling where we’ve had to bring a lot of data and manipulate it to create models. The second point of friction has been actually running like computed scale. To typically build a custom model, you need to actually like try 30/40 different sort of models, run sort of many calculations and then sort of decide. The third has been regulatory compliance and documentation. 

These models that….the reason it’s challenging in financial services is like you have a whole regulatory framework and you have to go against that management. And then, finally, like deployment. Once you’ve built a model, the traditional approach is to say, great, I’ve built this, I’ll document it, now I’m going to take it and throw it over the fence and have someone sort of code it. 

So, we’ve gone after these four problems in a very significant sort of way. We have some strategic advantages and how we can help our clients because we’re building these on our platforms and data. So, I’ll take you to these in turn. 

So, first, we have a lot of the data for several of our clients so it allows us to proactively source that data, curate it and significantly reduce the time and creating the right sort of training data set. So, if I’m a fintech looking to innovate a new product, like at Experian we can very quickly create a proxy data set and, historically, that has been a manual process now we’ve added automation. 

The second piece is an interesting one which is on the models. In the last year and a half/two years, we’ve built a technology which is akin to the technology that Google, Facebook, some of the leading tech companies run which really allows us to spend cloud-based compute and run sort of like tens and hundreds of models. 

At a recent client, one of our data scientists was saying, in one day he tried probably like 80 different sort of models and reviewed their results, an exercise which would normally take a data scientist several weeks of work because even though you’ve open source library, the tedium of creating a model, looking at its results, managing it, managing all of the engineering is complex. So, what we’ve done is we’ve abstracted away all of the engineering to allow for the data scientist to really do their job of figuring out what is it that would work. 

The third is on documentation and dashboards. We’ve got products which provide a lot of the standard regulatory documentations sort of framework and a lot of automation around this so it doesn’t put a restriction on how many times you try and what you do when standard documentations are collated. 

And, finally, seamless deployment which has been like the Holy Grail of all these machine learning and ML ops. What we’ve built is a mechanism to seamlessly deploy models into production which allows the hope for the whole world to know known as the MLOps Cycle so they can be monitored live, they can be re-trained, they can be managed. 

So, those are four of the big things we’ve worked on with some of the technology people investments we have and our main theme has been productizing the entire theme so we’ve productized it to make it available to our customers.

Peter: Right. So, I want to dig a little bit on that third point, the regulatory piece, because it’s something I’ve always been curious about. How much of these AI models do you have to sort of throttle back or adapt because there needs to be, you know, you need to be in compliance with all of the FCRA and all things that need to be explainability, you have to explain a credit decision, what is the impact like? 

You talked about data sets from Google and Facebook where they are going to have very different regulatory requirements. In some ways, they don’t necessarily need to scale back or to change to explain things like you have to do in financial services so what is the impact of having sort of that type of regulatory framework on the models themselves?

Shri: Yeah. It’s a great question because it has implications for models that will ultimately be permitted to be put into production and the process by which you build it as well. If you look at an unconstrained world in which you didn’t have a regulatory framework, what you would do is you would take the most sophisticated framework you had and the best data you have and you will throw models and you will have like machines maybe explore that sort of state, right, so create and have a gradient booster tree.

The problem is you then run into specific growth constraints like there are certain attributes which you use have to be explainable, they have to be monotonous so you can strain around certain attributes, Further, the topic of bias and standards is also becoming an important one. So, if I exaggerate for effect that the traditional process of how a data scientist goes after this is he says, well, I’m going to apply these constraints, build the first model, see if it works and then see if I can play with a bunch of these things and apply the constraints again. And, it’s often a real tradeoff between like performance and sort of the regulatory framework and what we can manage. 

Now, what we’ve done with the product is actually we’ve allowed many of those constraints to be baked into how the data is curated as well as how the model itself is allowed to go and search for solutions. So, it makes the job of a data scientist a lot easier saying, okay, you’re allowed to use these attributes, these attributes can only be used in certain ways and then at last, the machine don’t say, go, explore this sort of straight space and that’s a really important step for a data scientist because, otherwise, it creates a lot of tedious work where you’re almost playing like this game of cat and mouse saying, hey, I’ve got better performance, but have I violated regulatory constraints. 

So, there is a tradeoff and I think in the space we’ll continue to see more of that sort of tradeoff as our regulations evolve to manage sort of ML and AI, but we also believe that the product and the tech can evolve to address this.

Peter: Right, right, makes sense. So then, obviously, we live in a competitive world and Experian has competitors as well. What are you doing that’s different, how are you differentiating yourself from others in the space?

Shri: I think, for us, we believe there is a very significant opportunity in the mid-market and democratizing many of these capabilities which have, historically, been limited to maybe sort of large banks or lending institutions where they can afford this infrastructure. So, we’re differentiating ourselves in three ways. 

First is we’re providing an end-to-end experience across data, analytics and decisioning. Experian has, as you know, some of the most valuable data sets on lending on the planet. We also have a decisioning business which is around providing workflow and software into customers to allow them to make sort of lending decisions, policy rules and we bring sort of analytics. So, one big differentiator we have is we have the ability to really provide, and if I might draw a retail analogy, we have the ability to provide the Shopify equivalent to the mid-market. 

But, we say, hey, like if you’re a lender and you focus on what you do, you know best which is actually figuring out the right lending niche, figuring out the customers and your targets. We can provide that sort of end-to-end analytics data instead of tech. That’s the key differentiator for us. 

I think the second differentiator for us is we’re making a specific move to increase access to some of these sort of tools and how we price and what we’re doing like really democratization. So, we’re leaning forward and growing our base. 

And the third differentiator we have is we’ve got a very, very significant penetration of data with a number of lending institutions. Overnight, like the vast majority of lending institutions in North America, in some form, utilize Experian sort of data and what we want to do is bring a set of accessible products or analytics and AI to all of them. Right now, our penetration rate on that is low single digits, we believe that’s a huge opportunity ahead of us if we successfully democratize is to bring it into the long tail of lenders.

Peter: Okay, interesting.  So then, you’re talking to your clients, what would be, looking at all the different things that AI can do, what is the most important thing that businesses should be using AI for today?

Shri: I think maybe the answer has two parts to that question. The first is like how should they be using AI and what should they be using it for. In terms of the biggest way to get impact, I think a company should be taking a more holistic view of AI to get impact. Historically, there’s been a lot of infatuation with one part of AI which is largely sort of AI performance, but when you look at generating impact from AI more holistically, we think there are four components. There is not just AI performance which is, hey, I’ve built a better model, but AI adoption, AI scalability and AI trust so really to get impact from AI, it isn’t sufficient just to have AI performance which is a data scientist saying, I’ve got sort of a very good proof of concept. You’ve got to think about can that be embedded in the workflow to allow clients or companies to make better decisions, is it on a sustainable and scalable platform and, ultimately is it trusted by customers. Now, that’s fundamentally what we think is the need for AI impact. I think for lenders, in my mind, I think the obvious and in some ways the biggest opportunity is our financial inclusion. 

If I look at my business story, when I was sort of growing up in India, I remember my mother was sort of an entrepreneur, like had a number of ideas and things where she could have used capital to invest, but she really didn’t have as much access to lending, but if I look at the core of it like the lending credibility or the likelihood of default for someone like her, what she would have done with that sort of capital, I believe it’s sort of enormous. 

And I believe that’s true with a number of segments of the population across North America where with the right lens, with the right sort of framework, I believe it can be a “win win” for lending and for the customer. So, I believe there is a lot of potential in using AI and analytics for financial inclusion.

Peter: Right, right, yeah, for sure. I want to ask about something that…..Dave Girouard, the CEO of Upstart, obviously a pioneer in the AI space in lending, he said that all lending will be done by AI in the future and it seems to me when I talk to lenders, it feels like the…..there’s very few lenders of any type that are just saying, we’re not interested in exploring this, it feels like that conversation has changed in the last couple of years, but I’d love to get your perspective. Will all lending be done by AI and what’s it going to take to get there?

Shri: I agree with Dave and I do think that future is almost inevitable. I think the biggest challenge which I believe we will sort of manage and overcome is trust. Under sort of trust there is explainability, there’s bias and fairness and really under regulatory framework. I think the narrow reason why you don’t have a bunch of folks having adopted sort of AI, you’ll hear this often, well, there’s regulation and there’s structure, but if I look at the spirit of it sort of more broadly, really the overarching theme is trust, right.

I think the regulators as well are….they’re sharp, reasonable people making sort of…creating regulatory frameworks and they’re actually…having talked to a number of regulators, they’re quite thoughtful about this. I think the broader question is around sort of trust and creating the right frameworks to ensure that lending with AI is fair, transparent and trusted above all, but I do believe we will get to that journey in the same way. At some point, I believe it’s also inevitable that majority of cars on the road are going to be driverless.

Peter: Right, right, yes, yes. We’re not quite there yet. I would argue that the AI for driving a car is much more complex than it is for deciding whether a consumer should get a loan or not, seems to me. 

Anyway, we’re almost out of time, but a couple of more questions. I want to talk about the trends that you’re seeing and predictions for the future, I mean, what are some of the trends that you’re seeing today in AI analytics that teams really should be on the lookout for.

Shri: I think one interesting trend which you’re hearing some of the experts in the space talk about is the shift to what Andrew Ang, one of the leading thinkers in the space, calls data-centric AI. At the core of it, the concepts are like very simple and if you look at historically the big giggle around AI is like, hey, can I create a neural network or a gradient boost and can I take the same data and can I like get better results and better outcomes. Now, the dialogue is slightly shifting into another very significant point of leverage which is data-centric AI which is actually saying, can I get and create the right sort of training data to really make sort of better decisions and that’s opening up an interesting question on like tapping into more of data sources, managing the data and can you really get sort of better performance. 

There’s a lot of work being done in the AI space on data-centric AI on how to prepare data, manage data, extract data from sources which previously were sort of dismissed. So, that’s sort of one big trend we’re seeing which I think has important implications for the space we’re in and financial institutions as well because, historically, the data that can be used in lending has been carefully demarcated. I think there’ll be more thought in the future on how to sort of expand that and what else we’re willing to allow to consider into that. So, I think that’s one big trend. 

I think the other big trend is almost sort of an obvious one which is move to the cloud, but, actually, I see it under a broader theme where AI is actually moving to much more of an engineering discipline and a technology discipline. Historically, data science and AI was a set of things that data scientists did and it didn’t quite have the systems, the process, the rigor which software engineering sort of had. But now, you’re actually starting to see all of that rigor come in and particularly with migration to the cloud, you’re having ten data scientists who could work on the same sort of model like these ensembles of models and structure. 

Those problems are starting to become real and unless you have an engineering discipline akin to software to be able to manage that, you get into a whole bunch of complex issues where data scientist one creates a model and data scientist two tries to go and look at that like he’s not quite sure what was built on and when you’re putting it into production, is it lost. So, the whole engineering discipline around data science and AI is also a big trend which we’re seeing.

Peter: That’s interesting, I hadn’t heard that, that makes complete sense to me. Okay, so then, last question, as you’re looking out let’s say five years from now, how will Experian be using AI and advanced analytics in say September of 2026?

Shri: We have started on a journey where we have a broader model and product-type stock to a small set of funds. What I would hope is that we have successfully like arranged the full scale on that democratization bit and we’ve got a very, very significant portion of our data clients where we’ve actually opened up access to analytics and AI and many of these sort of advanced techniques and models and sort of broader, hundreds if not thousands of funds, that’s what I would sort of hope. 

The second thing I would hope at Experian is that we are powering Experian with analytics and AI sort of much more like across the business in a very, very significant way. We’re starting to make sort of forays into that at Experian. Beyond our consumer business and our decision analytics business, we also have businesses in the health space, the BIS space and we’re starting to use AI and analytics in those spaces. So, I would hope that AI and analytics fundamentally becomes core to Experian sort of DNA and stocks to power like a number of our products and businesses across.

Peter: Okay. Well, we’ll have to leave to leave it there, Shri, it’s going to be fascinating to see it all unfold. I really appreciate you coming on the show today.

Shri: Thank you very much, Peter, thank you for having me.

Peter: Of course, okay, see you.

Alright, you know, I’m no data scientist, but I do talk to a lot of lenders and what strikes me is that I don’t know of any lender that has gone and tested an AI model and done it in a serious way and then say, you know what, it’s not as good, it’s not as good as what we were doing before, I think we’ll just go back to what we were doing before. That just doesn’t happen and it makes me realize that as Shri was saying there, it’s inevitable that we are going to have this movement, it’s going to continue. 

No, it doesn’t mean that everybody in even five or ten years time will be using AI models, but that’s the direction we’re heading. I don’t know whether it’s five years, ten years, 15 years, but soon there’ll be no one using these old traditional models as AI will be taking over. That’s my prediction, anyway.

On that note, I will sign off. I very much appreciate you listening and I’ll catch you next time. Bye.

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Peter Renton is the chairman and co-founder of LendIt Fintech, the world’s first and largest digital media and events company focused on fintech.

LendIt Fintech conducts three conferences a year for the leading fintech markets of the USA, Europe, and Latin America. LendIt also provides cutting-edge content all year long via audio, video, and written channels.

Peter has been writing about fintech since 2010 and he is the author and creator of the Fintech One-on-One Podcast, the first and longest-running fintech interview series.

Peter has been interviewed by the Wall Street Journal, Bloomberg, The New York Times, CNBC, CNN, Fortune, NPR, Fox Business News, the Financial Times, and dozens of other publications.


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Source: https://www.lendacademy.com/podcast-316-shri-santhanam-of-experian/

Crowdfunding

Top 10 Fintech News Stories for the Week Ending October 23, 2021

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This week was all about funding rounds. Fintech raised billions of dollars from investors this week with N26 and FTX leading the way. Plaid is making waves in payments, we now have a bitcoin futures ETF and Facebook launched its digital crypto wallet. Here are what I consider to be the top ten fintech news stories of the past week.

Plaid Pushes Into Payments Business After Scuttled Visa Deal from The Wall Street Journal – Plaid is teaming up with a bunch of big names in payments such as Square, Stripe and Marqeta to create a “pay with bank account option” at checkout, going head to head with Visa and Mastercard.

SEC-approved Bitcoin futures ETF goes live from LendIt Fintech News – After years of trying, a bitcoin futures ETF finally launched this week. The Proshares Bitcoin Strategy ETF (Ticker BITO) is not a true bitcoin ETF, it is focused on bitcoin futures, butit was celebrated widely by the crypto community.

Facebook selects Coinbase as custody partner for its Novi cryptocurrency wallet from Markets Insider – Facebook launched Novi, its digital crypto wallet, this week and selected Coinbase as the custody partner. It also selected Paxos (USDP) as the stablecoin for transactions.

PayPal is in late-stage talks to acquire Pinterest from CNBC – Pinterest was not on my fintech M&A bingo card (it clearly should have been) but PayPal is in advanced talks to buy the social media company as it bets on the future of social commerce.

Two Crypto-Lending Firms Ordered Shut by New York’s James from Bloomberg – This may have been the strangest story of the week, not because the New York Attorney General sent cease and desist letters to two crypto companies, but because it got at least one of the companies wrong (Nexo does not operate in New York). There is real mystery as to who they were actually trying to target here.

FTX raises $420 million in funding round with backing from 69 investors including Tiger Global, Ribbit Capital from The Block – The crypto exchange FTX (formerly Blockfolio), the one with the ads starring Tom Brady and his wife, has raised another staggering amount of money making it more than $1.3 billion in equity funding closed in the last four months.

Challenger bank N26 raises $900 million at $9 billion valuation from TechCrunch – It seemed to me that N26 was falling behind a little after they withdrew from the UK and have failed to get much traction in the US but this funding round will help put them back on track. The CEO said their focus is now squarely on Europe as they look to go public in “3 to 4 years”.

Brex just signed a term sheet for $300M at a $12.3B valuation from TechCrunch – Brex has signed a term sheets for a big new funding round at a higher valuation, just six months after closing a round at a $7.4 billion valuation.

Fanatics Digital Collectibles Firm Candy Valued at $1.5 Billion from Bloomberg – Let’s not forget NFTs in this week’s funding frenzy. Candy Digital, a collectibles marketplace for NFTs, was just formed in June and is now a unicorn (is that a record?). The $100 million investment was led by Softbank and Insight Partners and included the likes of Peyton Manning on the cap table.

Fixed-income titan Pimco is starting to embrace cryptocurrencies, CIO says from CNBC – The world’s largest fixed income asset manager has waded into crypto with some of Pimco’s hedge funds already trading in digital assets and will gradually invest more.

Every Thursday the LendIt Fintech News team and a special guest discuss the news of the week live on LendIt TV, YouTube, LinkedIn, and Twitter. We have now made the show available in podcast format – just click on the audio player below.

The post Top 10 Fintech News Stories for the Week Ending October 23, 2021 appeared first on LendIt Fintech News.

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Source: https://www.lendacademy.com/top-10-fintech-news-stories-for-the-week-ending-october-23-2021/

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Top 10 Fintech News Stories for the Week Ending October 23, 2021

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This week was all about funding rounds. Fintech raised billions of dollars from investors this week with N26 and FTX leading the way. Plaid is making waves in payments, we now have a bitcoin futures ETF and Facebook launched its digital crypto wallet. Here are what I consider to be the top ten fintech news stories of the past week.

Plaid Pushes Into Payments Business After Scuttled Visa Deal from The Wall Street Journal – Plaid is teaming up with a bunch of big names in payments such as Square, Stripe and Marqeta to create a “pay with bank account option” at checkout, going head to head with Visa and Mastercard.

SEC-approved Bitcoin futures ETF goes live from LendIt Fintech News – After years of trying, a bitcoin futures ETF finally launched this week. The Proshares Bitcoin Strategy ETF (Ticker BITO) is not a true bitcoin ETF, it is focused on bitcoin futures, butit was celebrated widely by the crypto community.

Facebook selects Coinbase as custody partner for its Novi cryptocurrency wallet from Markets Insider – Facebook launched Novi, its digital crypto wallet, this week and selected Coinbase as the custody partner. It also selected Paxos (USDP) as the stablecoin for transactions.

PayPal is in late-stage talks to acquire Pinterest from CNBC – Pinterest was not on my fintech M&A bingo card (it clearly should have been) but PayPal is in advanced talks to buy the social media company as it bets on the future of social commerce.

Two Crypto-Lending Firms Ordered Shut by New York’s James from Bloomberg – This may have been the strangest story of the week, not because the New York Attorney General sent cease and desist letters to two crypto companies, but because it got at least one of the companies wrong (Nexo does not operate in New York). There is real mystery as to who they were actually trying to target here.

FTX raises $420 million in funding round with backing from 69 investors including Tiger Global, Ribbit Capital from The Block – The crypto exchange FTX (formerly Blockfolio), the one with the ads starring Tom Brady and his wife, has raised another staggering amount of money making it more than $1.3 billion in equity funding closed in the last four months.

Challenger bank N26 raises $900 million at $9 billion valuation from TechCrunch – It seemed to me that N26 was falling behind a little after they withdrew from the UK and have failed to get much traction in the US but this funding round will help put them back on track. The CEO said their focus is now squarely on Europe as they look to go public in “3 to 4 years”.

Brex just signed a term sheet for $300M at a $12.3B valuation from TechCrunch – Brex has signed a term sheets for a big new funding round at a higher valuation, just six months after closing a round at a $7.4 billion valuation.

Fanatics Digital Collectibles Firm Candy Valued at $1.5 Billion from Bloomberg – Let’s not forget NFTs in this week’s funding frenzy. Candy Digital, a collectibles marketplace for NFTs, was just formed in June and is now a unicorn (is that a record?). The $100 million investment was led by Softbank and Insight Partners and included the likes of Peyton Manning on the cap table.

Fixed-income titan Pimco is starting to embrace cryptocurrencies, CIO says from CNBC – The world’s largest fixed income asset manager has waded into crypto with some of Pimco’s hedge funds already trading in digital assets and will gradually invest more.

Every Thursday the LendIt Fintech News team and a special guest discuss the news of the week live on LendIt TV, YouTube, LinkedIn, and Twitter. We have now made the show available in podcast format – just click on the audio player below.

The post Top 10 Fintech News Stories for the Week Ending October 23, 2021 appeared first on LendIt Fintech News.

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Source: https://www.lendacademy.com/top-10-fintech-news-stories-for-the-week-ending-october-23-2021/

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Podcast 321: Michele Alt of Klaros Group

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Until recently virtually no fintech companies were interested in a bank charter. It was just back in 2016 that SoFi ran a Superbowl ad with the “Don’t Bank. SoFi” tagline. Now, they are looking to become a bank. Square and LendingClub have joined SoFi as approved banks (via different routes) and there are many applications that are still pending. So, I thought it was time to talk bank charters on the podcast.

Our next guest on the Fintech One-on-One podcast is Michele Alt, a co-founder and partner at Klaros Group. We spend a lot of time discussing the various options for fintech companies and we delve into some of the unique ways fintech companies are pursuing bank charters today.

In this podcast you will learn:

  • The impetus behind the founding of Klaros Group.
  • Why fintech companies want a bank charter.
  • The two main categories of bank charters.
  • The five types of exempt bank charters.
  • Why many fintech companies lean towards the ILC charter.
  • The advantages a national bank charter provides.
  • The main stumbling block for fintechs with the Bank Holding Company Act.
  • The interesting avenue that Figure has taken (more on Figure’s charter application here).
  • Why the fintech charter and any other national special purpose charters are dead.
  • How the states have taken the lead when it comes to chartering fintechs.
  • Why Varo’s application has not made it easier for other fintechs.
  • What is behind the frequent application withdrawals by fintech companies.
  • What Michele would do if she was running the OCC right now.

You can subscribe to the Fintech One on One Podcast via Apple Podcasts or Spotify. To listen to this podcast episode there is an audio player directly above or you can download the MP3 file here.

Download a PDF of the Transcription or Read it Below

Welcome to the Fintech One-on-One Podcast, Episode No. 321. This is your host, Peter Renton, Chairman and Co-Founder of LendIt Fintech.

(music)

Today’s episode is brought to you by LendIt Fintech LatAm, the region’s leading fintech event. It’s happening both online and in-person in Miami on Dec. 7th and 8th. Latin America is still the hottest region for fintech in the world and LendIt Fintech LatAm features the leading players in the region. So, join the LatAm fintech community this year where you will meet the people who matter, learn from the experts and get business done. In-person and virtual tickets are available at lendit.com/latam.

Peter Renton: Today on the show, I’m delighted to welcome Michele Alt, she is a Co-Founder and Partner at Klaros Group. I wanted to get Michele on the show because we’re going to be digging deep into bank regulation here, bank charters, fintech charters, the whole nine yards. I learned a great deal in this episode and I’m sure you will too so make sure you stick around all the way to the end. 

We cover the nuances of different types of bank charters, why fintechs go for one charter over another, we talk about some of the unique things that are happening like what Figure is doing, talk about the Wyoming State Special Charter they have there. We talk about Varo’s charter and we also cover some of the things that Brian Brooks talked about last year when he was head of the OCC and Michele also talks about what she would do if she was head of the OCC. It really was a fascinating episode, hope you enjoy the show.

Welcome to the podcast, Michele!

Michele Alt: Well, thank you, Peter, it’s delightful to be back talking to you.

Peter: Yes, indeed. So, let’s get started by giving the listeners a little bit of background about yourself. I know you spent many years as a bank regulator, but why don’t you give us some of the highlights of your career to date.

Michele: Be happy to. I am a Co-Founder of the Klaros Group and a Managing Director of Klaros Advisors. I am a lawyer by training and inclination, I must admit. I spent more than 20 years in various policy and legal roles at the OCC focusing on national bank powers, preemption, inter-agency regulation, licensing and Dodd-Frank. After leaving the OCC, I cut my teeth in the consulting world helping a range of banks with various risk and strategy matters, ultimately, focusing on bank chartering and fintech before leaving to co-found Klaros.

Peter: Right. So, tell us a little bit about that. What was the impetus behind the founding of Klaros Group?

Michele: Well, my partners and I believed that there was a need for a consulting firm focused on the future of financial services. We observed that legacy consulting firms were too tethered to the legacy financial services industry and not really attuned to the business models and technologies that increasingly define financial services in the US and around the globe. So, we set out to build a firm that combined deep experience in the management of financial services businesses, deep regulatory expertise and deep understanding of the capital markets and investment landscape.

Peter: Okay, interesting, interesting. So, I want to dive right in and just talk about bank charters. We’re going to spend a bit of time on this, not the entire interview, but it’s really interesting watching the space over the last several years where, you know, there was initially a real push for a fintech charter and we’re going to talk about that in a little bit, but then in recent times, fintechs are really going after a full bank charter. So, why do you think fintechs, you know, want this bank charter?

Michele: Well, you know, when my fintech clients come to me… they’re typically late stage, they’re worried they’re outgrowing the bank partnership they grew up with. Their options, at that point, are to figure out how to optimize that bank partnership, become a bank, acquire a bank or sell themselves. I work with my clients to figure out which of those options work for them and then help them execute on their decision. 

For the fintech clients who decide they want a bank charter, the reason they do is very simple. A bank charter provides direct access to the payment system, low cost stable funding in the form of insured deposits and in certain instances preemption of state laws so it’s a pretty good deal. Fintechs also…they want to reduce the complexity of their businesses, increase their efficiency and reach more consumers and for some fintechs the bank charter is the way to do that.

Peter: Right. So, let’s maybe talk about the different types of bank charters, I know there are several. Maybe you could kind of just give us a little bit of an overview of the different types of charters that are available.

Michele: Since you don’t want this podcast to be 45 minutes of bank charters, I will try to be brief because it could really be a long discussion, Peter. So, let me rate the charter types into two very broad categories. First Category are those that subject the bank’s parent company to the Bank Holding Company Act, that’s Category One. Category Two is those that don’t.

Peter: (laughs) Okay. So, all charters fit into one of those categories, Id’ say.

Michele: Almost all, almost all, yeah.

Peter: Okay.

Michele: So, on the non-exempt bank charters, so we have two basic types, FDIC-insured national banks , those are OCC-regulated, they’re members of the Federal Reserve and they can engage in a full range of banking services and then there are State Fed member and non-member banks. They are state-regulated and they can also engage in a full range of bank services. So, really on the non-exempt bank charters there are two basic types, national and state and they are full service banks. When we get into the exempt bank charters it gets more complicated and fintechs are typically interested in exempt charters. They are interested in those exempt charters so that the fintechs will not be subject to federal oversight and they can continue to engage within the broader corporate group and activities that may not be permissible for the bank holding company. 

Broadly speaking, there are five types of exempt charters. Let’s start with the one that is always the most popular is number one, ILCs, industrial loan companies or industrial banks, depending on the state statute, they’re the same thing, ILCs and industrial banks are the same thing. They’re offered in about six states, they are state-regulated, they can pretty much do what a full service bank can do with certain limited exceptions that you can work around. They are FDIC-insured, they are very controversial and we’ll get more into that in a minute. 

Number two on the hit parade is the national trust bank, those are OCC-regulated, they can only engage in activities permitted by state laws for state trust banks so they derive their powers from state law. Generally, that means no lending. So, a national trust charter is a very old type of charter, but the OCC recently conditionally approved national charters for several crypto companies which is, of course, a controversial use of that charter and we’ll get more into that in a minute too. 

Number three in the exempt charters are state trust companies, those are state-regulated, basically the same as national trust banks. Now, some states like New York are for trust charters for crypto companies, specifically. 

Number four would be the uninsured national bank, we’re going to talk about that in a minute when we talk about the Figure Bank application. 

And then, finally, Number Five is the Wyoming Special Purpose Depository Institution which is a SPDI, that is primarily a bank that accepts deposits and provides digital asset custody services and is prohibited from lending. A SPDI that is not FDIC-insured does not qualify as a bank under the Bank Holding Company Act so we’ll talk about those in a minute too. And then I would just say that there are some other states that are getting into the Wyoming SPDI game like Nebraska and Illinois and I think that’s a space to watch.

Peter: Interesting.

Michele: (laughs) So, those are the exempt and non exempt 

Peter: Well, you’ve given us a lot to dig into there. Maybe you can talk about the different….like you said, the ILC charter is one that many fintechs are going after and Square has been approved for theirs, but there are then others that are doing the, I don’t know what officially the charter is called, but Varo got this, they were the first.

Michele: That’s a national bank charter.

Peter: That’s just a national bank charter and so they are non-exempt, right.

Michele: That’s correct.

Peter: Yes. So, they have to adhere to all of the Bank Holding Company Act rules. Is the main reason that a fintech would go for an ILC rather than what Varo did, a national bank charter, is it because of some of those rules really aren’t very suitable for fintech companies. Maybe you can talk about that.

Michele: So, ILCs, pretty much every fintech client who comes across the transit for me ask me first about ILCs, they always want an ILC, right, and an ILC is a good gig if you can get it. (both laugh) You get pretty much all of the benefits of a full service bank without the Bank Holding Company oversight, but as I mentioned, they are controversial. Banking industry advocates argue that ILCs are a loophole to the Bank Holding Company Act sort of. Personally, I like this oversight and they argued that loophole should be closed. I would say that that has a receptive body ends of the FDIC, I think that the shift at the FDIC Board recently makes the prospect for new ILCs perhaps a bit dimmer and there haven’t been very many ILCs in the first place. 

There was a moratorium post-financial crisis and then you mentioned Square and now that has two ILCs that got approved for something. I don’t know how many more we’re going to see make it, make it across the finish line, but the other thing to come caution about ILCs is that the FDIC also has proposed a rule that would effectively impose Bank Holding Company Act-like requirements on the parent of an ILC. So, that might lessen the interest in these charters a little bit.

Peter: I mean, if a new fintech were not a new fintech but a new client of yours, potential client, comes to you and says, we’re interested in ILCs, do you advise them because there’s going to be risk involved because as you said, the FDIC Board has changed its make up, they’re not going to approve any more ILCs. So, you could go down that path and not have any luck, do you advise your clients now to sort of go to the national bank charter-type like what Varo did or what do you say?

Michele: Well, not in the first instance. What I do when a client comes and says, I want an ILC, usually, my first question is why, even though I know the why is because they don’t want a Bank Holding Company Act application to their business. But then, I dig a little bit deeper, right, so what is it that you’re concerned about, what is it that you think having an ILC will help you avoid, what are you trying to do. I’m not saying that Bank Holding Company Act application is not a big deal, it is a big deal, but being a bank of any kind is a big deal. 

So, what we do is we just work through the options with these clients and one of the main criterion that I apply is likelihood of approval and that depends not just on charter type, but what is the business at issue, etc. If you read the Nelnet and Square approvals there’s some insights on what the FDIC might be receptive to so it’s really not something I can say, you know, thumbs up, thumbs down about, it depends on the business itself. That said, fintechs should certainly consider national bank charters a la Varo, right. 

There are some really important benefits to a national bank charter for fintechs. Absent a national bank charter to operate nationwide, a fintech company must rely on a complex patchwork of licenses, attempt to comply with conflicting state rules, sometimes conflicting state rules and submit to perhaps a dozen different examinations by state agencies each year, it’s a hassle, right. A national bank charter, by contrast, is a single charter administered by a single regulator pursuant to a comprehensive set of rules. 

So, obtaining a national bank charter will allow a fintech to offer a cohesive set of products and services nationwide, focus it’s compliance efforts on the requirements of a single regulator, reduce its legal and regulatory costs, complexity and risk and offer its customers the security and safety of dealing with a federally-regulated and supervised national bank. That’s great, but it’s a big lift.

Peter: So, what is it about the Bank Holding Company Act that really is a stumbling block, is that something like a number of investors? I think I’ve read, what is the main stumbling block?

Michele: You know, there are often issues about ownership with fintechs. Quite often, they have, you know, very concentrated ownership and that doesn’t always align with the Bank Holding Company Act requirements. Ownership is an issue and often comes down to just are the FTVs, right, that are going to be conducted within the broader corporate group. For many fintechs, it’s no big deal, you know, they are primarily conducting activities that are bank permissible or financial in nature, but sometimes, I’ve had clients that, and I’m not going to name any, it’s no unusual for a fintech to have a brilliant visionary founder/CEO, right. 

Sometimes, they want to get into some pretty interesting (Peter laughs) areas that are just going to be non-starters before the banking regulators. And so, what I often see when we’re talking about when I said, you know, the potential applicant comes to me and says, I want an ILC, I don’t want a bank holding company and I say, okay, how come. In fact, a lot of times, what they’re doing is completely permissible within a bank holding company structure, but they don’t want to be constrained in case something really interesting comes up that they’d like to do.

Peter: Right, that makes sense. So, speaking of visionary founders, I want to talk about Figure and obviously Mike Cagney’s company. We had a session on this a few months back with the general counsel and yourself discussing this in detail and I’ll link to that in the show notes, but when I sort of heard about what Figure was doing I didn’t even know this path existed so maybe you can explain it and why someone would want to go down this sort of path that is not well trodden.

Michele: That’s true, it’s not well trodden. It’s very simple though in concept and here it is. Figure Bank would not take retail deposits, therefore, it would not be FDIC-insured, therefore, it would not be a bank for purposes of the Bank Holding Company Act and, therefore, the holding company will not be a bank holding company subject to that supervision. Very simple in concept, right. 

Deposits, the rest of that stuff does not flow. The thing that’s important to remember when we’re talking about this because a lot of people would say, what do you mean a bank that doesn’t take deposits, right, it doesn’t take insured deposits, I want to stress, insured retail deposits. There is ample historical precedent for this charter, keep this in mind, because the National Bank Act dates to post-civil war, time of Lincoln…….

Peter: Right.

Michele: …..which preceded the Federal Deposit Insurance Act by many decades, right. All of the national banks, originally, were not FDIC-insured. So, lawyers can do what they do and, you know, split hairs and get in the arguments, but that is the crux of it. The National Bank Act is not conditioned or premised on the idea that the banks would be FDIC-insured because when it was written federal deposit insurance didn’t exist. That said, there isn’t a lot of examples of banks currently that are uninsured in the way that Figure is attempting. That decision is pending with the OCC so we will see.

Peter: Right, right, interesting. So then, does this still mean that the fintech charter is dead. I mean, you were at the OCC I think with the genesis of this with Tom Curry, it all sort of came out then. What is the status and your opinion of the fintech charter?

Michele: Yeah. Everything that we’ve been talking about does not lead to the conclusion that the fintech charter is dead, but indeed, the fintech charter is dead, in my opinion. The OCC and I really commend Tom Curry on this, in 2016 recognized that the traditional national banks subject to the Bank Holding Company Act just doesn’t work for many fintechs seeking to innovate within the financial services space. Unfortunately, though, I think that the OCC got out of over it’s skis with the fintech charter in 2016 and didn’t have the buy-in of the other banking agencies or the trade groups and without that, I just don’t think that charter could succeed.

Peter: I mean, we’ve certainly seen a lot of traditional banks, trade organizations, you know, particularly the state, competent state board….supervisors, for example, have come out and they tried to sue to the OCC that there was no charter that had been issued so it was trying out, but I’d love you to weigh-in on this sort of conflict between the state bank supervisers and the fintech companies that want a federal charter-type thing. What do you say to them and what….fintech companies, by definition, are online-based, it knows no state boundaries typically so how do you kind of approach that argument.

Michele: This is a toughie. The debate and the dual banking system, state versus Fed, I am not going to say it’s as old as Adam and Eve, but it’s old (Peter laughs) and I’m not going to be able to solve that problem on this podcast. But, I think what we see, with respect to the idea of the fintech charter, are really good intentions on both sides, right. We see, as I said, the OCC seeking to foster innovation, right, in the national banking system and do so in a way that accommodates fintech business models, that’s great, right. 

On the state side, we see similarly good intentions, right, but what the CSBS typically points out is state regulators often are the incubators for innovation, we’ll get to that, the SPDI is a good example of that and that they are primarily focused on consumers in their states and know their needs very well, right, and are concerned about what might appear to be a work around some of the regulatory burdens that their state banks are faced with. Their state banks are not getting a pass on the BHCA.

Peter: Right, right, got it. So, before we move on, I want to just go back to revisit the Special Purpose Charter which is what the fintech charter was because we had Brian Brooks who had a short but quite active time as acting head of the OCC late last year and early this year, I mean, he was really vocal about how we should have special purpose charters. He talked about the fintech charter, he talked about the payments charter, what are your thoughts on those sort of narrowly-defined charters.

Michele: Well, I also commend Brian Brooks on his desire to foster innovation in the national banking system, but I think the current regulatory environment just isn’t conducive to new types of charters. With the caveat and in a minute we’ll talk about the possible StableCoin issuer charter that’s very intriguing, but leaving that aside, I think it’s also important to remember, there’s a lot you can do within the existing national bank charter, for example, or some of the state charters. 

So, within the existing national charter as we see, you’re not demonstrated by the Figure application, you can accommodate some very innovative business models and, as I said, there are a number of the SPDIs and the trust charters that we recently conditionally approved for some crypto companies show that within very, very old legal frameworks, innovation is possible.

Peter: Well, can we touch on that then now like the Wyoming Charter which….you know, they’ve granted the charter to at least two crypto companies, Avanti Bank and Kraken, can you describe what is unique about what Wyoming has done.

Michele: First let me say, I think that the Wyoming SPDI and other similar efforts afoot show that the states are going to eat the Fed’s lunch, right. (both laugh) As the winds are blowing cold on crypto in DC right now, there is more and more interest in developing these state charters. I’m getting more questions about it and I don’t see the state regulators, you know, comparing crypto to credit default swaps, right, they are very much signaling that they are open for business and receptive to new applications. 

So, I promise this will be my last commendation at the podcast, but Albert Portner in Wyoming has really provided a very interesting option allowing SPDIs to accept all types of deposits, including demand deposits from consumers which may be an on-ramp to crypto and other digital assets like in the Kraken Bank model. So, I think there’s much to be explored there and with, as I said, similar state efforts.

Peter: You keep saying SPDIs, I haven’t heard that term before, would you explain that.

Michele: Oh, I’m sorry. It’s Special Purpose Deposit Institution.

Peter: I’ve heard that, I just didn’t think that was how it was said.

Michele: (laughs) Are we talking about Speedy Gonzalez here?

Peter: Right, right, okay, great. So, let’s go back to Varo because…I believe you worked on that as well, but that was a long process and they got it over the line. It’s always hard to be first, but do you think that the fact what Varo has done has paved the way for an easier time for fintechs to go down that route now?

Michele: I don’t think it’s ever going to be easy (Peter laughs). You know, I just, a moment ago, promised that was going to be my last commendation and I know I’m doing a lot of commending on this, but my hat is off to Colin Walsh and his team including his general counsel, Marina Gracias. A De Novo National Bank application is not for the faint of heart. Varo applied for and received approval for a national bank charter then it had to apply for FDIC insurance which got approved, then they had to apply for status as a bank holding company, right, that is a lot of work. 

So, in response to your question, do they make it easier for other fintechs? No, they provide a model which is very important, they provide an example that the lift is large, but it’s not impossible. But, any applicant for a bank charter should prepare for a very lengthy chartering or perhaps change of bank control application if they go the acquisition route and if they succeed, a very high degree of regulatory complexity and scrutiny, right.

Peter: So, should it take three years, is that what people should expect which I think is roughly what it was for Varo.

Michele: I don’t think it should take (Peter laughs) three years, I don’t think the process is going to be fast. One important difference I think in the current environment, and we’re seeing and Michael Soo has made an important point of this which is we’re seeing a greater emphasis on inter-agency coordination in reviewing these applications. I think that one thing that’s kind of unfortunate is, speaking of the OCC, the OCC and the FDIC have slightly different application processes, but they use the same application. So, I think in Varo’s case and there were good reasons why it did a serial set of applications that I described, first National Bank and FDIC and the Fed, you can apply for the bank charter and the FDIC insurance at the same time which may reduce the overall processing time.

Peter: So, I’ve seen a lot of fintech companies over the years, let’s say some, they apply and then they withdraw the application. Why do they do that, is that just inexperience or is there some reason behind this apply/withdraw kind of process?

Michele: Nobody should ever apply thinking they may withdraw. Withdrawals happen for a variety of reasons. One reason though is that the agency has determined that the application will not succeed, either it’s not complete as presented or raises fundamental concerns on the part of the regulator. Common concerns with fintech applications are lack of profitability at the parent level or uncomfortable with banking and commerce. Those are two things that give regulators quite a bit of heartburn. The profitability issue, it’s a real rub. 

Fintechs often focus on growth over profitability, at least in their initial phases, and that is not an approach that the regulators are particularly comfortable with, right. Pursuant to Dodd-Frank, the parent company of a bank is required to serve as a source of financial and managerial strength to the subsidiary bank so if the parent is not profitable, that raises concerns about its ability to serve as a source of strength. These are issues that can tank an application or at least cause it to be withdrawn and resubmitted. I always tell my clients, we’re not going to go forward if there is any risk of withdrawal.

Peter: Obviously, profitability isn’t a deal breaker because Varo has not been profitable and they were approved so what’s the rub there?

Michele: I do believe Varo is intending to be profitable within the de novo period and that is, in fact, a hard requirement of the regulators.

Peter: Okay.

Michele: They don’t expect profitability out of the gate, but they do expect a bank to achieve it within three years.

Peter: Got you. So, final question, I want to sort of do a little fantasy game here like let’s say the current OCC pick is rejected and President Biden puts your name forward, you are confirmed by the Senate and you’re running the OCC, what changes are you going to make? I’m particularly interested in things that would make it better for fintech companies.

Michele: If in this fantasy I were leading the agency, I would make changes that would help consumers and help banks and fintechs by leveling the field on which they compete. I’m deeply concerned that a significant portion of Americans receive their financial services outside the regulated banking system. 

The fundamental purpose of bank regulation is to protect consumers and without visibility into what’s called the “shadow banking system,” the banking regulators really can’t protect these consumers. Unfortunately, I think that recent statements from Washington are reflective of a profound reluctance to allow fintechs into the regulatory fold and keeping fintechs out of that fold means that the banking regulators will not have to address the risk of certain innovative business models.

Peter: Right.

Michele: And it will mollify banking industry advocates worried about competition from fintechs and, therefore, opposed to chartering them, but it won’t keep consumers from seeking alternatives to banks and, therefore, really won’t keep the fintechs from eating the banks’ lunches. (laughs) There’s a lot of lunch-eating going on in this podcast right now, maybe I’m hungry. In other words, there’s a consumer demand for services provided by fintechs, that’s clear, right. 

Fintechs are going to meet that demand and unless chartered, fintechs will be able to do so free of the costly regulatory burden imposed on their bank competitors and that’s a fact. In my opinion, the best way to ensure consumer protection and healthy competition among financial services providers is to require fintechs offering banking services to consumers to apply for bank charters and submit to the rigorous oversight to which banks are subject.

Peter: Okay, interesting, simple and probably not what every fintech wants to hear, but it’s a great point to end on. It’s been really insightful, Michele, I’ve learned a lot today, I hope the listeners have as well. Thank you so much for coming on the show.

Michele: It’s my pleasure, thank you, Peter.

Peter: Okay, see you.

Michele: Bye.

Peter: You know, Michele and I were chatting after we stopped recording just now and we figured, it’s almost amusing in some ways how some of the banks and the bank trade associations how they have approached fintechs, in general. On the one hand, they say, well, it’s not fair because fintechs have a lighter lift when it comes to regulation, on the other hand, it says, we don’t want them to become regulated. So you can’t sort of have it both ways. 

The reality is it’s inevitable that the major players in fintech are all going to become fully regulated banks, there may be one or two exceptions, but the vast majority, if you want to be a really national scale fintech company and you really do want to have some kind of bank charter and that’s what we’re starting to see. I think, long term, it’s inevitable that we are going to see most of the major fintech companies with charters.

Anyway on that note, I will sign off. I very much appreciate your listening and I’ll catch you next time. Bye.

(music)

Today’s episode was brought to you by LendIt Fintech LatAm, the region’s leading fintech event. It’s happening both online and in-person in Miami on Dec. 7th and 8th. Latin America is still the hottest region for fintech in the world and LendIt Fintech LatAm features the leading players in the region. So, join the LatAm fintech community this year where you will meet the people who matter, learn from the experts and get business done. In-person and virtual tickets are available at lendit.com/latam

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Podcast 321: Michele Alt of Klaros Group

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Until recently virtually no fintech companies were interested in a bank charter. It was just back in 2016 that SoFi ran a Superbowl ad with the “Don’t Bank. SoFi” tagline. Now, they are looking to become a bank. Square and LendingClub have joined SoFi as approved banks (via different routes) and there are many applications that are still pending. So, I thought it was time to talk bank charters on the podcast.

Our next guest on the Fintech One-on-One podcast is Michele Alt, a co-founder and partner at Klaros Group. We spend a lot of time discussing the various options for fintech companies and we delve into some of the unique ways fintech companies are pursuing bank charters today.

In this podcast you will learn:

  • The impetus behind the founding of Klaros Group.
  • Why fintech companies want a bank charter.
  • The two main categories of bank charters.
  • The five types of exempt bank charters.
  • Why many fintech companies lean towards the ILC charter.
  • The advantages a national bank charter provides.
  • The main stumbling block for fintechs with the Bank Holding Company Act.
  • The interesting avenue that Figure has taken (more on Figure’s charter application here).
  • Why the fintech charter and any other national special purpose charters are dead.
  • How the states have taken the lead when it comes to chartering fintechs.
  • Why Varo’s application has not made it easier for other fintechs.
  • What is behind the frequent application withdrawals by fintech companies.
  • What Michele would do if she was running the OCC right now.

You can subscribe to the Fintech One on One Podcast via Apple Podcasts or Spotify. To listen to this podcast episode there is an audio player directly above or you can download the MP3 file here.

Download a PDF of the Transcription or Read it Below

Welcome to the Fintech One-on-One Podcast, Episode No. 321. This is your host, Peter Renton, Chairman and Co-Founder of LendIt Fintech.

(music)

Today’s episode is brought to you by LendIt Fintech LatAm, the region’s leading fintech event. It’s happening both online and in-person in Miami on Dec. 7th and 8th. Latin America is still the hottest region for fintech in the world and LendIt Fintech LatAm features the leading players in the region. So, join the LatAm fintech community this year where you will meet the people who matter, learn from the experts and get business done. In-person and virtual tickets are available at lendit.com/latam.

Peter Renton: Today on the show, I’m delighted to welcome Michele Alt, she is a Co-Founder and Partner at Klaros Group. I wanted to get Michele on the show because we’re going to be digging deep into bank regulation here, bank charters, fintech charters, the whole nine yards. I learned a great deal in this episode and I’m sure you will too so make sure you stick around all the way to the end. 

We cover the nuances of different types of bank charters, why fintechs go for one charter over another, we talk about some of the unique things that are happening like what Figure is doing, talk about the Wyoming State Special Charter they have there. We talk about Varo’s charter and we also cover some of the things that Brian Brooks talked about last year when he was head of the OCC and Michele also talks about what she would do if she was head of the OCC. It really was a fascinating episode, hope you enjoy the show.

Welcome to the podcast, Michele!

Michele Alt: Well, thank you, Peter, it’s delightful to be back talking to you.

Peter: Yes, indeed. So, let’s get started by giving the listeners a little bit of background about yourself. I know you spent many years as a bank regulator, but why don’t you give us some of the highlights of your career to date.

Michele: Be happy to. I am a Co-Founder of the Klaros Group and a Managing Director of Klaros Advisors. I am a lawyer by training and inclination, I must admit. I spent more than 20 years in various policy and legal roles at the OCC focusing on national bank powers, preemption, inter-agency regulation, licensing and Dodd-Frank. After leaving the OCC, I cut my teeth in the consulting world helping a range of banks with various risk and strategy matters, ultimately, focusing on bank chartering and fintech before leaving to co-found Klaros.

Peter: Right. So, tell us a little bit about that. What was the impetus behind the founding of Klaros Group?

Michele: Well, my partners and I believed that there was a need for a consulting firm focused on the future of financial services. We observed that legacy consulting firms were too tethered to the legacy financial services industry and not really attuned to the business models and technologies that increasingly define financial services in the US and around the globe. So, we set out to build a firm that combined deep experience in the management of financial services businesses, deep regulatory expertise and deep understanding of the capital markets and investment landscape.

Peter: Okay, interesting, interesting. So, I want to dive right in and just talk about bank charters. We’re going to spend a bit of time on this, not the entire interview, but it’s really interesting watching the space over the last several years where, you know, there was initially a real push for a fintech charter and we’re going to talk about that in a little bit, but then in recent times, fintechs are really going after a full bank charter. So, why do you think fintechs, you know, want this bank charter?

Michele: Well, you know, when my fintech clients come to me… they’re typically late stage, they’re worried they’re outgrowing the bank partnership they grew up with. Their options, at that point, are to figure out how to optimize that bank partnership, become a bank, acquire a bank or sell themselves. I work with my clients to figure out which of those options work for them and then help them execute on their decision. 

For the fintech clients who decide they want a bank charter, the reason they do is very simple. A bank charter provides direct access to the payment system, low cost stable funding in the form of insured deposits and in certain instances preemption of state laws so it’s a pretty good deal. Fintechs also…they want to reduce the complexity of their businesses, increase their efficiency and reach more consumers and for some fintechs the bank charter is the way to do that.

Peter: Right. So, let’s maybe talk about the different types of bank charters, I know there are several. Maybe you could kind of just give us a little bit of an overview of the different types of charters that are available.

Michele: Since you don’t want this podcast to be 45 minutes of bank charters, I will try to be brief because it could really be a long discussion, Peter. So, let me rate the charter types into two very broad categories. First Category are those that subject the bank’s parent company to the Bank Holding Company Act, that’s Category One. Category Two is those that don’t.

Peter: (laughs) Okay. So, all charters fit into one of those categories, Id’ say.

Michele: Almost all, almost all, yeah.

Peter: Okay.

Michele: So, on the non-exempt bank charters, so we have two basic types, FDIC-insured national banks , those are OCC-regulated, they’re members of the Federal Reserve and they can engage in a full range of banking services and then there are State Fed member and non-member banks. They are state-regulated and they can also engage in a full range of bank services. So, really on the non-exempt bank charters there are two basic types, national and state and they are full service banks. When we get into the exempt bank charters it gets more complicated and fintechs are typically interested in exempt charters. They are interested in those exempt charters so that the fintechs will not be subject to federal oversight and they can continue to engage within the broader corporate group and activities that may not be permissible for the bank holding company. 

Broadly speaking, there are five types of exempt charters. Let’s start with the one that is always the most popular is number one, ILCs, industrial loan companies or industrial banks, depending on the state statute, they’re the same thing, ILCs and industrial banks are the same thing. They’re offered in about six states, they are state-regulated, they can pretty much do what a full service bank can do with certain limited exceptions that you can work around. They are FDIC-insured, they are very controversial and we’ll get more into that in a minute. 

Number two on the hit parade is the national trust bank, those are OCC-regulated, they can only engage in activities permitted by state laws for state trust banks so they derive their powers from state law. Generally, that means no lending. So, a national trust charter is a very old type of charter, but the OCC recently conditionally approved national charters for several crypto companies which is, of course, a controversial use of that charter and we’ll get more into that in a minute too. 

Number three in the exempt charters are state trust companies, those are state-regulated, basically the same as national trust banks. Now, some states like New York are for trust charters for crypto companies, specifically. 

Number four would be the uninsured national bank, we’re going to talk about that in a minute when we talk about the Figure Bank application. 

And then, finally, Number Five is the Wyoming Special Purpose Depository Institution which is a SPDI, that is primarily a bank that accepts deposits and provides digital asset custody services and is prohibited from lending. A SPDI that is not FDIC-insured does not qualify as a bank under the Bank Holding Company Act so we’ll talk about those in a minute too. And then I would just say that there are some other states that are getting into the Wyoming SPDI game like Nebraska and Illinois and I think that’s a space to watch.

Peter: Interesting.

Michele: (laughs) So, those are the exempt and non exempt 

Peter: Well, you’ve given us a lot to dig into there. Maybe you can talk about the different….like you said, the ILC charter is one that many fintechs are going after and Square has been approved for theirs, but there are then others that are doing the, I don’t know what officially the charter is called, but Varo got this, they were the first.

Michele: That’s a national bank charter.

Peter: That’s just a national bank charter and so they are non-exempt, right.

Michele: That’s correct.

Peter: Yes. So, they have to adhere to all of the Bank Holding Company Act rules. Is the main reason that a fintech would go for an ILC rather than what Varo did, a national bank charter, is it because of some of those rules really aren’t very suitable for fintech companies. Maybe you can talk about that.

Michele: So, ILCs, pretty much every fintech client who comes across the transit for me ask me first about ILCs, they always want an ILC, right, and an ILC is a good gig if you can get it. (both laugh) You get pretty much all of the benefits of a full service bank without the Bank Holding Company oversight, but as I mentioned, they are controversial. Banking industry advocates argue that ILCs are a loophole to the Bank Holding Company Act sort of. Personally, I like this oversight and they argued that loophole should be closed. I would say that that has a receptive body ends of the FDIC, I think that the shift at the FDIC Board recently makes the prospect for new ILCs perhaps a bit dimmer and there haven’t been very many ILCs in the first place. 

There was a moratorium post-financial crisis and then you mentioned Square and now that has two ILCs that got approved for something. I don’t know how many more we’re going to see make it, make it across the finish line, but the other thing to come caution about ILCs is that the FDIC also has proposed a rule that would effectively impose Bank Holding Company Act-like requirements on the parent of an ILC. So, that might lessen the interest in these charters a little bit.

Peter: I mean, if a new fintech were not a new fintech but a new client of yours, potential client, comes to you and says, we’re interested in ILCs, do you advise them because there’s going to be risk involved because as you said, the FDIC Board has changed its make up, they’re not going to approve any more ILCs. So, you could go down that path and not have any luck, do you advise your clients now to sort of go to the national bank charter-type like what Varo did or what do you say?

Michele: Well, not in the first instance. What I do when a client comes and says, I want an ILC, usually, my first question is why, even though I know the why is because they don’t want a Bank Holding Company Act application to their business. But then, I dig a little bit deeper, right, so what is it that you’re concerned about, what is it that you think having an ILC will help you avoid, what are you trying to do. I’m not saying that Bank Holding Company Act application is not a big deal, it is a big deal, but being a bank of any kind is a big deal. 

So, what we do is we just work through the options with these clients and one of the main criterion that I apply is likelihood of approval and that depends not just on charter type, but what is the business at issue, etc. If you read the Nelnet and Square approvals there’s some insights on what the FDIC might be receptive to so it’s really not something I can say, you know, thumbs up, thumbs down about, it depends on the business itself. That said, fintechs should certainly consider national bank charters a la Varo, right. 

There are some really important benefits to a national bank charter for fintechs. Absent a national bank charter to operate nationwide, a fintech company must rely on a complex patchwork of licenses, attempt to comply with conflicting state rules, sometimes conflicting state rules and submit to perhaps a dozen different examinations by state agencies each year, it’s a hassle, right. A national bank charter, by contrast, is a single charter administered by a single regulator pursuant to a comprehensive set of rules. 

So, obtaining a national bank charter will allow a fintech to offer a cohesive set of products and services nationwide, focus it’s compliance efforts on the requirements of a single regulator, reduce its legal and regulatory costs, complexity and risk and offer its customers the security and safety of dealing with a federally-regulated and supervised national bank. That’s great, but it’s a big lift.

Peter: So, what is it about the Bank Holding Company Act that really is a stumbling block, is that something like a number of investors? I think I’ve read, what is the main stumbling block?

Michele: You know, there are often issues about ownership with fintechs. Quite often, they have, you know, very concentrated ownership and that doesn’t always align with the Bank Holding Company Act requirements. Ownership is an issue and often comes down to just are the FTVs, right, that are going to be conducted within the broader corporate group. For many fintechs, it’s no big deal, you know, they are primarily conducting activities that are bank permissible or financial in nature, but sometimes, I’ve had clients that, and I’m not going to name any, it’s no unusual for a fintech to have a brilliant visionary founder/CEO, right. 

Sometimes, they want to get into some pretty interesting (Peter laughs) areas that are just going to be non-starters before the banking regulators. And so, what I often see when we’re talking about when I said, you know, the potential applicant comes to me and says, I want an ILC, I don’t want a bank holding company and I say, okay, how come. In fact, a lot of times, what they’re doing is completely permissible within a bank holding company structure, but they don’t want to be constrained in case something really interesting comes up that they’d like to do.

Peter: Right, that makes sense. So, speaking of visionary founders, I want to talk about Figure and obviously Mike Cagney’s company. We had a session on this a few months back with the general counsel and yourself discussing this in detail and I’ll link to that in the show notes, but when I sort of heard about what Figure was doing I didn’t even know this path existed so maybe you can explain it and why someone would want to go down this sort of path that is not well trodden.

Michele: That’s true, it’s not well trodden. It’s very simple though in concept and here it is. Figure Bank would not take retail deposits, therefore, it would not be FDIC-insured, therefore, it would not be a bank for purposes of the Bank Holding Company Act and, therefore, the holding company will not be a bank holding company subject to that supervision. Very simple in concept, right. 

Deposits, the rest of that stuff does not flow. The thing that’s important to remember when we’re talking about this because a lot of people would say, what do you mean a bank that doesn’t take deposits, right, it doesn’t take insured deposits, I want to stress, insured retail deposits. There is ample historical precedent for this charter, keep this in mind, because the National Bank Act dates to post-civil war, time of Lincoln…….

Peter: Right.

Michele: …..which preceded the Federal Deposit Insurance Act by many decades, right. All of the national banks, originally, were not FDIC-insured. So, lawyers can do what they do and, you know, split hairs and get in the arguments, but that is the crux of it. The National Bank Act is not conditioned or premised on the idea that the banks would be FDIC-insured because when it was written federal deposit insurance didn’t exist. That said, there isn’t a lot of examples of banks currently that are uninsured in the way that Figure is attempting. That decision is pending with the OCC so we will see.

Peter: Right, right, interesting. So then, does this still mean that the fintech charter is dead. I mean, you were at the OCC I think with the genesis of this with Tom Curry, it all sort of came out then. What is the status and your opinion of the fintech charter?

Michele: Yeah. Everything that we’ve been talking about does not lead to the conclusion that the fintech charter is dead, but indeed, the fintech charter is dead, in my opinion. The OCC and I really commend Tom Curry on this, in 2016 recognized that the traditional national banks subject to the Bank Holding Company Act just doesn’t work for many fintechs seeking to innovate within the financial services space. Unfortunately, though, I think that the OCC got out of over it’s skis with the fintech charter in 2016 and didn’t have the buy-in of the other banking agencies or the trade groups and without that, I just don’t think that charter could succeed.

Peter: I mean, we’ve certainly seen a lot of traditional banks, trade organizations, you know, particularly the state, competent state board….supervisors, for example, have come out and they tried to sue to the OCC that there was no charter that had been issued so it was trying out, but I’d love you to weigh-in on this sort of conflict between the state bank supervisers and the fintech companies that want a federal charter-type thing. What do you say to them and what….fintech companies, by definition, are online-based, it knows no state boundaries typically so how do you kind of approach that argument.

Michele: This is a toughie. The debate and the dual banking system, state versus Fed, I am not going to say it’s as old as Adam and Eve, but it’s old (Peter laughs) and I’m not going to be able to solve that problem on this podcast. But, I think what we see, with respect to the idea of the fintech charter, are really good intentions on both sides, right. We see, as I said, the OCC seeking to foster innovation, right, in the national banking system and do so in a way that accommodates fintech business models, that’s great, right. 

On the state side, we see similarly good intentions, right, but what the CSBS typically points out is state regulators often are the incubators for innovation, we’ll get to that, the SPDI is a good example of that and that they are primarily focused on consumers in their states and know their needs very well, right, and are concerned about what might appear to be a work around some of the regulatory burdens that their state banks are faced with. Their state banks are not getting a pass on the BHCA.

Peter: Right, right, got it. So, before we move on, I want to just go back to revisit the Special Purpose Charter which is what the fintech charter was because we had Brian Brooks who had a short but quite active time as acting head of the OCC late last year and early this year, I mean, he was really vocal about how we should have special purpose charters. He talked about the fintech charter, he talked about the payments charter, what are your thoughts on those sort of narrowly-defined charters.

Michele: Well, I also commend Brian Brooks on his desire to foster innovation in the national banking system, but I think the current regulatory environment just isn’t conducive to new types of charters. With the caveat and in a minute we’ll talk about the possible StableCoin issuer charter that’s very intriguing, but leaving that aside, I think it’s also important to remember, there’s a lot you can do within the existing national bank charter, for example, or some of the state charters. 

So, within the existing national charter as we see, you’re not demonstrated by the Figure application, you can accommodate some very innovative business models and, as I said, there are a number of the SPDIs and the trust charters that we recently conditionally approved for some crypto companies show that within very, very old legal frameworks, innovation is possible.

Peter: Well, can we touch on that then now like the Wyoming Charter which….you know, they’ve granted the charter to at least two crypto companies, Avanti Bank and Kraken, can you describe what is unique about what Wyoming has done.

Michele: First let me say, I think that the Wyoming SPDI and other similar efforts afoot show that the states are going to eat the Fed’s lunch, right. (both laugh) As the winds are blowing cold on crypto in DC right now, there is more and more interest in developing these state charters. I’m getting more questions about it and I don’t see the state regulators, you know, comparing crypto to credit default swaps, right, they are very much signaling that they are open for business and receptive to new applications. 

So, I promise this will be my last commendation at the podcast, but Albert Portner in Wyoming has really provided a very interesting option allowing SPDIs to accept all types of deposits, including demand deposits from consumers which may be an on-ramp to crypto and other digital assets like in the Kraken Bank model. So, I think there’s much to be explored there and with, as I said, similar state efforts.

Peter: You keep saying SPDIs, I haven’t heard that term before, would you explain that.

Michele: Oh, I’m sorry. It’s Special Purpose Deposit Institution.

Peter: I’ve heard that, I just didn’t think that was how it was said.

Michele: (laughs) Are we talking about Speedy Gonzalez here?

Peter: Right, right, okay, great. So, let’s go back to Varo because…I believe you worked on that as well, but that was a long process and they got it over the line. It’s always hard to be first, but do you think that the fact what Varo has done has paved the way for an easier time for fintechs to go down that route now?

Michele: I don’t think it’s ever going to be easy (Peter laughs). You know, I just, a moment ago, promised that was going to be my last commendation and I know I’m doing a lot of commending on this, but my hat is off to Colin Walsh and his team including his general counsel, Marina Gracias. A De Novo National Bank application is not for the faint of heart. Varo applied for and received approval for a national bank charter then it had to apply for FDIC insurance which got approved, then they had to apply for status as a bank holding company, right, that is a lot of work. 

So, in response to your question, do they make it easier for other fintechs? No, they provide a model which is very important, they provide an example that the lift is large, but it’s not impossible. But, any applicant for a bank charter should prepare for a very lengthy chartering or perhaps change of bank control application if they go the acquisition route and if they succeed, a very high degree of regulatory complexity and scrutiny, right.

Peter: So, should it take three years, is that what people should expect which I think is roughly what it was for Varo.

Michele: I don’t think it should take (Peter laughs) three years, I don’t think the process is going to be fast. One important difference I think in the current environment, and we’re seeing and Michael Soo has made an important point of this which is we’re seeing a greater emphasis on inter-agency coordination in reviewing these applications. I think that one thing that’s kind of unfortunate is, speaking of the OCC, the OCC and the FDIC have slightly different application processes, but they use the same application. So, I think in Varo’s case and there were good reasons why it did a serial set of applications that I described, first National Bank and FDIC and the Fed, you can apply for the bank charter and the FDIC insurance at the same time which may reduce the overall processing time.

Peter: So, I’ve seen a lot of fintech companies over the years, let’s say some, they apply and then they withdraw the application. Why do they do that, is that just inexperience or is there some reason behind this apply/withdraw kind of process?

Michele: Nobody should ever apply thinking they may withdraw. Withdrawals happen for a variety of reasons. One reason though is that the agency has determined that the application will not succeed, either it’s not complete as presented or raises fundamental concerns on the part of the regulator. Common concerns with fintech applications are lack of profitability at the parent level or uncomfortable with banking and commerce. Those are two things that give regulators quite a bit of heartburn. The profitability issue, it’s a real rub. 

Fintechs often focus on growth over profitability, at least in their initial phases, and that is not an approach that the regulators are particularly comfortable with, right. Pursuant to Dodd-Frank, the parent company of a bank is required to serve as a source of financial and managerial strength to the subsidiary bank so if the parent is not profitable, that raises concerns about its ability to serve as a source of strength. These are issues that can tank an application or at least cause it to be withdrawn and resubmitted. I always tell my clients, we’re not going to go forward if there is any risk of withdrawal.

Peter: Obviously, profitability isn’t a deal breaker because Varo has not been profitable and they were approved so what’s the rub there?

Michele: I do believe Varo is intending to be profitable within the de novo period and that is, in fact, a hard requirement of the regulators.

Peter: Okay.

Michele: They don’t expect profitability out of the gate, but they do expect a bank to achieve it within three years.

Peter: Got you. So, final question, I want to sort of do a little fantasy game here like let’s say the current OCC pick is rejected and President Biden puts your name forward, you are confirmed by the Senate and you’re running the OCC, what changes are you going to make? I’m particularly interested in things that would make it better for fintech companies.

Michele: If in this fantasy I were leading the agency, I would make changes that would help consumers and help banks and fintechs by leveling the field on which they compete. I’m deeply concerned that a significant portion of Americans receive their financial services outside the regulated banking system. 

The fundamental purpose of bank regulation is to protect consumers and without visibility into what’s called the “shadow banking system,” the banking regulators really can’t protect these consumers. Unfortunately, I think that recent statements from Washington are reflective of a profound reluctance to allow fintechs into the regulatory fold and keeping fintechs out of that fold means that the banking regulators will not have to address the risk of certain innovative business models.

Peter: Right.

Michele: And it will mollify banking industry advocates worried about competition from fintechs and, therefore, opposed to chartering them, but it won’t keep consumers from seeking alternatives to banks and, therefore, really won’t keep the fintechs from eating the banks’ lunches. (laughs) There’s a lot of lunch-eating going on in this podcast right now, maybe I’m hungry. In other words, there’s a consumer demand for services provided by fintechs, that’s clear, right. 

Fintechs are going to meet that demand and unless chartered, fintechs will be able to do so free of the costly regulatory burden imposed on their bank competitors and that’s a fact. In my opinion, the best way to ensure consumer protection and healthy competition among financial services providers is to require fintechs offering banking services to consumers to apply for bank charters and submit to the rigorous oversight to which banks are subject.

Peter: Okay, interesting, simple and probably not what every fintech wants to hear, but it’s a great point to end on. It’s been really insightful, Michele, I’ve learned a lot today, I hope the listeners have as well. Thank you so much for coming on the show.

Michele: It’s my pleasure, thank you, Peter.

Peter: Okay, see you.

Michele: Bye.

Peter: You know, Michele and I were chatting after we stopped recording just now and we figured, it’s almost amusing in some ways how some of the banks and the bank trade associations how they have approached fintechs, in general. On the one hand, they say, well, it’s not fair because fintechs have a lighter lift when it comes to regulation, on the other hand, it says, we don’t want them to become regulated. So you can’t sort of have it both ways. 

The reality is it’s inevitable that the major players in fintech are all going to become fully regulated banks, there may be one or two exceptions, but the vast majority, if you want to be a really national scale fintech company and you really do want to have some kind of bank charter and that’s what we’re starting to see. I think, long term, it’s inevitable that we are going to see most of the major fintech companies with charters.

Anyway on that note, I will sign off. I very much appreciate your listening and I’ll catch you next time. Bye.

(music)

Today’s episode was brought to you by LendIt Fintech LatAm, the region’s leading fintech event. It’s happening both online and in-person in Miami on Dec. 7th and 8th. Latin America is still the hottest region for fintech in the world and LendIt Fintech LatAm features the leading players in the region. So, join the LatAm fintech community this year where you will meet the people who matter, learn from the experts and get business done. In-person and virtual tickets are available at lendit.com/latam

The post Podcast 321: Michele Alt of Klaros Group appeared first on LendIt Fintech News.

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