Fintech “banks” are coming to the USA

A few years ago, I wrote that when it came to the regulation of payments, America could do worse than adopt something along European lines. By “European lines”, I meant that a regulatory framework which separated systemically risky operations such as lending people money from systemically unrisky operations such as low-value payments would benefit all concerned.

The US has no equivalent of the EU’s Payment Institution (PI) licence, but this would be a practical way to allow new entrants access to the infrastructure needed to deliver great new products and services.

From In payments, the US is an emerging market | Consult Hyperion

Hence it was rather exciting to read the news that the US regulatory environment is about to change, and about to change significantly. This announcement is, I think, really important.

The Office of the Comptroller of the Currency will start granting limited-purpose bank charters to fintech companies,

From OCC Grants New Charter to Fintech Firms — with Strings Attached | American Banker

These special limited-purpose national bank charters (I can’t think of a snappy name for them yet  – I want to call them “near-banking” licences because they allow you to do some of things that banks do) mean that fintech companies can apply for a national licence instead of having to apply for licenses in every state. So if you want to offer some form of payment service, you will no longer have to apply for 50 (different) state money transmission licences.

Fintech firms that can apply for an OCC charter must offer at least one of three financial services: make loans, pay checks or receive deposits. The OCC is currently developing guidelines for a fintech bank charter that will be based on the comments received from the proposed paper.

From Regulator will start issuing bank charters for fintech firms

Were I to comment on the proposed paper, I would focus on the first of these financial services. It is the provision of credit that is the systemically risky service and it is this service that requires strict regulation. I make no comment on the issue of whether this should be dealt with at the federal level or state-by-state, but it does seem to me that if the proposed special fintech banking charter were to exclude this activity then it would create a regulatory category that is much more like the European Union “payment institution” or the Indian “payment bank”. I don’t know what other people think about this but I think that the European Commission’s general drive to separate regulation of payments from the regulation of banking makes a lot of sense and is founded both in sound regulatory strategy and economic theory. It’s the right way to go.

we can see a “back to the future” roadmap where banks go back to savings and loans and the “pooling” functions needed to support a modern economy, non-state actors provide money and — and most importantly in the short term — third-parties provide payment systems. In Europe, the regulatory wind is already in these sails.

From Why do banks run retail payment systems? | Consult Hyperion

To begin with an obvious example, Facebook recently obtained licences in Europe to operate as a Payment Institution (PI) and as an electronic money institution (ELMI). The regulatory burden of complying with these licenses is very limited compared to complying with a full banking licence, which is good for both Facebook and its customers who will be offered innovative new services through the platform (sending people money using Facebook as a front-end to national and international payment networks, allowing people to carry stored value accounts in Whatsapp and who knows what else).

The notion of a special-purpose charter has also drawn concerns from some consumer groups who want to ensure all of the banking and fair-lending laws apply to fintech firms and banks that fear they would lose business to fintech if they had to compete within the same banking system.

From Regulator will start issuing bank charters for fintech firms

 I am not an expert on consumer lending but I would have thought that the concerns of consumer groups in this area are perfectly reasonable and that the simplest way to satisfy those concerns is to keep the provision of credit with existing institutions that are tightly regulated in that regard. Therefore I would comment to the OCC that if they want to encourage more competition in lending it should be through a separate kind of special charter.

But back to the rest of the special-purpose charter. As to the concerns of the banks that they will lose business, well, tough. The purpose of the financial services regulatory environment is not to maintain the status quo and to defend incumbents against competition of all kinds across time. If some banks are concerned that the new special-purpose charter “banks” will be able to deliver payment services at a much lower cost (which I sincerely hope will be the case) then the rather obvious strategy is for these banks to form a subsidiary to handle payments and to have that subsidiary regulated through the same special-purpose charter as their competitors. 

This may not be enough to save them, by the way. Thomas Watson Jr is often quoted as saying in 1943 (*) that there was a world market for five computers. It turns out that he was right: they are Apple, Amazon, Facebook, Google & Microsoft and everything else is just a window into those. (I think Thomas was wrong – he didn’t forsee WeChat or Alipay – but you get the drift.) When these “internet giants” get their special-purpose charters, they will control both the customer interface and the financial system interface. Why will I ever come out of Facebook and run my bank app ever again? If my Mac’s “Messages” application can send money to your WeChat, what will happen to Transferwise? If I google “PayDay Loan” and the money arrives in my gmail account before you can say “where is the 21st century anti-trust legislation” what will happen to competition in the lending space? What happens why Microsoft asks you add to your bank account to LinkedIn and can then offer both “request to pay” and  instant payments on the platform? 

On final note, most of the commentary I read about this over the weekend focused on the ability of these “Internet giants” to obtain these charters and deliver payment services. There are, however, plenty of other types of organisations that might want to obtain one of these charters in order to provide financial services that either compete with lazy and fat incumbents or deliver innovation into new or underserved niches. AT&T could get a licence and launch USA-PESA. NetFlix could get a licence, join Visa and then issue its own credit cards. But if I were to grab my crystal balls and get all Nostradamus on your asses, I’d say keep an eye out for the retailers. If I was Walmart, I’d be thinking about getting me one of those special-purpose charters myself so that I could operate my own payment services without having to have a joint venture with banks (e.g., its partnership with GreenDot) or go through the expensive process of getting a subsidiary regulated as a bank.

In the late ’90s and early ’00s the company made numerous attempts to get into banking after it argued that the 1999 Financial Services Modernization Act allowed nonbank commercial operations to acquire financial services companies and operate their own banking operations. It failed to acquire a bank in Broken Arrow, Okla., in 1999, and its attempt to acquire a bank in California led to the state legislature to pass a bill specifically outlawing what is arguably permitted by the controversial banking deregulation bill signed into law by then-President Bill Clinton.

From Wal-Mart Would Love To Have A Banking License, But It Doesn’t Necessarily Need One

As I said back in 2011 when someone asked me who might become the Walmart of payments, I said Walmart. The OCC move brings this one step closer! My reasoning was obvious: the customer interface. Retailers are where the customers are and is where they make their payments. Right now if you want to use Walmart Pay you have to register a card, but there’s no reason why Walmart Pay couldn’t, as a bank, instruct the transfer of funds directly from your bank account.

Who knows what the result of the OCC consultation process will be, but on the whole I think that the notion of the special-purpose charter that makes it easier for non-banks to come into the space and compete is a good one. With Venmo up and running, the big banks launching Zelle, NACHA going to same day, The Clearing House launching instant payments and others, I’m sure, just around the corner with their blockchains and cybercurrencies and so forth, we are about to see the US landscape transform, much to the benefit of the users of the payment system.

(*) He never said this, but let’s not spoil it for all of the management consultants who like to put this on a slide about innovation.

Neo-banks and iso-banks

For some years, we’ve been talking about an emerging category of what we’ve been calling “near-banking”. I remember using the concept in a couple of projects around the O2 Wallet. Remember that? It was a mobile wallet with a companion pre-paid Visa card. We used it in a Cabinet Office Alpha project with welfare benefit recipients and it worked very well indeed. But it was canned shortly afterwards.

It wasn’t well-received. It seemed like a patchwork of products, was not very user friendly and was essentially not compelling enough to persuade users to try it.

[From O2 Wallet: no users and too much competition. It had to go | Mobile Money Revolution]

This was not, to my mind, a condemnation of the concept. Only a few days after Telefonica shut down O2 Wallet in the UK, we see T-Mobile in the US launching essentially the same product: a pre-paid Visa card linked to a mobile phone number.

The company announced today Mobile Money, a free checking account service available to anyone with a T-Mobile phone number.

[From T-Mobile Mobile Money – Business Insider]

The concept wasn’t the problem. I never saw any marketing of the O2 Wallet. I don’t remember ever seeing a TV ad or anything in the mainstream press.

A key problem here, Holden suggested, is the failure of NFC to take off as a contactless payments technology.

[From What does the closure of O2 Wallet say about the future of mobile payments? — Tech News and Analysis]

I disagree. I thought the NFC thing was tangential. Yes, O2 were a bit hopeless in getting NFC up and running and yes they should have looked at HCE sooner and yes it is symptomatic of a structural flaw that even a telco can’t get SIM-based SEs sorted out. This isn’t because O2 were especially hopeless. Look at what happened in Spain, where Bank Inter launched HCE-based solutions even though they are an MVNO with their own SIMs! I notice, by the way, that Bank Inter have taken advantage of Google’s decision to add HCE to KitKat and put their Mobile Virtual Card (MVC) solution on that platform. I do have to confess that I found some aspects of the O2 customer proposition baffling though. I remember when I got an e-mail from O2 informing me that

As a result of recent changes in the law, we’re obliged to ask you about the source of your funds, once you’ve loaded more than £2000 a year on your Wallet. Unfortunately, if we’re unable to contact you after three attempts, or get an inappropriate answer, we may be forced to block and subsequently close your account.

I’m really curious to know what an “inappropriate” answer might have been, but when someone sounding for all the world like a sophisticated fraudster phoned me up claiming to be from some Gibraltar-based entity wanting details about my personal financial circumstances, I told them. I knew, of course, that this was pointless time-wasting money-wasting AML nonsense but I did wonder what a typical member of the public might have thought about it.

But I digress. I have to say that I rather liked the product as it ended up. With two teenagers in the house I found it simple and convenient. We kept the Visa card in the kitchen and when one of the boys went to get some shopping or had to buy something for school or whatever they took it and used it and I got the transaction confirmation immediately on my phone and I could top it up when necessary.

It was sort of like a bank account for our house.

When I spoke about the rise of “near-banking” at Payments 2012 in London in May of that year, I made the point that there is an opportunity for a spectrum of near-banks that target a potentially wide variety of specific niches (the example I used then was a “Sagabank” for older people), and I still think that this is one of the attractions of the model. The near-bank is not a new idea. In 1997, I wrote (with my then fellow Consult Hyperion colleague Mike Young) an article for Internet Research called “Financial Services and the Internet” (Volume 7, Number 2, p.120-128). In that article we wrote about the potential for the new technology to assemble a banking service depending on the customers’ needs.

Financial services customers use IT to build a seamless environment for themselves, “with the underlying best-of-breed products originating from a wide range of suppliers”; Financial services providers “retreat to a small range of products that build on core competencies, but supplied to a global market”.

[From You searched for near bank – Tomorrow’s Transactions]

This came to mind when I read an interesting post about the new market segmentation for retail banking by the Starling Bank CEO Anne Boden. Anne refers to “neo-banks”.

If you look at the US and some of the European markets, you can see another area of growth that is likely to hit the UK market soon, in the form of so-called neo-banks. These brands claim to deliver the best in class digital experience, with none of the risk of a balance sheet – so they effectively put a layer of information management over another banks’ product set… Simple and Moven are probably the most well known names in this space, with Number 26 starting to grow their reputation across Europe.

[From Starling]

She then goes on to talk about the O2 Wallet category that is centred around pre-paid debit cards, although I think I might argue that these categories have a great deal of commonality.

The grouping of brands that have the greatest potential to cause customer confusion have to be the pre-paid debit cards.

[From Starling]

This made me think about breaking down the “near-bank” category. There’s a difference, I think, between something that looks like bank but isn’t (e.g., Moven or Holvi) and something that doesn’t look like a bank but performs the same functions as a bank in the eyes of the consumer (e.g., Bluebird). In both cases the proposition is essentially a mobile app plus a pre-paid card, but their grammar is different. Therefore, I propose a new terminology standard: I propose that we call the first category neo-banks (as Anne did) and that we call the second category iso-banks. Are we agreed?

With this terminology, we can distinguish neatly between neo-bank (Moven) and iso-bank propositions (O2 Wallet). In business terms, the neo-banks are competition to the retail banks but the iso-banks complement them in specific niches. I have a Simple account instead of a conventional retail bank account, whereas I have my Caxton FX euro wallet as well as a conventional retail bank account. What do you think?

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