This following is part of a new series we’re running. It’s called the Big Bank Theory, and it’s all about the future of banking. We see three options going forward: in the march towards digital, people will gravitate towards the digital arms of incumbent banks, give their business to new upstart challenger banks, or the biggest opportunity, which is bank with the brands they love. Through embedded finance, people are increasingly turning to companies they frequent often -- could be a big retail player like Walmart or SMB accounting software like QuickBooks -- to plan, store, and move money around.
The following series includes content from Tearsheet’s The Big Bank Theory Conference, held in November 2021. We had three full days with the top companies and professionals defining what banking looks like today and into the future. We heard from large incumbents and startups.
Square is one of the next generation technology companies that is absolutely part of the fabric of the future of banking. With a seller ecosystem of millions of merchants and the popularity of its Cash App, Square received a banking license in 2021.
I spoke with Luke Voiles, the firm’s newly appointed general manager of banking. I’ve spoken to Luke in the past, where he led Intuit’s foray into embedded finance and lending. We discuss Square’s roots and ethos, diving into the firm’s founding story. Luke shares where the firm sees opportunity to provide financial services for its users -- now and into the future.
Here are some takeaways from Voiles' talk.
The eyes of a distressed investor: "I am a distressed investor, like special situations, seeing all these loans that banks had made, and what they did wrong or did right, and all these other fintech companies, or like specialty finance companies. So that really was most of my career: taking a team, renting some scanners, going into a file room at a bank."
Leading Square Banking: "I've been at Square for about three months now. And what attracted me really is the purpose of Square. We want to open up financial services to all of these underserved small businesses and consumers. We want it to be fair, accessible and inclusive."
Evolution of Square's banking activity: "The banking products just follow up pretty naturally. The processor puts the money into an account. And then Square has to move the money out to the customers bank account -- that’s where and how it all started. It can take a couple of days to get the money. And with ACH, there's no confirmation that the money got there. And so the customer’s bank will sit on the money for two or three days to make sure they actually got the money. There's a major pain point: I just made a sale. If I got paid cash, I could walk to the next stall and spend it, but I just got paid with credit card and now have to wait three days to get the money."
Listening to what SMBs want: "When you have millions of customers, there are subsets, especially the ones that don't have access to financial services, that are asking for banking explicitly. We were dumping all of the Customer Success information into a place where we can actually do machine learning on it and figure out like themes of what's going on. These themes come out, like this is the only business account I'm using, and I need more features. I need to do mobile check deposit, right, it just keeps piling on and on. "
Here’s my talk with Square’s general manage of banking, Luke Voiles.
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The following excerpts were edited for clarity.
Embedded finance career squarely in the credit cycle
The way I've described my career path is that I'm effectively a victim of the credit cycle. I graduated just after the tech bubble burst last time with a BA in computer science, trying to become a programmer. It was a pretty tough job market at the time. When I look back at my story, I didn't really make any of these decisions -- everything kind of decided for me or the world decided for me -- but there's this decision tree of stuff.
I picked law school. I wanted to know how things worked, figured I would go try that. The disappointing thing after being there in the first semester is that I realized that I'm not going to be a good lawyer. I'm not going to be happy -- it's not going to work. And so I decided to do the joint program. So that opened up another whole tree of choices, which is okay. During the MBA year, I applied for a bunch of internships and happened to get a small hedge fund in Texas that took a shot on me to be their intern. And that opened up a whole new slew of things. There was a bunch of investment paths that just opened up. So I'll take one of those and graduate a year before the global financial crisis. The hedge fund blows up and the world is falling apart.
And so that really dictated the bulk of what my career has been. I am a distressed investor, like special situations, seeing all these loans that banks had made, and what they did wrong or did right, and all these other fintech companies, or like specialty finance companies. And with all these assets, every type of cash flow you can imagine, we looked at over time. So that really was most of my career: taking a team, renting some scanners, and going into a file room at a bank.
This is where my mind starts to blow up with fintech versus traditional banking, and like filtering through the paper loan files, scanning them into a digital form to get it off to our partner that's going to help us underwrite these things. It's mind blowing how far things have come in 10 years for a lot of the smaller banks that still have loan files in boxes and rooms.
Then the cycle gets better: we went to like the most benign eight or nine years of credit for a long time, so you can't really do much distress. So I spent a bunch of time the last few years in private equity, trying to lend money to the lenders, looking at the 50 year old factoring companies and merchant cash advance companies that are great. They have 20 basis points of losses, but it's completely manual and paper based. Then you have the fintechs that are amazing customer experiences, but not much operational experience or credit experience. You see all the full spectrum of underwriting in like 20 or 30 different platforms.
Then another kind of happenstance event got me back into tech. I wanted to be the tech guy when I graduated undergrad. It didn't work out but I finally got back to it years later. TPG recruited me to come help build the lending business into one of their tech companies. And five years into it, it was another amazing product learning experience. It's amazing on that side, to be very customer focused and take the distressed background, add the tech to it.
Then I had the opportunity to join Square. I've been at Square for about three months now. And what attracted me really is the purpose of Square. We want to open up financial services to all of these underserved small businesses and consumers. We want it to be fair, accessible and inclusive. And it's exciting to get up and go to work every day knowing that you're really helping people that wouldn't otherwise have access to these financial services across the spectrum, globally. We're not just in the US. So that's like where I am. We have an amazing team. We're one of the largest small business alternative lenders in the US. And we're growing as fast as we can, trying to help as many customers as we can.
Applying experience and knowledge
It's comforting to know that you've seen a lot of the ways things have gone wrong. And so when you're looking at the possible paths forward on the business, I'm constantly looking over my shoulder. What is Plan B and Plan C for each of these possible outcomes, and where are we headed? When you go through the cycle, you have to know, and you have to be driving the ship in a way that actually will make it through the storm, so to speak.
I think it's extremely helpful to have seen so many things that have gone wrong over time, but also have the tech. So it's just a balance between like, let's go grow and be an amazing tech company and let's be a solid, prudent financial services company at the same time. The neobanks and the new startups that can strike that right balance will be the ones that succeed. If you don't, it's the end for some. We saw a few fail in the last cycle, right?
Finding yourself in fintech
I guess there's a bit of a diaspora from TPG. A bunch of really smart investors from TPG have now spread because the main office was in San Francisco. So you get that solid risk DNA into companies like Opendoor and others. But you can see it right now, like Opendoor is doing great until it's not. And it's because the DNA from the investors are actually helping them succeed. There are a lot of people on the New York side trying to get into fintech and it can be hard because if you're not a product person, it's tough to break in. I came in kind of sideways, as well.
But I think it's starting to merge, right? It's not that exciting sometimes to go buy a bunch of mortgages and have to like kick people out of their house. That's not a fun thing to get to work for. So, there's actually a pretty big draw to be able to get excited to be at work and help people. I think fintech and the story of ‘fintech for good’ is starting to pull people in. We can really actually help people with this. And it's fun to be forgiving.
The Square Banking story
I think it's helpful just to hit the founding story real quick. If you haven't read Innovation Stack by Jim Kelly, it's a great book. Don't skip the footnotes because the width is sort of buried in the footnotes. It's a pretty funny read -- it's great. But if you go back, the viral growth of Square was because they just opened up financial services to every tiny seller at a farmers market that wanted to sell whatever they were selling and accept credit cards. It was really a way to push the boundaries of the system, like the card rules, the way everything worked, to say, hey, we'll just become the merchant. And then we'll let you process with this amazing little unique thing that lets you just process it. The POS becomes the phone -- that is the beginning of the same consistent story of being fair, accessible and inclusive across the entire spectrum. And so that was the first customer pain point.
The banking products just follow up pretty naturally. The processor puts the money into an account. And then Square has to move the money out to the customers bank account -- that’s where and how it all started. It can take a couple of days to get the money. And with ACH, there's no confirmation that the money got there. And so the customer’s bank will sit on the money for two or three days to make sure they actually got the money. There's a major pain point: I just made a sale. If I got paid cash, I could walk to the next stall and spend it, but I just got paid with credit card and now have to wait three days to get the money.
So naturally, how do we solve that problem? One, let's use the debit rails. Let's push through the debit rails to get the money instantly into their account and confirm that the money's there, so the banks will release it immediately. So instant access to money is one new product.
The other is okay, great, we have the customer here. Let's just give them a debit card. If they don't already have access to the financial system, we're the first thing that they got. Let's give them the card and let them have access to spending their money through the debit rails directly. It's attached to the balance account that we have for you and you could spend your money instantly and swipe your card for the next Square vendor, and just keep on going. And so that's the next layer down.
And then the third product is loans. So customers are processing a bunch of transactions and over time, they want to grow their business. They need to buy more inventory. And it's a natural fit to say, okay, great, we have perfect visibility and validity on the data from revenue coming in from at least one channel, which is your credit card revenue channel. And we can lend against that revenue flow, like very special situations tight. Here's the cash flow stream, very predictable. Here's your money based on that. You don't need personal or consumer credit to underwrite that -- you need the cash through the historical cash flows to do it. So you can actually open up pretty dramatically to large populations that aren't served otherwise. That's really the startup lending business.
I think we've done $9 billion in loans today and the average size is less than $7,000. So it kind of shows you how impactful small loans are to so many customers. It’s really helping them.
Planning for banking products
I wasn't there in the beginning. From the outside, it’s logical, right? This kind of goes back to the embedded banking versus non embedded banking -- the hardest thing was, when I was in private equity looking at the financial services or specialty finance companies, to see which ones we should be lending money to or making equity investments in. The two hardest things to do are acquiring customers at a cost that makes sense and getting a consistent data set that you can automatically and operationally efficiently underwrite and get paid back.
When you read Innovation Stack, [banking is] not really on the radar. It's more like, let's figure out the customer problem and solve it. It's not broader top down strategic thing here. It's bottoms up: what are the customer’s problems and what problems do we want to solve? And so banking naturally comes out because those are the customer pain points.
Talent inside and outside
The story of Innovation Stack is that we're kind of pirates and scrappy, and we're going to make this work. But when you get to multi billion dollars a year level of business and billions and billions of GPV, you have to grow up a bit. You want to strike the balance, where you have the right leadership that can help steer the ship and keep the same kind of bottoms up Innovation. That's the balance that Square is trying to strike. So you see more financial industry expertise coming in, but really doing it in a way that doesn't slow down innovation. That's the hard part.
Square’s Banking offering
If you think about what I've described before, you're only talking about one way to get money in, and two ways to get money out. So you have the credit card receipts: they are the only money coming into the account. The instant transfer and ACH out is one way to get out and a debit card does the other money out. And so naturally speaking, this is the only business bank account some customers have. They need an account and a routing number, so they can actually put money in from other sources or pay bills or do other things with this account where the money is sitting.
So, it's natural to say okay, let's add an account routing number and turn it into a real checking account and let them do everything you can with a normal checking account. Then it's okay, what are the pain points of these businesses? I'm a seller selling stuff, and I have to pay taxes every quarter. So how do I save this money? And so it's okay, let's set up a way to automate the same way we deduct our payments out of the cash flow and make it super easy for the customer to not even have to worry about the payments on the loan. You can say, Okay, you can automatically save a percentage of every sale and set it in a way that it's going to match the taxes you owe at the end of the year. So you create folders, and one of those is a savings folder for taxes. And so then you create an actual savings account. And because we got a charter in March, we have Square Financial Services, so we can issue an actual savings account to our customers.
And so you add the savings account to go forward. We rebranded as Square Banking in the US. We have what was Square Capital -- it’s now Square Loans. We have Square Checking, which is the debit card and others and we have Square Savings. So it says those core features of actual banking, we have that. So it really evolved from one way to get money into an account now to your own bank accounts, by slowly adding all these features. And now you actually have a full suite of basic features for banking at this point. With some slick automation, like you don't have to think about the loan payment, you don't have to think about the savings, it starts to make things really easy for you.
Customer demand and pain points
When you have millions of customers, there are subsets, especially the ones that don't have access to financial services, that are asking for this explicitly. We were dumping all of the Customer Success information into a place where we can actually do machine learning on it and figure out like themes of what's going on. These themes come out, like this is the only business account I'm using, and I need more features. I need to do mobile check deposit, right, it just keeps piling on and on.
As we have larger and larger sellers, there's going to be more needs for them to say, Okay, I'm actually a bigger company. I need these other features. And so we have roadmaps that are trying to solve all these problems for all these types of customers. It really is kind of bottom up driven. We have these teams like our sprint teams that are very close to the customers and they know what they need. They build the roadmaps from the bottom up. And so we just got through annual planning, and it's really the sprint teams in the bottom that are driving what they know their customers need that then bubbles up to what we go do. It is very much customer driven.
Accessibility and fair lending
We have a loan product I'll use as the example. I talked about payments already-- that we became the merchant and we underwrite the customers and onboard them. That opened up a whole bunch of access for the loan product, which is the harder piece I think to do. We're not really just using that cash flow data, but this 12 months of historical credit card processing data. And if you only use that, then there is no discrimination. The business speaks for itself, right? They have these cash flows that we can fully pretty well predict what the cash flow is going to look like for the next 12 months. And the customer doesn't have to think about paying us back because we're holding a bit of every credit card transaction that comes into their business. They're paying back a bit of their loan each time. That removes the discrimination component and removes the fair lending pieces.
I've been through fair lending reviews in the past that show you have a bit of discrimination, however it's determined. It's because of FICO. And that's okay. That just rubs me the wrong way. We don't use FICO at all. We're not seeing that before we underwrite. Sure, we have some portfolio management on the backend, where we look at it and see what the risks look like. But on the front end, we don't need it. It actually allows us to open up dramatically to broader populations. Same thing on KYC/KYB. A lot of the KYC/KYB automation to just the basic onboarding to the financial services account can be blocked, if you're a thin file customer.
If you don't have a credit file in the US, it can be hard for you to actually access the financial services system. There are a lot of startups around the space trying to figure out how to find alternative datasets -- the whole problem with this is you have to have a loan to get a score and you have to have a score to get a loan. So there's just this catch 22 that people get stuck in any alternative datasets we can get. I think the bureaus are all over this as well, like how do we use bank transaction data to say, okay, this is actually a quality customer and they should have access?
And so it's just breaking down those barriers over time. And our product naturally doesn't need FICO. We don't need the credit score to actually make these lending decisions for these small businesses. And it really opens it up. I think the one stat we're the most proud of is that 51% of the loans we make are to women owned businesses. If you look at the comparable (there's not much data here -- there are some pushes now to get more data with 1701 and we're supportive of that) -- the SBA data that you can see shows that 17% of loans they make go to women owned businesses.
We're very close to the demographics with the loans we're making. And that's amazing to be able to say like, look, we're just lending to almost everybody based on the history of their business. And so the more these embedded financial services companies can use the data they have, they already know their customers. I think it's just a mindset of we really want more and more customers to come in and have access. And if you are creative and experiment your way into what might work, then it's great.
Roadmap for Square Banking
The thing literally keeping me up at night right now is how to do this in 20 more geographies. Square has got a big push to go international right now. The Square Banking team, though it's not called that everywhere, is live. We're live with loans in Australia. We have instant transfer and cards in Canada. That's all public.
It's an enormous amount of research in each market, like how do we go to each of these markets that Square isn't already going into? Because we're naturally just an attached business -- like we have to be in the flow of the money with credit card transactions to have our loan product work. And so we're going to naturally follow the core payments team of Square around the world where they go, but it's not an easy thing to go figure out how to enter the market, because all of those four things are regulated differently in each market, and have different restrictions. You either need to partner with a bank or get a license, or figure out a way to enter the market. And so a lot of what we're focused on is okay, here's what we know our customers want, we're doing a ton of customer research in the other geographies to see which of those features are the most important to them. Then we're building a roadmap out to decide which products are launching and what order in which market.
And how are we going to work with bank partnerships? Or is it through getting our licenses? I'm pretty comfortable in the United States, because I know how it all works here. It's fun to go try to figure it out in all these other geographies. We have amazing teams on the ground, each face compliance and the regulated entity team that makes it really easy for us to go do it fast with the core product team still here together. So it's a lot of thinking International.
And there's a big push also to go up market. We're thinking about how we grow our banking services that are really focused on these underserved customers to actually help the larger businesses, too.
Maybe I'm biased because of my distressed background and constantly looking over my shoulder on the risk side, what's happening is that the neobanks are coming in. They have amazing features that could drive viral growth. The problem is, in order to monetize a bank, you have to be good at lending. And that's the hardest part. It's absolutely the hardest part. So I think you have other guests, they're going to speak about, like credit focused neobanks. And so from my perspective, they have a leg up in a sense that they figured out the credit side already, because it's easy to make loans. And I'm sure you've heard this a bunch, but it's pretty hard to get paid back. And it's even harder to get paid back during the cycle.
These challenger banks coming in, if they hadn't figured out the lending part yet, that it's just not gonna work. That's where the rubber meets the road, so to speak. Yes, you can come in with amazing features and attract a bunch of customers, but if you can't actually profitably lend, you're not going to be able to monetize the same way a bank monetizes. Maybe there's other revenue streams. But it's just a tough thing to do to be a financial services institution without the lending part.
For me, it's the ones that can strike the balance with viral growth, like Square has viral growth with their payments product and we can attach to that. There's other neobanks that have different features like a couple of days early wage access, for example, to drive a bunch of volume growth. But if you can't actually monetize in a way that makes sense in, a stable regulatory way over time,, there's risks on the regulatory side for some of this as well. But if you can't figure out the lending part then I don't think you ultimately succeed.
And the valuations are absurd right now. I think, in some sense, at least in the VC space, writing $100 million dollar checks, doing very little diligence, is kind of messing up the space. There's so much money flowing in. When we have the cycle again, there's going to be some more victims of the cycle, just like my career. There's going to be some more victims of the cycle here where they'll wash out.
You have all these customers, and you're still growing. But the unit economics don't make sense. And now you're out of money. What do you do? I'm not going to try to predict it all. We made it through COVID. That was a unique thing. We haven't been through a recession yet. And inflation makes me worry a bit, but we'll see what happens when we actually go through the first recession. We'll see what happens to a lot of these neobanks..
The bank charter
I'm not sure all these charters getting pulled will be resubmitted. I would be very surprised if anybody else gets one, given who has the seats now, who the decision makers are at the FDIC and OCC. I don't think more charters are coming. I will be surprised, but I can be wrong. I can always be wrong. But for us, we timed it pretty well. We have ultimate flexibility in how we offer our product. We control our own entity, our bank. And if we need to offer a feature that our bank doesn't do, we can use a different bank. The partner bank model doesn't go away for us. We can set it up -- we have ultimate flexibility on how we go to market in the US.
Internationally, we're not going to get a bank in every market. It doesn't make sense. Like most fintechs don't actually need the bank charter in most markets. Based on all the research I'm seeing now, with a bank partner, you can do everything effectively but call yourself a bank.
That's the thing that's so cool about fintech is you can take all these pieces with partner banks, different features, different products, and you're this architecture stack. You have all these products that are plugged into this API layer, all these capabilities, and then all these partners down below. You can just connect the product to whatever partner in whatever geography you need to offer that feature and do it in a regulatory way, a way that makes sense from a regulatory risk perspective.
And so really, it's about building that engine that can go do this globally.
Square and banking crypto
Jack [Dorsey] has a separate team called TBD that is very focused on this stuff. I'm not as close to that team. I'm focused on trying to make all this work with the existing financial services system. We're going to partner with that team to see if there are things we can test with them but that's in the future. The Square story is about pushing the boundaries to figure out how to make this stuff work and make it better for people. Part of that push is now the whole crypto, defi, Bitcoin and Lightning focus right now -- it is kind of a parallel path that we will be partnered and supportive on but it's a different team. The team is amazing and they're going to go figure out some amazing stuff. I'm going to be just as surprised by what they build as you probably.