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Financial reform: Friend or foe to fintech startups?

Financial services companies have been buzzing with equal parts fear and excitement about Donald Trump’s plans to unravel the financial reforms put in place after the 2008 financial meltdown.

As expected, Trump signed an executive order two weeks into his presidency to begin undoing the Dodd-Frank Act, a 2,000-page policy so overbearing to many legacy banks that it’s been blamed for the decline of community banks and business lending.

While banks eagerly await a rollback, its implications for fintech startups have been less certain.  Loosening the rules should make banks better able to partner with fintech startups, but consumer protection and access to data could still be at risk. And there’s been buzz about the possibility scrapping the Consumer Financial Protection Bureau, which was created under Dodd-Frank, but Trump hasn’t made that order yet.

We asked attendees at the LendIt USA conference in New York to share their views and concerns with the current administration’s proposed regulatory reform — and whether it’ll be a friend or foe to the fintech industry.

Rob Frohwein, CEO, Kabbage
A change in Dodd-Frank will be a boon to the fintech industry. There are two major blockers for banks getting into this industry. One is regulatory. The other is technology. If you remove the regulatory challenges — or at least the perceptional regulatory challenges — you put them in a position to start thinking about product in the space. We are a provider of technologies. We would love to work with banks and provide them a better service and product for small businesses.

Leslie Smith, managing director, Silver Hill Funding
I don’t think it’ll impact the tech per se. It’ll impact how people use technology. Most of these companies do things automatically. There are no people in many processes. The biggest impact to this space would be that they do need people in order to check off the box that says they’re in compliance. People continue to innovate and create really awesome tools through technology. The regulations will drive whether they can do that without people.

Rohit Arora, CEO, Biz2Credit
There’s a lot of optimism among banks, especially the small- and mid-sized ones who have been most impacted by deregulation in the last eight years. 1. As banks get more aggressive, there will more opportunity for more bank-fintech partnerships. 2. With the proposed [Office of the Comptroller of the Currency] fintech charter, fintech companies can become limited-purpose banks without having to get a charter. It’s pretty positive, but the administration has to follow through. They say a lot of things, but we haven’t seen any action. They’ve raised expectations now.

Melissa Goldberg, senior innovation strategist, Commonwealth
We’re particularly concerned about consumer protection and making sure all the work that’s been done to protect consumers doesn’t get undone. When you think about our organization, that’s half of it. The other half is around promoting innovation because fintech for financially vulnerable consumers is a great opportunity to reach people outside the traditional banking sector. Right now, we’re trying to figure out the balance between the two that allows people to innovate and think in a new way that doesn’t go against rules there to protect the interest of consumers.

Lenore Kantor, president, Launch Warrior
It means uncertainty and unpredictability, which equals volatility. That will be good for trading but not so good for fintech startups or anyone looking to launch a new initiative. All businesses should be preparing multiple scenarios for how to adapt in a rapidly changing environment.

Colin Darke, general counsel and chief compliance officer, RocketLoans
Smart regulation is important for the industry. If that involves deregulation in the sense that there are overlapping regulations or regulations no longer applicable to the modern age, then that’s good. But you still need to balance it so you have responsible innovation — you always need to protect consumers. There’s definitely room where deregulation amounts to smart regulation that would help this industry. There are a lot of misconceptions and confusion in fintech.

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The regulatory pitfalls of online small-dollar lending

Ever since the 1800s, respective U.S. governments have attempted to find the perfect balance between regulation and deregulation. As the 2008 financial crisis demonstrated, finding this perfect equilibrium is no easy task.

The fintech movement, with all the convenience, transparency, and innovation it brings to the user, presents a formidable challenge to regulators, banks, and fintech companies themselves. New fintech creations are expanding the financial map, and it’s only recently that regulators have started to gain a foothold in this new landscape.

One sector that has been struggling to find its regulatory footing in the age of 1-click checkout is lending. Part of this has to do with the complicated, conflicting multitude of state laws trying to police the online lending industry. “If the states come together and find a way to harmonize their rules and regulations, it will be easier for compliance and easier for consumers to understand what the rules of the road are,” said Lisa McGreevy, president and CEO of the Online Lenders Alliance.

The 7-person D.C. organization, which represents online companies offering small-dollar loans, is trying to convince states that as far as online lending is concerned, cooperation is the best way forward. “It’s a constant discussion that we’re having with Congress and federal regulators and even with the states,” said McGreevy. “We’re saying to the states: we need a uniform system to operate.”

It’s not simply that the states are taking their time adapting to the new reality of online loans. Online lenders are concerned that federal agencies may not understand the nature of online lending well enough to police it. Most recently, online small-dollar lenders have taken issue with the CFPB’s proposed rule to end payday debt traps.

The rule, which would require small-dollar lenders to ensure their customers have the ability to repay their loans, has serious implications for lenders and for borrowers. McGreevy argues that the sheer complexity of the rule means that consumers will have a difficult time understanding their credit options, while the rules prescriptiveness won’t allow companies the flexibility of using their own algorithms or their own underwriting.

“We support a federal rule,” McGreevy explained, “but we’re all concerned that this is going to result in fewer credit options for people.” McGreevy isn’t alone. The Pew Charitable Trust thinks the rule would leave borrowers vulnerable to payday sharks while locking out lower-cost loans from banks.

Moreover, Kevin Foster-Keddie, president and chief executive officer of Washington State Employees Credit Union and its small-dollar online loan platform, QCash Financial, is worried that “the rules as proposed by the CFPB may also have the unintended effect of driving away consumer-friendly financial institutions that provide better alternatives.”

For McGreevy, voices like Foster-Keddie’s from the credit union camp are a confirmation that the CFPB needs to rethink its small-dollar strategy. “Making small-dollar loans is a highly specialized industry,” she said. “Even the credit unions have a hard time in this market space. And I think the fact that they are saying this rule is going to result in fewer credit options is a harbinger for everybody.”

The O.L.A. is one of the industry’s in-house regulatory bodies trying to keep online lenders in check. Instead of viewing the O.L.A. as a millstone around their necks, online lenders have actually been the drivers for the creation and implementation of best practices.

“The companies that are members of O.L.A. want to set the standards for the entire industry,” McGreevy remarked. “We’re not interested in having bad actors and fraudulent businesses give the industry a bad name.” Neither, it would seem, are some of the big-name online lenders, who launched their own self-regulating association in April 2016.

For the O.L.A., the major challenges are protecting consumers, both from fraudsters and from unethical online lenders. The O.L.A. consumer hotline receives various types of fraud reports, from the nefarious IRS phone scam to standardized prepayment terms as a prerequisite to loan issuance. O.L.A.’s best practices make sure their members steer clear of any underhanded dealings with consumers, but not everyone wants to lend responsibly, and so the hotline phones keep ringing.

The line between unethical lending and aggressive marketing isn’t always clear, and O.L.A. has had to step in over the 11 years since they were established to help online small-dollar lenders understand what’s ok and what’s not. Several years ago, small-dollar online lenders were offering lines up to $5,000 with no credit checks.

“Unfortunately, the average customer couldn’t get what was promised,” McGreevy explained. O.L.A. put a stop to that with their best practices. Companies that join the O.L.A. can’t advertise using those terms. Recently, the “no credit check” marketing ploy has resurfaced, and the O.L.A. is in the process of tracking offending companies down.

O.L.A.’s best practices may not solve all of the regulatory hurdles that small-dollar online lenders want to overcome, but the fact that responsible lenders are interested in having regulation in place is a good sign for the 12 million consumers in the market for small-dollar loans. “I think that across the board, online, brick and mortar, it’s always better when the industry can self-regulate,” said McGreevy, “and we have accepted the challenge and the responsibility to self-regulate.”

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Hi Five! The five fintech stories we’re following this week

5 trends we're tracking in finance

Forget DIY banking. Build your own bank.

More banks are creating interfaces for startups and other fintech partners so they can connect directly into their plumbing. Rather than weaken the role of the incumbent financial institution, this platformification of banking re-entrenches the bank at the center of financial services. In this setup, the bank manages the UI and customer experience, plugging in partners’ technology and services via APIs.

Alas, this type of model means that banks can afford to get slimmer – Radius Bank recently closed its branches. The industry is already on an employee diet, shedding branches and people with them. With up to 50% of the global financial services workforce at risk of losing their jobs, it begs the question. What should the industry do with all these people?

PayPal, powered by Visa, coming soon to a store near you.

A new deal with Visa paves the way for PayPal to enter into retail. PayPal will no longer discourage customers from funding accounts with a credit card. Interesting move by Visa, for sure, but it brings PayPal closer to being a true competitor in the digital wallet space, according to Tradestreaming’s Josh Liggett.

For PayPal users, that could mean more time spent fumbling with the new-fangled credit card reader in a store. Go ahead and spend with wild abandon, though. The CFPB wants to shield consumers better from creditor calls with new regulations it’s working on. All’s good — the agency really just wants consumers to pay what’s rightfully theirs to pay.

Those wacky hedge funds.

Hedge funds are interesting beasts. In a way, despite their antics, they provide windows into understanding our own humanity. That’s why this story, about sex, fear, and video surveillance at Ray Dalio’s shop, the massive Bridgewater Associates, is particularly scintillating. Beyond the he-said, he-said, Dalio likes to emphasize his firm’s radical transparency. But one employee said in a complaint earlier this year that the hedge fund was like a “cauldron of fear and intimidation”.

Across Connecticut, Steven A Cohen’s hedge fund family office, Point72 made a bet on a startup fintech firm, Quantopian. For its part, Quantopian lets people build their own quantitative investing strategies and make money by licensing these algorithms back to the firm, which invests in them. The equity investment for Cohen was relatively modest, but his firm pledged up to $250 million to be invested in Quantopian strategies in a move that illustrates a growing interest in quant strategies for some of the largest asset managers.

As Goldman Sachs enters online lending, peer to peer lending is dead.

“The little guy’s opportunity to earn yield like a Wall Street bank has been replaced with actual Wall Street banks,” wrote deBanked’s Sean Murray. GS is set to enter the online lending space and with that, the excited, democratic ethos behind peer to peer lending is all but gone. In its stead are traditional financial services moving into this new online domain. Distributed, personalized capital sources have been replaced with large lines of credit and lending facilities.

Prosper is said to be pitching a fund that would invest in its loans. Executives are meeting with potential clients this week to pitch the Prosper Capital Consumer Credit Fund, according to a person familiar with the matter who asked not to be identified discussing confidential talks. The fund’s managers are targeting returns of 6 percent to 8 percent. Not sure of those returns? Here’s why marketplace lending fund returns don’t look good.

Everyone’s getting in, online

Not everyone has gone whole hog over fintech. Some firms have taken their time, dallied in a partnership or two, before launching a full-fledged online offering. Fidelity fits that bill, launching its own retail robo offering, Fidelity Go, after breaking up with standalone roboadvisor, Betterment.

The mortgage industry is also finally finding a way to really embrace the web and not just for lead generation. A whole slew of firms are finally working on improving the home buying process –  75 percent of home buyers would use online mortgages if they knew they could speak with someone when needed. “I was frustrated by how offline, opaque and inefficient the mortgage application experience was,” said Rajesh Bhat of Roostify, one of the new upstarts.