Many FinTech companies have the goal of selling their product directly to consumers. Most of them are financed by Wall Street related backers (hedge funds, private equity firms, venture capital firms, etc…). In fact, it is common knowledge that these types of investors will never invest heavily in anything that “does not have a direct intersection with the consumer”. The goal is always to have a quick exit strategy to what is commonly termed a “strategic buyer”. In the case of FinTech, this “strategic buyer” has always been commercial banks. There are numerous problems with this however. In a recent poll conducted by the Fintech Innovation Lab of New York (yes there is such an organization!) it found that 60% of polled commercial bankers cite regulatory, compliance, or security issues as major stumbling blocks in acquiring these types of companies.
Lending Technology
Since FinTech is such a broad term, we will focus only on those firms that are (so called) lending to the public. The technology involved is almost always termed “a proprietary algorithm” used to make the loan decision, but in most cases is little more than the old standardized methods that banks have been using for decades. Credit scores, bank statements, and rudimentary background checks can now quickly be run by almost anyone. Decisions can be made in as little as 24 hours. Funding is usually quick and easy. All of this sounds great until traditional bankers start looking at these young FinTech company protocols and get nervous. Why?
Risk Management
Simply put, there is no risk management in place at many of these firms. The idea of funding an individual or a company with a loan in 24 hours sounds great, but how risky is this strategy? Turns out it is more than just a little risky, it can be catastrophic with no risk management protocol in place. The age old adage of “if it sounds too good to be true, it likely is” could never be so profound.
Regulation
The issue of reporting is often lost on FinTech firms. In some cases, these firms are not regulated and do not attempt to comply with what bankers must comply with if this technology were to be under their purview. Regulators, for instance, require that banks have contingency plans to get services back online within 72 hours of an outage. Additionally, a FinTech may be required to provide Service Organization Control (SOC) reports, security controls and internal IT audits to validate protocols. All of this should be part of a firm’s regulatory compliance criteria but often is completely ignored.
Legal Rulings
Recently, two court cases in the State of New York emerged with interesting results. In the first and of the most immediate consequence, a New York judge tossed out a lawsuit against four Merchant Cash Advance (MCA) companies. A small business owner had brought suit against the firms, claiming usurious interest rates on $685,000 worth of cash advances. The judge rejected that argument, ruling the MCA contracts are not loans and therefore cannot be usurious. The court also cited an earlier case favoring Pearl Beta Funding as precedent.
Separately, a company called Kabbage, one of the larger online lenders, is prepping for what could be a class-action lawsuit in California that would challenge what is referred to as the “bank origination model.” Plaintiffs allege violations of state usury, false advertising, and unfair competition laws, as well as violation of RICO statutes.
Summary
Banks and FinTech firms are still miles apart on philosophical business principals. However, one thing is clear and that is each has something the other desperately wants. Banks want the speed and ease of doing business that technology brings. FinTech needs desperately the discipline and management that Banks bring. Will they fit together? Ultimately, yes.
For now, if you are a borrower: Buyer Beware!
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Mr. Cox is Managing Principal with Pendleton Capital Group, Inc. – a factoring and trade financing company headquartered in Houston, TX. PCG provides professional “best practices” Factoring and Trade Financing and other small business services. His office is in Houston, TX, and he can be reached for additional information or consultation at adam@pendletoncapitalgroup.com or 713-808-9746. The company’s website can be accessed at www.pendletoncapitalgroup.com
