Friday, July 24, 2020

Snail Mail: Ghosts of Fintech's Past, Present & Future

Slow Ventures Snail Mail

Friday, July 24th, 2020

Welcome to another edition of Snail Mail! Today we're diving into the ghosts of Fintech's past, present and future.

We recently hosted a conference with Inspired Capital to discuss Fintech moving forward, based on what we've done so far and the changing consumer landscape. We thought this was the perfect time to talk about this given the beginnings of the first wave of fintech: the financial crisis of 2008. There's reason to believe that the current crisis will usher in a new era. 

Here's the TLDR: Get ready to go into Kroger to apply for your next mortgage powered by JPMorgan; if you thought credit scores were complicated now, just wait; and the only way to be able to send money instantly for free will only happen because new companies will build around the old payment rails. While there isn't a consensus around who will end up being the big winners providing these services, there is a broad belief that this time is coming, perhaps much sooner now due to Covid. 

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How non-Fintech companies will become Fintech companies

A hot topic of the event was the opportunity for enterprise software in Fintech as a way to help consumers and the businesses serving them in the future. For those of us deep in the space, it's been obvious for a while now that non-financial companies were going to move into Fintech, but until recently, it was unclear how that might happen. We're starting to see some clear examples of this trend emerge.. 

Exhibit A: the Goldman partnerships with Apple and Amazon, where it powers a credit card and small business lending for the companies, respectively. Sure, Goldman could have tried to launch those businesses on its own, but what kind of scale would that have gotten in the first few months and/or years? There's no doubt that by doing these partnerships with tech firms that have massive customer distribution, Goldman grew these businesses far more rapidly than they would have otherwise.

In this arrangement, Goldman powers a lot of the backend, and then Apple and Amazon get to offer new products to customers without having to take on the risk or the beyond complicated world of financial regulation if they did it on their own. According to our panelists, this is the future thanks to APIs and other moving parts in the background that have made this arrangement easier than ever. 

With the help of some of the upstarts working on this, one day we're going to be able to walk into an Apple or a Kroger to apply for a mortgage rather than a JPMorgan branch. JPMorgan will just be offering the mortgage through a whitelabeled arrangement (while keeping its B2C offering).

Financial infrastructure is still a mess, so build around it

Sometimes, it feels more like we're in 1920 rather than 2020. Payments are still expensive, there's a fee if you want to deposit money instantly, merchants are paying a slew of players for each transaction, and more. Why is this still the case when at the same time, we can apply for a mortgage on our phones, buy a stock in an app, or get our credit scores in a matter of seconds? It seems to largely be the fault of the rails powering all of this, which were built for a system where people had one or maybe two financial providers. AKA: no need to move money quickly. Over the last couple of years in particular, the needs for money movement have changed dramatically. Can you and your spouse count on one hand the number of places you have money at? Doubtful. 

Startups are now taking cracks at this, but payments are, well, complicated, not to mention, the large players are disincentivized to help innovate since they'd lose out on fees. It's small businesses and consumers that stand to benefit from the innovations we're likely to see here. You see, if we build platforms that lower the barrier to entry, there would be a lower cost for the merchant and potentially more options for the consumer. The players innovating here have a lot of potential runway. 

Credit scores are only going to get more complicated and alternative data is hard 

We certainly aren't here to argue that the credit scoring system isn't a mess, but it's not going away. In fact, there's a growing amount of noise around credit scores that has made the system more complicated than ever, especially during a shock to the system like a global pandemic. Trying to figure out who is and isn't the best credit risk while millions are unemployed (many of whom had good salaries and credit scores before)? Best of luck. 

Every startup, large bank, and retailer is using big data. Even a decade ago, coming up with the score came with a lot of noise.  Adding in alternative data, cash flows, and other pieces of information, almost no one can make sense of it on their own. It's worth quickly mentioning that FICO has been extremely efficient, even with its flaws. We needed a way to find out if someone was going to pay us back at scale, and this did just that. But now, everyone is trying to digest new data that they couldn't before to see if there are other ways to better model how credit worthy someone is. 

However, in the absence of being able to go all in on alternative data like Tala, it's nearly impossible to do this right. The chances your models are wrong are very high when you consider that only a few of the things alternative models are scoring against were around during the last credit cycle. That means that you only know how many of them perform in the good times, which is the far less important time to understand. 

This brings us back to infrastructure. Rather than everyone trying to build new internal systems to digest data and make underwriting decisions, there are B2B companies offering ways to make sense of data and better understand which 650 credit scores are likely to go to 800 and vice versa. Those companies can also proactively go to companies not currently offering financial services and tell them they can whitelabel new offerings. For example: if a neobank wants to get into student loan refinancing or Kroger wants to start offering personal loans, they have the option of doing it this way rather than taking the time and resources to build it in house. Just slap on a few APIs and you're good to go (ok it's a bit more complicated than that, but you get the point). 

The current financial system failed at trust, how does fintech avoid that?

All of this brings us to our final point: trust. It's something that is quintessential to every successful financial relationship. If your customer doesn't believe you have their best interest in mind, if your service is spotty, if they don't think their data is safe, then you won't be successful in the long term. 

This very lack of trust was a big reason that consumers were so willing to give fintech a shot in the first place. Remember Occupy Wall Street and how furious everyone was with banks in 2008? They had no reason to think that their banks had their best interests in mind. The incentives, in many ways, seemed better aligned at startups, at least at the surface level. 

In order to maintain its success, fintech can't lose sight of this. If a consumer ends up believing that Fintech Startup ABC is just trying to get them into a product in order to make more money itself, then that consumer will be gone faster than you can say corona. Not to mention, this can end up being systemic. If a few bad actors start taking advantage of consumers, it could end up hurting other players by association. Not every bank was evil during the crisis (only like 99% of them), but that didn't matter to the consumer. Every bank was guilty by association. 

The current crisis gives founders and creators no other option than to buckle down and focus on building something that is best in class and truly helps their customers. At the same time. many will encounter the temptation to boost revenue in ways that don't have your customers' best interests in mind as revenue falls in the current climate. While the latter might do better in the short term, it's the company that's putting the customer first that's going to have a shot at winning in the long term. 

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