Fintech, Small Business & the American Dream

by Karen G Mills

  If a bank does want to become a “small business bank of the future,” there are a number of ways in which they can acquire the expertise and technology necessary to compete. Around the same time as the Numerated spin out was happening, there was an explosion of partnerships between fintechs and banks. In December 2015, JPMorgan Chase led the way by announcing a partnership with OnDeck under the Chase brand.2,3 This was not an easy process and it took more than a year for JPMorgan to complete the partnership, due to the technical requirements of systems integration and third-party regulations that required OnDeck to be compliant with bank vendor standards. The arrangement was viewed by many as a brilliant move. JPMorgan Chase gained access to the technology and expertise of one of the leading fintech players without paying billions of dollars to acquire OnDeck, which had gone public with a large valuation just a year earlier. And in another win for the bank, Chase was the brand giving the small businesses this new level of service. However, others saw this effort as a mistake, including some inside the bank. Why not create their own innovative product as Wells Fargo had? And why put so much time and energy into such a small segment of their overall lending portfolio? Nevertheless, the investments continued. From 2016 to 2018, as many other banks were adjusting their bearings, JPMorgan Chase pumped more than $20 billion into developing new mobile and digital products and invested in more than 100 fintechs.4

  Wells Fargo began its foray into the online lending space in May 2016 through its FastFlex small business program. During the initial rollout, loans were only available to existing business customers who had held accounts with Wells Fargo for at least a year. The transactional data the bank already possessed proved invaluable to the underwriting process. FastFlex offered loans starting from $10,000 and up to $35,000, targeting a portion of the small business lending market often overlooked by other traditional banking institutions.5 Wells Fargo also built out a section of its website dedicated to assisting small businesses. Wells Fargo Works for Small Business® offered advice on topics relevant to small businesses, success story videos, business and marketing planning centers, and even a competitive intelligence tool that helped small businesses map out their competitors, customers, and suppliers to determine where best to target their next advertising campaign.6 These efforts extended the bank’s activities, but were not transformative. In 2016, Bank of America launched Erica, a “virtual financial assistant” that could retrieve account information, make transactions, and provide help to the bank’s customers using “predictive analytics and cognitive messaging.”7

  The initial efforts of JPMorgan Chase, Wells Fargo, and Bank of America signaled that these banks wanted to play in the new lending environment, but these early templates should not be viewed as the final model. Small business lending markets continue to change rapidly, and merely adding information and tools will not be enough for these important large banks to maintain their leadership.

  In this shifting small business landscape, all banks, large and small, face a decision: should they evolve their activities or stick to existing ways, and if they decide to be engaged in innovation, how should they go about it? Should they build a product internally, partner, or buy the new technology? And, how will small business innovation relate to other fintech investments in data access, payments, or artificial intelligence that they might make?

  A Playbook for Banks

  A surprising number of banks, including many who were smaller and more traditional like Eastern, decided that they were not dinosaurs (as Bill Gates had described them in 1994) and found ways to innovate.8 Bob Rivers of Eastern Bank saw a benefit in finding a lower-cost, more automated way of delivering small loans, as it allowed the bank to make some profit and maintain the relationship with the business. If a business cannot come to a bank for a $100,000 loan, it is unlikely to come to that bank for the $500,000 loan it needs down the road. Rivers believed that his bank would be in serious financial trouble if it did not innovate in small business lending, which led him to take on big initiatives, like Eastern Labs, even though doing so upset many of the bank’s norms and processes.

  There is, however, a second line of thinking at many banks: the “not my problem” approach. This stems from the view that the bank does not have the time or capacity to compete with fintech companies, and sometimes operates on an implicit assumption that fintech firms are a passing fad or will not directly compete with banks. For some banks, this approach has meant doubling down on their strengths, including high-cost activities like manual underwriting, believing that the bank’s procedures result in better lending decisions than a technology-enabled process would deliver.

  Some banks have developed a middle ground, such as Frost Bank in San Antonio, which took an innovative approach without giving up its strong reputation for relationship lending.9 Frost began offering online mobile products that were well-designed and user-friendly, while maintaining a call system in which customers were directed to a real person, instead of an automated menu. All final loan decisions involved a face-to-face interaction. Frost saw value in maintaining their emphasis on relationship lending, but used technology to reduce costs and make the borrower experience faster and easier.

  Questions Banks Should Ask

  More generally, framing the question as an “either/or”—either a bank is innovative or it is not—often obscures the larger set of questions that banks should consider when deciding what to do about small business lending. To develop a strategy that fits each bank, we propose asking a new set of questions (Figure 9.1).

  Figure 9.1 Decision Matrix for Banks

  First, does the bank even want to serve more small business customers? For some banks, the answer will be no. For others, like Eastern Bank, small business lending is a priority. How might a bank make this decision? On the one hand, small business loans tend to be small and therefore low profit, particularly if the costs to acquire, underwrite, and process the loan are too high. They are also diverse in terms of risk, so a portfolio of small business loans has to be monitored effectively, which can take time and expertise. On the other hand, making small business loans can be done profitably and allow banks to cross-sell other products to the small business. In the past, it was acceptable for banks to say that small business was a priority, but to put off concrete actions that would improve their small business products and customer experiences because they knew there were few alternatives for small businesses seeking credit. In the emerging, more competitive environment, lip service will no longer be sufficient.

  If the answer is “no,” the bank does not want to service more small business customers, then the next question is whether the bank wants to hold small business assets on its books, even if they do not provide small business loans themselves. If the answer to this second question is no, there is no need to go any further. However, if the answer is yes, then buying small business loans can be an appropriate strategy for smaller banks. Companies like Community Capital Technology have begun providing a marketplace for smaller banks to buy and sell loans.10

  Another strategy, more appropriate for larger banks, is to invest in online lending companies as a way to indirectly participate. From 2012 to 2017, Citibank, for example, participated in 30 funding rounds to over 20 fintech companies hoping to both earn some return and monitor interesting developments in the fintech space.11

  For banks that answer “yes” to wanting to serve more small business customers, there are a range of mechanisms to do so. The first is partnerships, which involve some level of integration with a fintech provider. Banks can use an alternative lender’s technology to power an online loan application, often “white labeling” the online application, underwriting, and technology, by branding it with the bank’s own marketing. Citizens Bank, for example, partnered with online lender Fundation to provide a digital application and processing for small business loans, with same-day decisions and funding within three days of approval.12

  Others have copied Citibank and incubated fintech companies i
n a separate environment, then bought or partnered with those that add value to the bank. Barclays, for example, started the “Rise” program, an effort to attract the best ideas and entrepreneurs to accelerator programs in seven locations, with the tag line, “If you are involved with Fintech, you need to be involved with Rise.”13 This provided a mechanism to monitor industry developments and latch on to the best ones that fit within the bank. In August 2018, Barclays teamed up with MarketInvoice, a tool that helps companies sell their outstanding invoices in exchange for working capital. Barclays obtained a minority stake in the technology platform and announced plans to use the fintech’s investor capital and invoice financing capabilities to provide capital to its small and medium-sized businesses.14

  A second way to serve more small businesses is referrals, in which banks refer declined applicants to online lenders. In the United Kingdom, the government mandated that banks refer declined small business loan applicants to a fintech provider for consideration. Although this has not been very successful in the United Kingdom, some banks and fintechs in the United States have partnered on referrals to help the bank serve more customers. In the Citizens Bank/Fundation partnership, for example, Fundation will sometimes provide loans to small businesses that do not meet Citizens’ credit approval criteria.15

  The third option is offering the bank’s small business lending products through an online marketplace. Small businesses are increasingly looking for a central location where they can get access to the growing variety of loan options. Early fintech entrants, Fundera and Lendio, provide a platform on which banks and fintechs can offer lending products to small business customers, who can comparison shop to get the loan that is right for them. These online marketplaces generally reduce customer acquisition costs for lenders and provide potential borrowers with a user-friendly experience. If banks can offer lower interest loans due to their cheaper capital costs or other factors, these channels can also help them compete directly with fintechs in a transparent marketplace.

  The fourth option is to develop capacity in-house, as Eastern Bank did. This can be done through incremental innovation or with the goal of transforming the bank. These in-house innovations can range from the automation of existing bank processes to the development of new underwriting methods based on machine learning and alternative customer data, like utility bill payments. Wells Fargo, for example, is pursuing a large innovation project that involves pooling all of its information in a central data lake, and using this resource to create new insights and ultimately improve lending products for small businesses.16

  With this range of options, how should banks that want to serve more small business customers decide which strategy is right for them? The choice depends largely on how much time and money the bank is willing to invest to enter the new marketplace, and the level of integration the bank wants between the new digital activities and their traditional operations. In other words, the two questions that banks must ask are: “how much time and money do I want to invest?” and “how much integration do I want to have?” The following chart puts the strategic options described earlier into a matrix that explains the level of resource investment and integration associated with each (Figure 9.2).17

  Figure 9.2 Strategic Decisions for Banks

  Making a decision about how much time and money to invest to compete with disruptive innovation requires answering an additional question, “How threatening is innovation to the business?” At Eastern, Bob Rivers thought technology was very threatening. He saw that within a few years of the fintechs’ emergence, a growing percentage of small businesses were applying online, and they preferred the borrower experience of online lenders to the paperwork-intensive process of banks like Eastern.18 When he and O’Malley looked into Eastern’s small business transaction data, they saw that even the small businesses that banked with Eastern were taking loans from online lenders. This led Rivers to invest 1 percent of Eastern’s annual gross revenue into the Labs project and to dedicate a great deal of personal time and attention to Eastern Labs.

  Determining how much integration is appropriate requires asking another question: how essential is small business lending to the bank’s business? As the regional leader in SBA lending, Rivers knew that small business lending was core to his business. He also knew that if small businesses started going to online lenders instead of to Eastern, it could have implications not only for Eastern’s small business lending, but also for all of the other products cross-sold to their small business borrowers. Thus, Rivers decided he needed the small business innovation activity to be highly integrated into his bank. This meant pursuing the high-risk strategy of building his own product. It also meant putting Eastern Labs in the lobby of the bank’s headquarters so that the entire organization understood the level of commitment that the CEO wanted to attain.

  Innovation in a Traditional Bank

  Any innovation inside of a traditional organization, such as a bank, is difficult. Banks tend to have risk-averse cultures, in part because they are heavily regulated and must protect customer deposits. What if the technology doesn’t work? What if customers don’t like it? What if internal personnel don’t want to change? When the management of the traditional business feels threatened by the innovation, they may try to stymie it. (On the other hand, an innovation that is not at all threatening to a core business line is probably tangential to the bank, and may not be worth taking up in the first place.) So how should banks think about structuring whatever innovation activity they decide to pursue?

  One prominent theory of organizational behavior suggests initially separating the innovative activity from the day-to-day operations of the business, creating an “ambidextrous” organization, in which each activity has a separate budget, personnel, processes, and metrics for success. This approach allows the traditional organization to continue to pursue the profit-generating activities that sustain the current success of the business, and provides a protected environment for the innovators to take risks and explore new and disruptive approaches.19

  In addition to creating a separate structure, these efforts have little chance of success without the personal attention and active oversight of the top leadership—in particular, the CEO. Bob Rivers clearly showed this commitment, providing significant time, attention, and financial resources to Eastern Labs. Developing senior team buy-in is also critical and requires a narrative and logic about the identity of the company that is broad enough to encompass the innovation activity. In addition, incentives, culture, and metrics, particularly compensation and bonus plans, must be modified to support the new goals across the entire senior team.

  The most challenging aspect of ambidexterity is that, after innovations have been incubated in a separate, protected environment, they need to be successfully integrated back into the organization. This is an easier process if the benefits of the innovation are a two-way street. Rather than something that is done “over there,” there must be aspects of the innovation that create immediate value to the traditional organization. For example, in Eastern Bank, loan officers began to realize that the new automated loan process was creating a better experience for their customers. Both loan officers and small business owners could get an answer more quickly, and the underwriting was generally aligned with the bank’s own standards, making the process more efficient for everyone. In this process, they were also outmaneuvering their competition, by making sure that every creditworthy borrower who walked in the door or logged onto their website had a good experience and received a loan from Eastern. Rather than being a threat to the employees in the core business, technology was an opportunity to enable their success.

  On the other hand, getting the whole organization behind an innovative idea can be hard to accomplish. The founder and former Chairman of Intuit, Scott Cook, a successful entrepreneur and sponsor of innovation, learned this lesson during an attempt to integrate a new tax product into his established business. While the innovation was valuable to the company, thos
e in the traditional TurboTax business felt threatened by the new product and did not allow it to flourish. Eventually, despite a strong senior level commitment, the innovation died.20

  Even with a commitment to innovation at the top, how does a traditional bank attract the talent necessary to transform the business? Some large banks have tried to create more entrepreneurial environments, such as Barclays with its “Rise” centers. In 2015, the Dutch banking group ING completely restructured the organization and operations of its Netherlands office, transitioning to an “agile” model inspired by that of large tech companies. In this way, they hoped to attract and retain innovation talent and compete as a fintech platform.21 At Eastern, even though they ended up losing the initial team of innovators in the spin out, the CFO of the bank noted that Eastern Labs increased their reputational capital within the entrepreneurial community, making it easier to recruit new talent. As he put it, “We certainly got a lot of publicity and cache out of it. When I’m recruiting prospective hires, I’m always surprised at how interested they are in Labs.”22

  The Bank of the Future

  What is the successful model for the small business bank of the future? Can today’s banks evolve to be those players, or will they be beaten out by new entrants, small or large? There are three major hurdles that the banking industry must overcome to be successful in the new technology-enabled financial services environment. First, banks of the future will need a threshold level of data integration to provide the intelligence and customer service that small business lending will require. Small businesses will want to use their bank accounts, credit facilities, investment accounts, and other services in a much more seamless fashion. And from the bank’s perspective, all of this information will be important for credit analysis. To do this, banks will need to find ways to evolve their legacy systems, whether they develop new technology in-house or provide integration with applications developed by third parties.