Banks Start to Resemble Fintechs. Is it Enough to Stay Relevant?

Dave SPAC Deck, FDIC "Tech Sprint," CFPB on MLA, Illinois 36% APR Cap

Jun 20, 2021

Hey all, it’s Jason.

Happy Father’s Day to my US readers (which includes my own dad!). Yesterday also marked the first time Juneteenth was celebrated as an official federal holiday — an important recognition of the history of slavery in the United States.

Last week, I had the pleasure of attending the inaugural Fintech Meetup event and really enjoyed the opportunity to connect and exchange ideas with participants from across the fintech and banking landscape. My thanks to the organizers for their hardwork!

I also had the opportunity to join host Jason Henrichs on the Breaking Banks podcast to discuss the interplay of bank/fintech business models, fees, and innovation. You can listen here or look for episode #394 where ever you get your podcasts.

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Establishment Banks Are Starting to Resemble Fintechs. Is It Enough to Keep Their Customers?

More establishment banks are shrinking or eliminating fees and beginning to offer fintech-like features.

Capital One recently rolled out early direct deposit, a feature popularized by challengers like Chime and Varo. And last week, regional banks Citizens and Regions announced they would “rethink” overdraft policies.

That “rethink” doesn’t include any plans to eliminate overdraft fees, however. Both Citizens and Regions are more dependent on overdraft revenue than their peer set, deriving 12.2% and 17.7% of non-interest income from the practice, respectively.

Regions’ overdraft policy update is to change the order in which customer transactions are processed to post credits before debits, which feels like the definition of “too little, too late.”

Curious how other industry insiders view these product and feature changes at establishment banks, I reached out to three experts to ask:

Are moves like this from big banks enough to stay relevant with low/moderate income and younger consumers and keep them from defecting to challengers?

Ron Shevlin, Director of Research at Cornerstone Advisors and author of Fintech Snark Tank:

“Just matching early access to paycheck isn't nearly enough. Without a broader set of services and features — like elimination of overdraft fees, SpotMe-like features, and credit building products — moves like this are little more than virtue-signaling attempts to demonstrate how the big banks 'care' about low- to middle-income consumers.”

Tilman Ehrbeck, Globlal Managing Partner, Flourish Ventures (which has invested in digital banking companies Chime and Aspiration):

“The recent moves by mainstream banks to eliminate certain fees and advance salary deposits are good news for many lower income customers, especially those who still want access to a physical branch. While we’re excited to see the likes of Chime and Aspiration spurring change in the industry, it’s hard to see why digitally native, younger customer would ever go back to a traditional bank when so many cost-effective and convenient alternatives are available to them today.”

Brian Hamilton, CEO of digital bank One:

“Traditional banks are definitely trying to stem the outflow of customers to digital players- and yes, they are copying some features and benefits that new companies have implemented from the get-go such as low/no fee banking or 'early paycheck direct deposit'.
But there’s something more fundamental than overdraft fees that traditional banks can’t change with the stroke of a pen: the costs of maintaining physical branches. Big banks have to support physical branches, and those branches are incredibly expensive. To pay for them, they charge higher interest rates on credit cards, and offer lower interest rates on savings than their digital competitors - and that fact won’t change unless they shut that part of their businesses down.
And that's just one example of legacy structure among many. It’s a matter of economic sustainability and customers are waking up to alternatives. Therefore, the outflow of customers will continue, especially now that COVID-19 showed people that entirely remote banking was feasible (and perhaps preferable).”

Feature Parity Is Necessary, But Not Sufficient

My take? To stem the tide of users moving to challenger products, establishment banks will need to go beyond feature parity (which they haven’t even achieved).

Yes, part of the appeal of challengers is features like early direct deposit or no-fee overdraft, but these are an outcome of a customer-centric approach focused on solving their users’ problems — a lesson establishment banks still haven’t learned.

FDIC Announces “Tech Sprint” on Unbanked

Last week, the FDIC announced a “tech sprint” inviting banks, non-profits, academic institutions, and private sector companies to help answer the question:

“Which data, tools, and other resources could help community banks meet the needs of the unbanked population in a cost-effective manner, and how might the impact of this work be measured?”

While the challenge of helping unbanked households persists, I question if this is really the best use of the FDIC’s limited resources and the right approach to improving bank account adoption.

According to FDIC’s own 2019 survey, 95% of households are banked. Those that are unbanked aren’t all that interested in getting a bank account, with 75% of unbanked households saying they’re “not at all” or “not very interested” in having a bank account:

Looking at the primary reason households gave for being unbanked, this doesn’t appear to be an “innovation” problem — but perhaps more of an awareness and trust problem.

Challengers and, increasingly, establishment banks offer accounts with minimal or no fees. Lack of trust or perceptions about privacy seem unlikely to be remedied through the FDIC’s “tech sprint” approach.

Illinois Proposes Regs to Implement “Predatory Loan Prevention Act”

Illinois’ Predatory Loan Prevention Act (PLPA) was signed by Governor JB Pritzker on March 23 and immediately took effect. The state’s banking regulator, the IDFPR, has now proposed a set of rules consistent with the act, as well as updates to other consumer lending statues to make them consistent with the new law.

The PLPA bans credit products that exceed 36% APR, calculated consistently with the Military Lending Act. According to Ballard Spahr (emphasis added):

“The Act extends the 36% “all-in” Military Annual Percentage Rate (MAPR) finance charge cap of the federal Military Lending Act (MLA) to “any person or entity that offers or makes a loan to a consumer in Illinois” unless made by a statutorily exempt entity. The Act provides that any loan made in excess of a 36% MAPR is considered null and void, and no entity has the “right to collect, attempt to collect, receive, or retain any principal, fee, interest, or charges related to the loan.” Each violation of the Act is subject to a fine of up to $10,000.”

I’ve previously written about the number of startups offering “cash advances,” often advertising them as 0% APR. Instead, their revenue comes in the form of “tips” (often defaulted to 10% of the advanced amount or more) and expedited funding fees.

The general argument from the sector is that the tips are voluntary and thus shouldn’t be considered a finance charge. Reading the plain language of TILA Reg Z’s definition of a “finance charge,” the tips — optional or not — arguably could meet the definition (emphasis added):

“The finance charge is the cost of consumer credit as a dollar amount. It includes any charge payable directly or indirectly by the consumer and imposed directly or indirectly by the creditor as an incident to or a condition of the extension of credit.”

This includes 3rd party fees (eg, expedited funding fees), where use of the third party is required as a condition of or an incident to the extension of credit (even if the consumer can choose the third party) OR if the creditor retains a portion of the third-party charge, to the extent of the portion retained.

We know Dave and MoneyLion do retain a portion of the expedited funding fee, as both list it as a key revenue source in their investor materials.

A common legal tactic some of these companies employ is to structure their cash advance products as “non-recourse,” meaning, if the borrower defaults, the lender has no remedy — no negative credit reporting, collections, or law suits.

At the time a user takes a cash advance, they’re typically agreeing to automatic repayment, either from a spending account offered by the same company or their external linked checking account — where ever their direct deposit goes, which is usually a condition of qualifying for the advance.

This structure arguably could fall under Reg Z’s definition of credit, which includes (emphasis added):

“Credit includes a transaction in which a cash advance is made to a consumer in exchange for the consumer's personal check, or in exchange for the consumer's authorization to debit the consumer's deposit account.”

These practices haven’t gone without notice. As I wrote about last week, MoneyLion boasts five open inquiries into its business practices from federal and state regulators. Dave’s recently released investor materials (more on that below) also disclosed an ongoing inquiry from the CFPB.

With Illinois’ passage of and ongoing rulemaking tied to the PLPA, these types of “free” cash advance apps are likely to face heightened scrutiny in the state — potentially being forced to adapt their business model/fee structure or exit the state altogether.

*as always, I’m not a lawyer, even if I like to play one in this newsletter. If I’ve missed something or you disagree with this analysis, let me know.

CFPB Reasserts Right to Examine MLA Compliance

Trump-appointed leadership at the CFPB halted use of exams to enforce the Military Lending Act in 2018, arguing that the agency didn’t have the necessary statutory authorization.

Acting CFPB director Dave Uejio disagrees. Last week, the CFPB issued an interpretive rule reasserting its authority to examine supervised financial institutions for compliance with the MLA. The MLA offers certain protections to active duty military members and their families, including:

Limiting the annual percentage rate on many loans to military borrowers to a maximum of 36%;
Prohibiting lenders from requiring military borrowers to arbitrate disputes;
Prohibiting lenders from requiring military borrowers to waive their rights under any state or federal law

This move paves the way for stepped up scrutiny of lenders’ compliance with the law — including challenger banking products that offer loans or cash advances used by members of the military.

Dave “Banking for Humans” Investor Deck Teardown

Every once in a while, I’ll do a tear down of an investor deck for a fintech that is in the process of SPAC’ing. Last week, I broke down Dave’s products, business model, and financials. You can check it out in this tweet thread: