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Over the Tipping Point on Bank Modernization

Updated: Sep 9, 2020

An interview with Bob Birmingham at Maquette Advisors

Published September 8th, 2020

The disruption unleashed by the pandemic represents a tipping point: in this moment, banks now have both the available technology and the business case to modernize. Consequently, the industry overall is poised to advance both inclusion and better financial outcomes for people on the one hand, and greater system efficiency on the other.

This evolution is not without it's potential pitfalls, however. For example, masked by the rush to set up deferment programs and CARES Act credit reporting changes are concerns over how this information can be used and whether people understand the true costs or implications of a deferral.

Bob Birmingham joins us from Maquette Advisors to discuss. Bob is a fellow former US financial regulator (a la CFPB and FDIC) and now advises fintechs and banks on regulatory and compliance matters, including technology modernization.

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Mack: Welcome, Bob. Even before the current pandemic, technology and fintech were rapidly growing sectors within finance. What shifts do you foresee as permanent?

Bob: On the other side of this crisis, people and how they interact with commerce and financial services is going to look very different. Over the last decade, there has been a building wave of technology solutions, but there hadn’t been that moment to force change until now.

This crisis represents a large disruption to financial services businesses. They are likely to operate in a leaner manner with less physical overhead and fewer people. The big challenge for them will be balancing human capital and technology. For traditional banks, it has always been weighted towards human capital. Now I believe we’ll begin to see more 50-50 in the relative weight between the two.

What I expect we’ll see is a big shift towards technology with budgets, jobs, and roles reflecting this. Ultimately, this is going to lead to a consumer finance industry with better cost structures, providing more competitive, better products to people.

Mack: I couldn’t agree more. The business case for tech solutions, particularly at traditional banks, has never been stronger.

Bob: That’s right. Adopting technology has never been easier. Even 5- or 10-years ago, there weren’t a lot of fintechs or solutions for modernizing banking institutions. Organizations that adopted tech developed things in-house which created a big barrier for smaller institutions. These institutions were never designed to hire engineers and build out different tech stacks.

My observation is that it isn’t a bad thing – everyone now has equal opportunity to technology. There are so many fintechs and tech companies competing for business in this space to serve financial institutions. With the right level of diligence, you can buy solutions to help modernize your bank, whether that’s how you interact with consumers, handle manual processes, mitigate fraud, manage large collections, self-help, or call centers… it’s intimidating but it’s also never been easier. Don’t let fear of the unknown stop you from proceeding with evaluating technology solutions.

Everyone now has equal opportunity to technology... with the right level of diligence, you can buy solutions to help modernize your bank.

Mack: Every day there seems to be more banks and fintechs announcing partnerships. With over 10,000 fintechs globally and counting, it can be a bit daunting to begin identifying the right tech solutions. Where would you recommend banks start?

Bob: Start internally. Ask, ‘where has the current crisis changed roles within your organization the most?’ Identify roles or teams that have changed, are no longer needed, or can be made more productive through technology. Within your organization notice where your workforce is displaced, or where your people were no longer able to be as productive. Start there and automate certain processes and ensure employees can continue to remain engaged and productive.

In the fintech ecosystem there are so many interesting solutions. There are some great solutions out there related to compliance testing, underwriting, AML/BSA, customer service, regulatory change monitoring/management and fraud. As you re-evaluate your internal workforce, you can identify tech solutions that solve for the challenges you’re experiencing within each functional team.

A boon for banks in these fintech partnerships has been with white-label financial products. If there are financial services you’re set up for but haven’t offered in the past, you can work together to develop those. For example, a bank that offers auto and mortgage loans can now offer personal loans or savings/debit products as a white-labeled product. These partnerships give banks the opportunity to offer a wider range of products to their customers at better prices.

Mack: As we look beyond the current crisis, what gives you optimism for people and their finances?

Bob: Advancement of access and inclusion. We’re going to have to serve the underserved markets better and reach consumers in different ways. This includes the youngest generation that’s now entering their early 20s.

I’m excited because I believe this is the moment that will force us to get past long-standing issues of financial inclusion and literacy and say that we can do better. The incumbents and fintechs can increase inclusion, decrease the cost of credit, and generate better financial health outcomes.

Stronger use and access of the financial system is what leads to stronger financial positions for people. This is what helps people achieve the American dream. When you don’t have access to it, it puts you at a disadvantage. Financial health and outcomes haven’t been the focus of the financial system, however. You have some pockets, like the CRA [Community Reinvestment Act]. But broadly, financial literacy, health, and wellness are still being addressed.

The incumbents and fintechs can increase inclusion, decrease the cost of credit, and generate better financial health outcomes. Stronger use and access of the financial system is what leads to stronger financial positions for people.

Mack: Absolutely. The industry seems well poised in the coming years to help drive better financial outcomes for people. What evidence do you see that this is already underway?

Bob: I see innovative companies changing this and banks partnering with them. It’s not a direct line, but a structural reorientation. In partner bank networks for example, it started with only 1 and now there are 50 to 100+ banks partnering with fintechs. I don’t see this slowing down and pretty soon it’s going to become all. I don’t see them continuing to operate without working with fintechs in niche fields.

Fintechs demonstrated this most recently with PPP loans. They were able to get money out the door and into small businesses across the country, quickly. I’m hopeful this experience made it so obvious that we weren’t ready and we should have been.

I also see it with the regulators. Through this crisis, it seems that the FDIC and OCC embraced technology and are ready to help support it through their organizations. Previously, it seemed that their default mode, and maybe rightfully so, was to assume the worst until proven otherwise – this crisis may have flipped that paradigm which is a win for modernizing banking.

Mack: The Federal Government’s pandemic response has introduced many policy changes as it relates to loan deferment programs and credit data reporting. What do you think the legacy of this response will be on the industry?

Bob: It’s a turning moment. I ultimately see more regulation coming from the prudential regulators on deferments and credit reporting. I also see companies with a renewed focus on that area. Banks and creditors are going to be more creative because not all delinquencies are the same. There’s going to be a lot of creativity in this space which will lead to more regulation and oversight, especially for clearer disclosures.

What is clear, is that there is a gap in regulation. Masked by the debate of whether deferments are calculated into your credit score is whether you will be treated differently as a result of your deferment.

I am personally bothered by the fact that most consumers do not understand the cost or implications of a skip-a-payment or deferment. It’s not universally understood. There is no way in the current environment that every borrower who has taken a deferment has needed it. I suspect that it’s sometimes framed as no-cost, but it’s not true. It has effects on extending the term, additional interest, or other impacts.

While deferments are not calculated into your credit score, there needs to be a broader push for financial health and understanding here. A lot of the more complex underwriting decisions don’t look at solely the credit score anymore (if at all) and they’re looking at the detailed credit bureau data. Their models may consider this data differently and these pandemic deferments may still adversely affect the consumer. It’s not crystal clear what the cost is here.

What is clear, is that there is a gap in regulation. Masked by the debate of whether deferments are calculated into your credit score is whether you will be treated differently as a result of your deferment. Your bank, for example, may decide to treat you differently (i.e., higher interest rate) or deny you for credit if you defer one loan and apply for a second. There’s no law to prevent this. Every financial product is likely to require fair disclosure to educate people on these implications.

I predict that more oversight will come to deferment programs. Based on how these options are presented… they should trigger another TILA or TILA-like disclosure that conveys the cost to the person of taking this action and information on negative credit reporting.

The deferment of interest on federal student loans has added to the confusion. It’s hard for people to differentiate a free benefit with something that’s going to cost them more money. There’s no doubt that we’re going to see confusion and more complaints about this.

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