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Nov 4, 2019

The neobank’s promise: No branches near you

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All-digital banking is becoming more popular in the United States.

The tech industry is coming for traditional banking. Digital payment apps are changing how we move money around. A wave of so-called neobanks — all-digital services that let people do everything on a smartphone without any branches — is cropping up in the United States.

Companies are using new ways to evaluate people for loans, and tech companies like Amazon, Apple and Uber are offering credit cards or getting into financial services. It is an interesting time to be a banking regulator.

I spoke with Jelena McWilliams, the chairman of the Federal Deposit Insurance Corp., best known for providing federal insurance to licensed banks. The agency also has oversight and consumer protection responsibilities. McWilliams told me that there’s a lot going on. The following is an edited transcript of our conversation.

Jelena McWilliams: The question for us on our regulatory side is are we going to be standing in the way of that innovation, or are we going to be open minded enough, while making sure that the banks are safe and sound, and there’s adequate protection? I do think that the banks of the future are going to be more agile, and I do believe that those banks will service not just the financial needs of the customers, but perhaps expand even above that.

Molly Wood: What are the biggest innovations that you’re seeing? When these banks say, “We’re doing this digital innovation,” what do they mean? Or what are you seeing happening?

McWilliams: Usually what we see is the way that they’re able to reach customers and consumers and underwrite models of credit risk, by far more quickly and based on alternative data products. That’s what we’re seeing right now. They’re using folks’ Starbucks receipts, and how much money is coming in and out of their accounts on a monthly basis, to be able to underwrite loans to customers. That’s truly novel because for decades, our credit risk scoring models in the United States have been based on purely the use of credit. If you have immigrants who are new to this country, if you have folks who are unbanked or underbanked, who had a relationship with a bank, didn’t know how to utilize it to their advantage, and they’re paying high fees are now disenfranchised, and they don’t go to a bank anymore — their credit is invisible. These companies are now able to take a look at their monthly cellphone bills and how are they paying the rental bills, how are they shopping for food. There’s a two-fold approach here. One is, that’s a lot of private data that these companies are collecting, which if you’re really concerned about the privacy and consumers’ choice, you have concerns about, right?

There’s also an opportunity to say, “But this data is very useful if you’re looking to bring people into the banking fold” if you believe that being a part of the banking system is good for the banking system and good for the people. I can tell you from personal experience, I came to the United States with $500. I landed here on my 18th birthday. I immigrated without my parents, and on my second day, I realized I should have a bank account. I opened up bank account and a checking account that I have to this day, 28 years later. Then I realized also as quickly that I should have a credit card, because everybody had a credit card. If you watch infomercials on TV, you should have a credit card. Three easy payments of $7.99 gets you a lot of stuff. I applied for a credit card, and I was very quickly rejected because I was in the United States for all of a week or two weeks. I had no income, no job, no assets, no credit history. The bank offered me instead a secured card, and I took $300 of my $500 and I sent it into the bank so I can have a secured card. I imagined, I had to call my father back in the former Yugoslavia while the country was falling apart in the civil wars and the banks were closing down and he lost his life savings in a run on the banks to tell him, “Remember the $500 you loaned me to have to take with me to the United States? Yes. I sent $300 to the bank. I’m going to borrow money from the bank, the bank is going to hold my money for a year and I’m going to pay them bank interest on my money. And all of this, Dad, makes sense.”

It’s impossible to explain that concept. But after 12 months of on-time monthly payments, I was able to get an unsecured card, which then led to me actually being bankable and creditworthy. I was able to establish good credit history with a good credit score, got an auto loan, home loans, student loan, and I was able to become a part of the system. Now I’m at the point where the system works for me. And by becoming a part of the financial system, as a young immigrant to the United States, meant that I belonged. When I pulled out that credit card in a grocery store, I looked just like the people around me. That was my first sense of belonging — the irony of a little plastic card.

The FDIC estimates that 8.4 million households in the United States were unbanked in 2017. (Karen Bleier/AFP via Getty Images)

Wood: That is remarkable, and I hear you saying that everyone should have that opportunity. And as all these services get more digital, I wonder how much the digital divide starts to really play into that.

McWilliams: The digital divide — I think there is a bridge over that digital divide, and here’s why. The FDIC does the unbanked and underbanked survey every few years, and most of those consumers have smartphones or cellphones with some kind of a Wi-Fi capabilities. They do everything on that cellphone. They use it to communicate; they use that device to move money to pay their bills, etc. This is where some of the disrupters come into play. They’re looking at the divide and looking for bridges and figuring out how they can reach the audience of unbanked, underbanked, new immigrants, low- and moderate-income households. They do utilize smartphones and use Wi-Fi technology in their cellphones to offer them products and services based on their usage of money, not necessarily just their credit history.

Wood: This seems like a good time to jump into cryptocurrency. Can we talk about Libra for a second?

McWilliams: We can’t talk about a specific currency because of our regulatory frame, but I’m happy to talk about generally crypto assets and cryptocurrencies.

Wood: Where do you see this going? How long is it before a central bank or a government issues a cryptocurrency?

McWilliams: I know there are talks underway as to what the role of the regulatory bodies in this space is. As a regulator, you want to make sure that innovation is able to foster, but at the same time, there are certain developments, such as the crypto assets, that have the possibility to undermine the whole central banking system of a country. We need to make a decision as policymakers, how are we going to look at the crypto assets? One of the things that needs to be decided is is it an asset or is it a security? Is it a currency? If it’s a security, we know how to regulate it because we have securities laws. If it’s truly a currency, then we need to start thinking about the implications of that, including what does that mean for the deposit insurance?

Wood: Do you think other innovations can answer some of the needs that Libra points out, which is a global seamless payment system, the ability to serve the unbanked in an easy and digital way?

McWilliams: Every time we see a disrupter, I always ask why, what was the need that this company — especially if they’re able to successfully roll out their products and services — why were they able to step in and do this? What was lacking in the marketplace that somebody planted the seed, and there was fertile ground, and the seed grew into this product? As I look at the cryptocurrencies and crypto assets, the issue of real-time payments comes into place. Also the issue of are we able through digital channels and distributive larger technology and blockchain to do more and better than we did in the past in terms of how we look at the monetary system within a country? I honestly don’t have an answer yet. One of the things that they want to make sure of is that we don’t either bless something we’re not sure about and we don’t understand its implications for the consumers in the marketplace and the financial stability and systemic risk, frankly. But also, we don’t want to discourage innovation. I feel like I’m on a seesaw every day, and I’m right there in the middle of the seesaw, one leg on each side, trying to figure out how to create that balance where we do enough to encourage innovation, but we don’t do something that would cause the system to irreparably go into disarray. 

Wood: It must be difficult. You see these companies plowing ahead, you see people saying the U.S. is so far behind on blockchain. I would imagine that almost every regulatory body feels this way, that you don’t want to get left behind, but you don’t want to do it wrong. The stakes, when it comes to global monetary policy, are way higher, right? How stressful is this for you?

McWilliams: It’s stressful, all right. Doing laundry is stressful as well in my household. Here’s the bottom line, here’s how I look at this: To the extent that these currencies and crypto assets and blockchain are developing to help society be better, we need to take the big picture into the equation here. As you think about them developing, central banks of the world have a very easy job of saying no immediately and stopping all of this in their tracks. Every single central bank, I would imagine, has the power to say no to the rise of the new currency. The fact that that has not happened should tell you that it’s a positive development, I think, because the regulators are at least taking the time to understand the implications while analyzing the impact on the system. It’s stressful because you don’t want to make a mistake. You don’t want to be that 21st century regulator that somebody in the 22nd century writes a book and says, “Oh, we would have been so much further ahead but for Jelena McWilliams at the FDIC.” You want to make sure that you’re open minded but careful. That’s why the regulatory agencies need to adjust to the new reality. We need to hire more data science background people. We need to hire more [quantitative analysts]; we need to hire people who understand algorithms, who are able to take a look at a distributed ledger and understand each step of the way. They need to understand the implications of blockchain. We need to change the regulatory agencies, because if you really think about it, we’re dealing with the 21st century technology with a workforce from generally the 20th century, based in some cases on some regulatory agencies and the laws and organic statutes as were given to us by Congress in the 19th century.

Related links: More insight from Molly Wood

I spoke with Jelena McWilliams at a conference last week in Las Vegas called Money20/20, which is pretty much all about financial technology and was heavily focused on digital banking. I moderated a panel with three so-called neobanks, sometimes called challenger banks, that are digital only, trying to offer more consumer-friendly services than big banks. They’re focused on lower overdraft fees or speeding up how fast you get your paycheck. Consumers definitely do want this.

A new survey on digital banking finds that more than three-quarters of consumers do want to use digital and mobile banking services and feel like they are generally safe. But a stubborn 20% or so still want the ability to go into a physical branch to talk to a human or deposit cash on those rare occasions when you sell your car or have a garage sale.

What do you think? Are you ready to go all digital with your banking? And would you rather do that with an existing bank that you know and probably hate, or are you ready to give a challenger a try?

Email me and let me know, or tweet me.

By the way, for a couple video highlights from my panel with Chime, Varo and the upcoming all-digital business bank Grasshopper, and more reading about this topic overall, click here.

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