Data-driven disruption

Plaid, a fintech that connects consumers’ financial services apps to their bank accounts, is actively tapping talent with experience working in the banking sector, a strategy it says is helping it execute on its goal to grow its relationships with traditional financial institutions.

In the past several months, the San Francisco-based company said it has filled roles with executives who have spent time at banks such as Goldman Sachs, JPMorgan Chase, HSBC, Royal Bank of Canada and Standard Chartered. 

Several senior-level Plaid hires that have come from the traditional banking space include Patrik Ringstroem, Plaid’s head of strategic initiatives, who used to head corporate strategy at JPMorgan Chase; Plaid Product Lead Pete Tiwari, who was head of digital product management at Goldman Sachs’ Marcus; and Raja Chakravorti, Plaid's financial institutions midmarket leader, who has held roles at JPMorgan and Goldman Sachs.

"Over the past year, bringing in some of the new employees to Plaid who have deeper banking experience has helped us do a couple of things," said Ginger Baker, head of financial access at Plaid. "One is to have conversations in a way where we are using the same language, where we are prioritizing the same things that are important, and we are aligning around the same kinds of principles more easily." 

Baker said Plaid has also brought in product leaders and technical leaders who have experience working with innovation teams at banks.

"They're better able to work with banks to bring these experiences and these principles to life," Baker said. 

Since joining Plaid a year ago, Baker said the fintech has doubled its efforts to improve its relationships and build trust with financial institutions.

"There's a recognition that the financial institutions’ customers, who are also customers of many of the applications that use Plaid’s services, are really who the entire industry is trying to serve," Baker said. "The ability to build bridges not only with our developer clients, but our financial institution partners is critical in making sure that the consumer is served in the best way possible." 

Baker, who has held roles at Facebook and Square, said Plaid has been intentional about seeking out talent that hails from both the tech and banking industries.

"We want to complement that kind of experimental thinking with people who are grounded in the realities, the regulatory environment understanding, and the technical understanding that our traditional banking partners are faced with every day," Baker said. 

The strategy appears to be paying off. Plaid, which claims to connect to more than 11,000 financial institutions in the U.S., Canada, the U.K, and Europe, said it has either completed or has in place data-sharing agreements with most major U.S. financial institutions. 

The fintech, in recent months, secured deals with U.S. Bank and Capital One, as it looks to gain ground on a data-sharing agreement goal it announced last year. Plaid plans to have 75% of its traffic dedicated to application programming interfaces (APIs) by the end of 2021.

Baker declined to share how far along Plaid is in meeting that goal but said its recent contracts with U.S. Bank and Capital One, which represent the vast majority of traffic, have helped the fintech make "a significant dent in that number."

"It's something that I know, coming from the financial institution side, is important to banks," said Ringstroem, on data-sharing agreements. "And frankly, it’s a goal that we share."

Plaid’s mission to forge stronger relationships with banks, as well as increase its API traffic, comes as the interplay between data aggregators and financial institutions hasn’t always been amicable. 

Institutions such as JPMorgan Chase and PNC have taken issue with screen scraping, a method Plaid and other aggregators have used to gather customer data to link their accounts to financial apps, such as peer-to-peer (P2P) payment platform Venmo and robo-adviser Betterment. 

Some banks have cited privacy concerns with the practice and have blocked some aggregators from accessing passwords through screen scraping. Wells Fargo, for example, signed a data-sharing agreement with Plaid that lets the data aggregator pull customer data from the bank's server through an API, which the bank cites as more secure.  

But not all banks have the technology budget to build their own APIs, a disparity that perpetuates a lack of consumer choice, some fintechs have argued. 

Plaid last year launched Plaid Exchange, an API platform to help smaller institutions compete with larger firms by moving them away from credential sharing, or screen scraping.

Some banks, meanwhile, have taken issue with Plaid's methods. TD Bank sued the data aggregator last year, accusing Plaid of knowingly creating a user interface that features the bank's trademark, logos and green color scheme and mimics the bank's login page in an effort to "dupe" TD customers who are linking their bank accounts to payment apps "into believing they are entering their sensitive personal and financial information in the bank's trusted and secure platform." TD filed a motion in May indicating the case had been settled.

Plaid’s continued efforts to boost its API traffic come as the White House issued an executive order encouraging more financial data sharing in the banking industry. 

"With the recent executive order, I think that this consumer-at-the-center principle is going to become even stronger in the industry," Baker said. "I'm delighted that we have a series of milestones, and proof points of partnerships over the last year that are really going to help us to build similar types of relationships and partnerships with other institutions going forward."

President Joe Biden issued a slew of executive orders in early July aimed at promoting U.S. competition and cracking down on anticompetitive practices, according to a statement released by the White House. Among those orders are two measures that would provide more scrutiny of bank mergers and give consumers greater control over their financial data.

One order requires the Department of Justice (DOJ), the Federal Reserve, the Federal Deposit Insurance Corp. (FDIC), and the Office of the Comptroller of the Currency (OCC) to update guidelines "to provide more robust scrutiny of [bank] mergers." Another "encourages the Consumer Financial Protection Bureau (CFPB) to issue rules allowing customers to download their banking data and take it with them."

The administration’s financial services-related orders are among 72 actions and recommendations that take aim at corporate consolidation in an effort to boost competition in several sectors, including healthcare, technology and transportation.

The Biden administration pointed to "excessive consolidation" from bank mergers and the impact rural and nonwhite-majority communities have felt as a reason more scrutiny is needed regarding financial services M&A. 

"Though subject to federal review, federal agencies have not formally denied a bank merger application in more than 15 years," the administration said, citing a paper by Jeremy Kress, a University of Michigan professor who previously worked on bank merger oversight at the Federal Reserve.

"Excessive consolidation raises costs for consumers, restricts credit for small businesses, and harms low-income communities," the administration said.

A source with knowledge of the orders told Reuters "a rash of bank closures across the United States" has led to "a crisis of competition."

"[W]e’re dealing with the bad effects for a lot of people, and it’s also hard to switch options," the source told the wire service. 

The U.S. has lost around 10,000 banks, or 70%, over the past 20 years, according to data from the Federal Financial Institutions Examination Council and the Federal Reserve Bank of St. Louis.

The Biden administration’s plan to encourage financial data sharing in the banking industry is welcome news to fintechs and proponents of open banking. 

The debate over who owns customers’ financial data has pitted some fintech startups against some of the largest financial institutions in the past year, as data aggregators’ screen-scraping practices have been blocked by some banks citing privacy concerns. 

Some aggregators, such as Plaid and Finicity, use the practice to connect consumer accounts to fintechs such as peer-to-peer (P2P) payment platform Venmo and robo-adviser Betterment. 

JPMorgan Chase and PNC have blocked some aggregators from accessing passwords through screen scraping in favor of entering into data access agreements with fintechs through the use of application programming interfaces (APIs), a tokenized method that many banks say is more secure. 

But not all banks have the technology budget to build their own APIs, a disparity that perpetuates a lack of consumer choice, fintechs have argued. 

In October, the CFPB issued an advance notice of proposed rulemaking (ANPR), which addresses Section 1033 of the Dodd-Frank Act, a statute that gives consumers the right to access their financial information held by a bank.

The White House hopes the executive orders will encourage the agency to push ahead with those changes, a source told Reuters. 

Richard Prior, CEO of the Financial Data and Technology Association (FDATA), a global trade group that advocates for opening banking, applauded the order. 

"This is potentially huge news and an outcome that has long been fought for by FDATA North America and its diverse community of member companies," he wrote in a LinkedIn post. "There are certainly many subsequent critical pieces of the puzzle that will need to follow for a healthy and successful Open Banking/Open Finance ecosystem, but a defined consumer data right is at the heart of what is needed to drive this. Examples abound in markets around the world, at different stages of maturity and implementation. It will be truly an historic moment in the journey for the U.S. to see this step taken."

Meanwhile, the Bank Policy Institute (BPI) appeared to take issue with the Biden administration’s assertion that the banking industry needs more scrutiny to prevent anticompetitive practices and consolidation.

"By any analysis, banking is among the most competitive, least concentrated industries in America, as anyone who has shopped for a credit card, mortgage or deposit account knows," BPI President and CEO Greg Baer said in a statement. "Moreover, banks continue to lose business to unregulated FinTechs or government-sponsored enterprises, whose presence in the market current DoJ guidelines inexplicably ignore in assessing market competition. Those guidelines should be amended to reflect the underlying law."

The intersection of the Consumer Financial Protection Bureau (CFPB) and the concept of disparate impact in lending came to the fore twice in a 24-hour span.

Six fintechs — PayPal, Square, Varo, Affirm, LendingClub and Oportun — asked the bureau in a letter to give more guidance on how it will apply the theory of disparate impact when artificial intelligence (AI), machine learning (ML) and alternative credit data are used to make lending decisions.   

Under disparate impact, a policy can be illegal if it has a discriminatory effect on a protected class but may not be if the intent behind a business serves a "substantial, legitimate, nondiscriminatory interest."

Specifically, the letter asks the CFPB to state that disparate impact does apply to business models that use artificial intelligence. The companies also want guidance on when a disparity in lending decisions rises to a level that might signal discrimination. The fintechs are asking the CFPB to offer a threshold as to when and how lenders should seek alternative models or data, and for the bureau to explain the extent to which lenders can collect demographic data for reviews of their own fair lending compliance.

The letter, also signed by the National Community Reinvestment Coalition (NCRC), comes in response to a March request for information (RFI) from five regulators, including the CFPB, perhaps meant to forge an interagency policy surrounding the use of artificial intelligence and machine learning. The comment period for the RFI closes Thursday. The six fintechs are members of the NCRC’s Innovation Council for Financial Inclusion.

"We cannot stand by and allow algorithms to resurrect old biases in new packages, or introduce new forms of discrimination hidden in proprietary code," NCRC CEO Jesse Van Tol said in a press release. "Now that use of AI and ML systems is becoming more commonplace, it is critical that the bureau updates its regulations to hold lenders accountable to building underwriting systems that prioritize the rights of consumers, and particularly for historically disadvantaged and underserved groups."

The use of alternative credit data in lending profiles, at times, has had a positive impact. Online lender Upstart in 2019 reported a 27% increase in loan approvals over the previous two years and a decrease in the accompanying interest rate when using alternative credit data.

But while machine learning can help boost access to credit for populations often underserved by traditional credit score evaluations, the alternative data points — or combinations thereof — that make up the lending algorithm can still reveal unconscious bias.

Upstart, for one, gets leeway from the CFPB for taking advantage of a no-action letter. Perhaps, in being proactive and asking the bureau for feedback to tweak their own methodology, the six fintechs could garner similar regulatory grace.

"We appreciate disparate impact’s statistical, outcomes-based approach to identifying discrimination," the fintechs wrote in the letter. "We also believe this outcomes-based approach establishes disparate impact as a pro-innovation framework for preventing discrimination."

The CFPB has asserted that disparate impact applies under the Equal Credit Opportunity Act (ECOA). The fintechs are asking the bureau to update its guidance to reinforce that stance. The CFPB has issued a request for information on whether the ECOA and its Regulation B should be amended to align with two Supreme Court decisions that concern gender identity discrimination and disparate impact.

"Strong regulatory protections against discrimination in lending are critical for a just society, and for technology innovation to succeed," Armen Meyer, LendingClub’s head of public policy, said in Tuesday’s press release. "Fintech has united in support of strengthening these regulations that address the risk of digital redlining."

Credit reporting bill

Meanwhile, lawmakers on the House Financial Services Committee debated a bill that would create a public credit reporting agency couched within the CFPB.

Many Democrats on the panel cited a 54% jump in consumer complaints filed with the CFPB between 2019 and 2020 — the majority of which pertained to Experian, Equifax and TransUnion.

"The big credit reporting agencies have skirted responsibility time and time again," Rep. Maxine Waters, D-CA, said in a hearing.

Amy Traub, a witness at the hearing, described the three companies’ sway on Americans’ credit as a "private stranglehold."

"A public credit registry is needed to serve the public interest and how it will develop algorithms that diminish the impact of past discrimination, deliver transparent credit scoring, improve accuracy and offer a publicly accountable way to address disputes," said Traub, the associate director of policy and research at the nonprofit Demos.

But some Republicans countered that accuracy wouldn’t improve under a government entity.

"If you believe the government is going to make less errors than the private sector, who has to be responsible for being able to have good information out and can be sued for it … you're either naive or misinformed, or worse," said Rep. Blaine Luetkemeyer, R-MO.

Other detractors took issue with the consequences of data ownership.

If credit reporting fell under the CFPB, Rep. Roger Williams, R-TX, said, "not only will you force consumers to hand over all their data to the federal government, but it will also remove all incentives for the private sector to innovate and come up with new models that will better predict the creditworthiness of borrowers."

Consumers ferry funds to their friends through Venmo and Zelle with relative ease and low costs, but cross-border payments — particularly for businesses — are significantly hairier.

Cross-border payments still often rely on a process whereby funds travel through a network of correspondent banks, adding time and fees along the way. Critics of this method point to its lack of transparency. Compared to consumer payments, business payments can require complicated know-your-customer (KYC) processes, and for more documentation to be exchanged compared to peer-to-peer consumer payments.

"New entrants tend to offer cheaper fees, faster transactions and a degree of automation that can be achieved via the use of application programming interfaces," said Nick Maynard, a lead analyst at Juniper Research.

Historically, banks have dominated the cross-border payments market. For consumers and small- to medium-sized businesses (SMBs) — entities that typically move smaller amounts of money — pain points center around high costs, transaction times that can take days, and the inability to get a line of sight on where a payment is in the process. The global average cost of sending $200 was 6.5% in the fourth quarter of 2020, according to the World Bank.

"There's all kinds of delays and fees associated with [legacy cross-border money transfer methods]," said Erika Baumann, a senior analyst at Aite Group. "You may or may not know what those fees are and then have to send a secondary transaction to make up for that if your recipient is short-paid, because of the fees taken during the correspondent banking process."

Among the market participants, Baumann said the largest bank players in cross-border payments have the deepest correspondent banking relationships — including JPMorgan Chase, Citi, BNY Mellon and Bank of America. Some prominent fintechs playing in the cross-border payment field include Wise (formerly TransferWise), Ripple, Rapyd, Banking Circle, dLocal and Payoneer.

In recent years, fintechs have tried to make cross-border business payments cheaper and faster. This has been carried out through two methods: cross-border payment rails that don't run on traditional bank networks; or tech solutions that allow clients to connect to legacy bank rails more easily.

While bank players still dominate the global money-transfer market for large corporations, fintechs are gaining market share for customers that move smaller amounts of money, particularly SMBs.

But the cross-border payment market is more complex than a "bank-versus-fintech" paradigm. The market is moving toward a 'coopetition' model, as banks and fintechs seek to serve clients that fall outside of their core customer bases. Additionally, the need for bank and nonbank networks to "talk to one another" is a driving force for fintechs and banks to cooperate more closely.

The market

There will be almost 14 billion business-to-business (B2B) cross-border transactions in 2021, Juniper Research found. The value of B2B cross-border payments will reach $35 trillion by 2022, the firm said. Other estimates, including from consultancy Ernst & Young (EY), suggest the value of global cross-border payment flows could be considerably higher, reaching $156 trillion by 2022. Of that, EY estimated $150 trillion will be B2B transactions — and that the total volume of cross-border payment flow is growing by 5% annually.

Most large banks rely on the Society for Worldwide Interbank Financial Telecommunication (SWIFT) cross-border payment network to carry out international payments. SWIFT has been rolling out a global payments initiative, SWIFT gpi, since 2017 to enhance cross-border transactions' speed and transparency, allowing them to settle faster (within a day, and often within minutes). Clients using SWIFT gpi can also pinpoint where a payment is in the process. More than 75% of all payments through SWIFT are carried out through SWIFT gpi, a spokesperson for the cooperative said.

Analysts say banks rule the roost on business cross-border payments for large corporate entities because of the huge volumes of money they're moving, and the benefit of the additional client relationships banks have with large corporations.

Hugo Cuevas-Mohr, president and CEO of Mohr World Consulting, estimated 25% to 30% of the business cross-border payment market, by number of transactions, is up for grabs by fintechs. But banks dominate the market because they provide additional services.

"Knowing your client is very important for any financial institution [moving funds], and knowing a business is a little bit more complex," Cuevas-Mohr said. "You need more information with a paper trail."

While SWIFT gpi helps move the needle on addressing cross-border payment hurdles, it hasn't eliminated all sources of friction in the space — particularly when dealing with banks that aren't using the SWIFT gpi system.

"Not every bank in every region, and every country is going to [have] SWIFT gpi, so there has to be reliance on the correspondent banking model to some degree," Baumann said.

Fintechs' own networks

Nine-year-old Ripple and 11-year-old Wise are among prominent fintechs running their own cross-border payment systems.

Wise's cross-border payment system for businesses operates in a similar fashion to its consumer-to-consumer international money-transfer offering. The company has a network of local accounts around the world, from which recipients are paid, and the money never crosses borders. This makes sending money cheaper and faster than traditional foreign-exchange methods, with time frames ranging from instant (30% of the time) to two days at most. Wise also has bank clients with which it partners to offer foreign-exchange services.

Wise moves $72 billion per year, of which 20% to 25% are business payments, said Alastair Thompson, the company's global head of business development and partnerships. A significant proportion of Wise's business clients have 50 or fewer employees, and Wise is building technology to make it available to midsize businesses with up to 250, Thompson said.

By partnering with tech companies like accounting platform Xero and corporate expense management platform Emburse, Wise is able to expand its reach among midsize companies. But Wise, which has a one-time transaction cap of $1 million, isn't yet set up to serve large corporations that move significant volumes of cash, and it isn't able to do forward contracts, which lock in exchange rates for the purchase or sale of a currency at a future date.

"At that top end of business size, there are multiple reasons why we're not there yet," Thompson said. "Our sweet spot for payments size is in the tens of thousands up to the hundreds of thousands as a single payment." Single payments over $1 million are typically carried out through SWIFT, he said. Wise claims it saves its customers $1 billion a year in transaction fees compared to legacy bank cross-border payment methods.

Meanwhile, Ripple works with banks and business clients to offer blockchain-based cross-border payment solutions.

"The current cross-border payments infrastructure is built on a system that was developed pre-internet," said Pat Thelen, a vice president and managing director at the company. "The result is that remittance costs are disproportionately high compared to the small values of these payments and they often negatively impact the people who have the least."

Ripple's payment network, RippleNet, uses blockchain technology to move money instantly while providing transparent fees, real-time payment status and certainty, Thelen said. RippleNet also offers an on-demand liquidity service where digital asset XRP acts as a bridge between two currencies. But not all clients use that; rather, some use RippleNet's messaging and settlement layer and are supported by a liquidity provider on the network to complete cross-border money transfers.

RippleNet allows users to send cross-border payments in three seconds, with less than 1% cost to the sender, the company said. American Express is a notable U.S. client, but 90% of Ripple's cross-border clients are located outside of the U.S., including Banco Santander, Japan-based SBI Group, Siam Commercial Bank and others, Thelen said. In total, Ripple has "hundreds of clients," and in 2020, processed nearly 3 million transactions over RippleNet, which represents nearly fivefold volume growth compared with the prior year, Thelen said.

While a higher proportion of activity on Ripple's cross-border payments network is for consumers, the company is capturing growing demand from small businesses, Thelen said, including for cross-border supplier payment use cases.

XRP is at the center of a lawsuit the Securities and Exchange Commission (SEC) filed against the company in December.

Network providers

Other fintechs, including Payoneer and Rapyd, are helping businesses and financial companies more easily access legacy bank-led cross-border payment rails.

Payoneer, which in February announced plans to go public through a merger with a special-purpose acquisition company, said all of its payment volume is business payments. It processed more than $44 billion in payment volume last year, according to a recent SEC filing. Charles Rosenblatt, the company's chief strategy officer, said "upwards of 80%" of Payoneer's payment volume is cross-border transactions.

"We don't feel like we need to use alternate rails to the banks," Rosenblatt said. "We use SWIFT to move money in different scenarios, so what we need to provide is a better user interface, user experience and compliance framework."

Payoneer, and companies like it, differentiate themselves with a more customized and user-friendly interface for their clients.

"Banks and their functionality are not really built for mass payouts," Rosenblatt said. "For our clients, we create an easier experience than using the bank [and] we also have more features and functionality than most of the banks do."

Brendan Miller, head of global product marketing for Rapyd, said the company uses bank money transfer methods, but through its proprietary application programming interface (API), developers can tailor user experiences. Rapyd's API allows clients access to payments, checkout, collection of funds, disbursements, compliance and card issuing.

The future of bank-fintech coopetition

Citi processes between $4 trillion and $5 trillion in payments a day, most of which are business-to-business payments (it doesn't break down the proportion of those that are cross-border transactions). The bank has been investing in efforts to improve the client experience with cross-border payments while enhancing transparency and speed. This includes efforts to route payments to nonbank channels, including digital wallets; building tools to improve communication with clients about cross-border payments; and tapping advances in industry messaging infrastructure, including SWIFT gpi.

"SWIFT gpi is like putting a FedEx tracking chip on a payment, so you effectively know where, at any point of time, a payment is," said Manish Kohli, Citi's global head of payments and receivables. "While SWIFT gpi doesn't expedite payments on its own, the increased transparency and payment data help banks like Citi route cross-border money transfers better, sometimes significantly improving transfer times."

The bank has also built client-facing tools that can be used for cross-border transactions, including Citi Payment Insights, which includes status updates through a visual tracker; and Citi Service Insights, which allows clients to communicate with the bank about payments and track inquiry statuses.

On fintechs, the bank said it doesn't see them as competition because many nonbank payment providers are Citi clients. "With these payment companies, we collaborate," Kohli said. "Some, we make investments in, and some we use as components of a solution."

He noted a partnership between PayPal and Citi that allows the bank's institutional clients to make payments into customers' PayPal digital wallets through Citi's cross-border payments platform.

Large banks are also tapping emerging technologies, including blockchain, to improve cross-border money transfer processes. JPMorgan Chase, for example, said in April it was using blockchain to improve money transfers between financial institutions globally, including payments originating from Taiwan banks to beneficiary banks in other markets.

As banks invest in technology to meet client demand, some industry watchers say bank-led innovation on cross-border payments is at least partly driven by fintech pressure.

"I think they are very concerned about [fintechs]," said Vinay Prabhakar, vice president of Volante Technologies, a cross-border payments technology company that works with banks and fintechs. "They have a level of agility, a level of technology capability, and they have a lack of legacy that enables them to move much faster."

As banks and nonbanks innovate, competition may ultimately give way to coopetition, in which bank and nonbank payment methods become increasingly interconnected. In 2019, for example, a Ripple executive said its offering "can be very complementary" with SWIFT. Wise said in an April document that one of its goals for business payments is to "receive funds via SWIFT as a Wise for Banks partner."

The challenge for many nonbank closed-loop payment networks is the lack of interoperability with existing cross-border payment rails such as SWIFT.

"There are [payment] providers that have been operating in this closed-loop system that have seen the limitations of their capabilities in terms of reach, and some of these [nonbank] payment providers are actually integrating into the traditional banking rails to be able to actually build that reach," said Isabel Schmidt, head of direct clearing and asset account services products at BNY Mellon.

BNY Mellon is one of the top five banks in the U.S. for cross-border payments, Schmidt said, declining to provide figures but adding that of the hundreds of thousands of transactions carried out by BNY Mellon each day, the vast majority are cross-border.

What's likely to come next, Schmidt said, is a move toward a more integrated cross-border payments ecosystem connecting various bank and nonbank participants, with each targeting a specific client base.

"All of the players, I think, will focus on, or try to find their niche, in terms of what really differentiates them and where they can add value," she said. "The payment landscape overall in the next few years will actually become somewhat more complicated before it gets a lot simpler."

The Federal Deposit Insurance Corp. (FDIC) in February named Sultan Meghji the regulator's first-ever chief innovation officer, a position FDIC Chair Jelena McWilliams has been seeking to fill since she first announced the creation of the agency's Office of Innovation in October 2018.

Meghji, who in 2016 co-founded St. Louis-based fintech Neocova — which provides artificial intelligence (AI), analytics and other cloud-based systems to financial institutions — is tasked with leading the FDIC's efforts to promote the adoption of innovative technologies across the financial services sector.

"Under his leadership, I am confident we will find innovative ways to utilize technology to modernize our bank supervision, enable community banks to adopt technological solutions, and bring more underserved people into the financial fabric of our nation," McWilliams said in a statement.

Meghji, who joins the bank regulator at a time when the current upward trend in banked households could be under threat amid the pandemic, said technology is vital to ensuring people aren't left out of the banking ecosystem.

"Technology is the best enabler of banking the unbanked," Meghji said, adding that the coronavirus pandemic has exacerbated the challenges that have kept some of the nation's underserved communities from fully accessing the nation's banking system. "It's almost impossible to talk about moving the needle on the unbanked without also talking about the pandemic. Those are linked arm in arm."

The FDIC's biennial How America Banks report found 5.4% of U.S. households — approximately 7.1 million — were unbanked in 2019, a decline from 6.5% in 2017.

"[F]indings from multiple years of the survey suggest that the unbanked rate is likely to rise as the unemployment rate rose from its level prior to the pandemic," McWilliams said in a speech ahead of the report's release last year. 

"I think the vectors of success for dealing with the unbanked are going to be digital in nature. The more you can get real-time digital platforms into the banking sector, the more opportunity we will have to move the needle," said Meghji, who worked on an aid mission to help implement digital banking in Kenya, Tanzania and Uganda. "Bringing a customer on digitally where they can do three taps with their mobile device, versus going into a branch that may or may not be open — it's night and day."

'A disruptor'

Amid consolidation, competition from larger banks, credit unions, fintechs and nonbank lenders, the survival of community banks hinges on their ability to keep up with innovation, McWilliams said at a conference on the future of banking at the Federal Reserve Bank of St. Louis in 2019.

"This is not optional for the FDIC. We must lay this foundation because the survival of our community banks depends on it," she said.

She told Banking Dive in 2019 the agency was on the hunt for "a disruptor" to head its new innovation department, “somebody who understands technology, is not a regulator, is preferably not a Washington insider, but somebody who actually has created technology or developed technology.”

During his time at Neocova, Meghji said he was impressed with the FDIC's vision for the new department.

"When the chairman started talking about this job initially, a lot of us who were in the fintech sector at the time got really excited," he said. "I'm just so honored that the job was around when I could lift my head up and say, 'Hey, maybe I could do that.'"

Meghji said he's keen, in his early days at the FDIC, to listen and learn from others to figure out where the pressures, opportunities and demands are in the banking ecosystem.

One of the top concerns for community banks today is navigating the rapid growth of the financial services landscape, Meghji said.

"Some are still struggling to deal with the pace of change," he said. "It's been increasing for a while now and it's going to continue increasing. I don't just mean technology, I mean in terms of different types of financial services products being offered and different players."

Meghji said he's received many questions from bankers about how they should be prioritizing their approach to technology and vendors. 

"It doesn't matter where you are in this market, whether you're a bank, a tech company or a regulator, technology is a de facto part of the discussion now and it has to be built into the organization," he said.

Meghji, who has served as an adviser to the U.S. Treasury, the G7, the Office of the Comptroller of the Currency (OCC) and the FBI in areas of cybersecurity, quantum computing and AI, said he expects to bring his expertise in emerging technologies to the new position.

"You don't bring somebody who's an artificial intelligence expert into a role like this if you're not going to be thinking about emerging technologies and things that are impacting the system on a daily basis," he said.

As a growing number of retailers and tech companies wade into the financial services space, traditional banks and digital challengers can expect to see the competition for consumer accounts intensify.

But for banks carving out a niche service, the threat may not be as imminent, said James Stevens, a partner in Troutman Pepper's financial services practice.

"If you're a challenger bank that has sliced up your niche, then Walgreens may not really be a threat to you because Walgreens is out there offering products and services to the entire consumer market," he said. 

The same goes for community banks who specialize in small-business banking, or who cater to a specific local need in their geographic footprint, Stevens said. 

"As you start to see more retailers getting into these partnerships, where they're going to start offering financial services, I think it's probably the biggest threat to the large challenger banks that are really focused on a broad swath of the retail consumer population," he said. 

Digital banks like Chime, Current and Varo offer perks such as no-fee accounts and early access to direct deposits — features that appeal to a large group of consumers living paycheck to paycheck. In offering these services, they’re competing with well-established players like JPMorgan Chase and Bank of America, who have brand recognition and large branch networks on their side. 

But when retailers like Walmart and Walgreens announce plans to offer their own banking products, their existing consumer reach, brand awareness and even bricks-and-mortar presence could provide a significant edge in gaining market share with financial services. 

"Having 9,000 locations where somebody could drop off a form, look at a product or go in and ask a question about something financial related, I think that's definitely something the retailers bring to the table," Stevens said.

Large banks are acknowledging that it’s no longer just fintech and digital challengers that pose a threat, but big-box retailers and tech giants as well.  

"Their strengths are extraordinary, with ubiquitous platforms and endless data," JPMorgan Chase CEO Jamie Dimon wrote in his annual letter to shareholders, calling out Amazon, Apple, Facebook, Google and Walmart as formidable challengers in the financial services space.

These tech and retail giants will embed payments systems within their ecosystems and create a marketplace of bank products and services, Dimon predicted.

"It seems like the prize that everybody's focused on is to create one of these 'super apps' that sells financial services products,” Stevens said. “If you're a financial institution and you can get people looking at your app or looking at your website on a daily basis, the chances of them buying more products and services are going to go up dramatically. What retailers bring to the table is they offer a broader scope of things that can be purchased."

As retailers and tech giants go broad, traditional banks and digital startups say they are finding success in narrowing their focus of services. 

KeyBank launched a digital bank in March that provides tailored financial services to healthcare professionals. 

"We want to choose specific areas where we want to compete. Those are going to be a bit narrower, but we just know if we can pick those narrow spots, we can compete to win," said Jamie Warder, executive vice president and head of digital banking at the Cleveland-based bank. 

The launch of the digital platform follows KeyBank’s purchase of student loan refinancing startup Laurel Road in 2019.

Warder said KeyBank will continue to pursue additional acquisitions similar to its Laurel Road deal — transactions that help it achieve targeted scale as it looks to remain competitive.

Challenger banks have also recognized the value of offering targeted services that appeal to certain affinity groups. 

Daylight offers products geared toward the LGBTQ community, while Greenwood, MoCaFi and Paybby are targeting Black and Brown communities. 

Digital players that have launched to serve the immigrant market include Cheese, Fair, Remitly’s Passbook and Majority.

Magnus Larsson, Majority’s CEO, said the growth in the number of digital banks looking to serve the immigrant market indicates a demand for more targeted offerings in financial services.

"It's also proof that the banking space is going to become verticalized. I'm quite sure about that,” he said.

Four months after launching its industrial bank, Square launched business checking and savings accounts — offerings that form a bundle of products called Square Banking.

The company suggests Square’s banking products — which have no account fees, minimum deposits or balance requirements — can help Square merchants better manage their flow of funds. The savings accounts will carry a 0.5% annual percentage yield (APY). Meanwhile, Square Lending, a rebranding of Square Capital, will continue to offer loans to sellers through the capabilities of the in-house bank.

“By bringing banking services to the point of sale, we’re able to give sellers instant access to their sales, the ability to automate their savings by putting aside a percentage of each sale they make, and proactive loan offers that are based on their sales and potential rather than their personal credit history,” Christina Riechers, head of product at Square Banking, told Banking Dive.

Square’s banking offerings are an extension of its growing suite of money-management tools for sellers, including a debit card it rolled out in 2019, and Square Capital loans that were launched in 2014. The debit card, which included a Federal Deposit Insurance Corp. (FDIC)-insured checking account in partnership with Sutton Bank, offered instant access to card sales processed through Square. 

The money-management tools connected to Square's checking account resemble those of many neobanks: the ability to automatically save a portion of each sale and direct savings toward specific priorities, including tax obligations. 

Riechers said the banking product roadmap was “heavily influenced” by what the company heard from sellers who used the debit card, which saw 140% growth between 2019 and 2020. 

“As more sellers adopted the Square Debit Card to have instant access to their funds, we saw many sellers begin to treat their stored balance with Square as their primary home for business finances,” Riechers said. 

Competitive edge

As Square’s merchant customers use its various payment and inventory management tools, the banking products will help keep sellers in Square’s ecosystem and offer a rich source of data from which to suggest other products, including “proactive loans.” 

“[With banking], Square gets to maintain and own that entire relationship in a way that they did not previously,” said John Popeo, a partner at bank consultancy The Gallatin Group. “That's going to give them a leg up on their competitors and also enable them to capture more data and more information.”

Square was granted an industrial loan company (ILC) charter in March 2020. By operating through an ILC charter, Square retains an advantage over banks and fintechs that offer business banking products. Industrial banks are state-chartered, federally insured depository institutions that are subject to supervision by the FDIC and the applicable state regulator. Therefore, compared to traditional banks, Square, with its ILC charter, only needs to answer to two regulators, reducing its compliance cost, Popeo said.

With its ILC charter, Square can originate small-business loans without having to go through a partner. Another advantage Square’s bank, Square Financial Services, has is that it can engage in commercial activities — with some limitations. The FDIC in December approved a final rule giving the agency authority to examine the parent holding company — subject to written agreement — and review the scope of commercial activities that may affect the subsidiary ILC.

“Their parent holding company can engage in commercial activities where they might otherwise be precluded from doing so under the Bank Holding Company Act,” Popeo said. “The [FDIC] rule clarifies existing precedent to require prior FDIC approval for certain changes at the ILC level in a way that somewhat levels the playing field between ILCs and traditional banks.”

Having a banking charter also insulates Square from competition from fintechs and e-commerce platforms that offer banking and other financial services, analysts said. One company that plays in a similar field is online-to-offline commerce platform Shopify, which offers seller loans and a seller banking product called Shopify Balance.

“[Square] really has the ability to expand its capabilities without the need to partner,” said Gilles Ubaghs, a senior analyst at Aite Group. “Shopify, by contrast, works with a number of partners for both payments and broader financial services, meaning it can't be as vertically integrated.”

Micro-seller niche

Ubaghs said Square has carved a niche with micro-sellers who often use Square’s physical point-of-sale devices as a gateway to other product offerings.

“Square’s big advantage here over the competition is that they have a strong foothold amongst smaller-scale micro merchants, and a much stronger position when it comes to physical point-of-sale environments,” he said.

Riechers said the product offerings were crafted with Square sellers in mind. The company is pitching the simplicity and integration of Square’s banking products with other Square seller tools as a selling point.

“Square Checking and Square Savings can be used by any small business that signs up for Square, [but] the products are most magical when they use Square for payments, given the automated savings and instant access to funds,” she said.

Ronak Doshi, vice president at research and advisory firm Everest Group, said Square’s foray into checking and savings accounts makes sense as a way to lower the cost of customer acquisition and drive higher customer lifetime value. 

While the company is focusing on direct customers, it doesn’t close the door to business-to-business (B2B) opportunities, Ubaghs said.

“[Square], in theory, could expand into the broader B2B space,” he said. “Commercial cards, in general, are on the rise, and lots of businesses are turning to new providers even where they have less of a traditional card acceptance or point-of-sale environment.”

But as Square operates as a bank and delves deeper into crypto, there may be some reputational risks to manage, Popeo said.

In a tweet July 15, Square CEO Jack Dorsey said the company is creating a new business “focused on building an open developer platform with the sole goal of making it easy to create non-custodial, permissionless, and decentralized financial services.”  The primary focus of the unit, as yet going by the name TBD, will be Bitcoin, Dorsey said.

“They've done a very good job of managing those reputational concerns, but I think as we move forward and regulators are exploring [oversight] of stablecoins and inner workings of cryptocurrencies, I'm very curious to see how Square continues to navigate the opportunity afforded [to] them — not only with respect to Bitcoin but with respect to other cryptocurrencies," Popeo said.

Card issuing and processing platform Marqeta is on a mission to make it easy for businesses of all sizes to roll out cards simply and quickly. 

The company has made a name for itself helping large tech companies, including DoorDash, Uber and Instacart build debit card capabilities. And in February, it rolled out plans to expand into credit cards.

It is also finding a client base among incumbent banks: The company in January announced a tie-up with Goldman Sachs to issue debit cards for the soon-to-launch Marcus checking account, embedding such capabilities as real-time access to spending data. Alongside cards, Marqeta also plays in the buy-now-pay-later space, with partnerships with Affirm and Afterpay.

The 11-year-old Oakland, California-based company in February reportedly filed confidentially for an initial public offering at a $10 billion valuation. In a crowded market of card players, the company's chief product officer, Kevin Doerr, emphasized Marqeta's primary advantage is a flexible, application programming interface (API)-based tech stack that allows its partners to launch cards in months instead of years.

"We've modernized the capability to issue debit prepaid and now credit cards, by essentially making it an API problem," Doerr told Payments Dive. "The time to market actually saves [partners] a tremendous amount of money."

Marqeta's toolset helps it reach companies large and small. For newer tech companies, the advantage of integrating with Marqeta is the company can move at its own pace, thanks to the lack of a legacy technology layer and a better cultural fit.

"There's something really profound about saying, 'That company is more like me than other companies, and it's more reflective of how I develop and think about my product,'" Doerr said. "We are more like [large tech company clients] than the legacy processors, including how we think about constructing solutions, how we think about the practices and the approaches in our actual code base, and how we think about the actual offerings."

As it looks to the future, Marqeta seeks to apply to credit cards an approach that helped it successfully scale its debit-card offerings. By the end of 2020, more than 270 million cards were issued through the Marqeta platform. 

'Dial up or dial down'

Marqeta's credit-card offering allows partners to quickly launch cards with flexible controls, including giving partners the ability to turn parameters — including rewards, annual percentage rates and credit lines — on or off with minimal friction, in real time based on custom rules. 

It allows partners access to dashboards instead of legacy spreadsheets, along with capabilities to activate users instantly and embed cards into digital wallets. The company is first partnering with fintech Deserve, whose founder and CEO, Kalpesh Kapadia, recently told TechCrunch the credit-card market is saddled with a high cost of operations and a lack of customization and speed.

"We're giving you the APIs which you turn into switches, and you get to decide how much you want to dial up or dial down or to turn things on and off," Doerr said.

Marqeta said it sees opportunities to move into new use cases, both financial and nonfinancial, but Doerr wouldn't comment on specific priority areas. From a broad perspective, he suggested the company is working to help clients navigate complexity.

"We've already been operating with some of our customers in the [employer] expense area or the travel-related area," he said. "Per diem spending is a complex area for even midsize companies that are trying to allocate a certain amount of money to an employee."

As Marqeta grows its card offerings, it faces competition from both legacy and upstart payments players, including Stripe, Synchrony, CoreCard and Galileo. But as Marqeta moves into credit cards, it will lean on its biggest differentiator, which is simplicity, said David True, a partner at PayGility Advisors. 

'Card-as-a-service'

Marqeta minimizes the number of steps involved in launching a card product, and offers a single point of contact instead of a circuitous journey, True said. It is a workflow analogous to banking-as-a-service relationships, in which fintechs help clients develop banking offerings by taking the friction out of onboarding for their partners.

"[With legacy players], clients have to build a business case, and they have to find a bank that is willing to work with them and then they have to find a processor — Marqeta can step in the middle and say, 'You can sign a contract with us and we take care of everything else,' and that makes life simpler for the client," True said.

Marqeta has also benefited from a push toward digital payments, but Doerr said he's not sure if the pandemic and its emphasis on touch-less transactions have significantly changed the nature of the credit business.

Asked about the biggest risk to Marqeta's business, the company suggests the resilience of its technology stack will be crucial as it supports use cases as they evolve.

"We want to build for scale and for resiliency [as] our customers expect dial-tone capability — the notion that the service is just always on, like your lights, heat, electricity, and you flip a switch and you expect it to be there and never question it," Doerr said.

Chime was the most downloaded digital banking app in the U.S. during the first half of 2021, with 6.4 million installs, according to data collected by Apptopia. 

The San Francisco-based challenger bank more than doubled the 2.7 million downloads second-place Current garnered during the same period. Varo Bank and Gen Z-geared Step came in third and fourth with 1.95 million and 1.94 million downloads, respectively, during the six-month span from Jan. 1 to June 30.

The coronavirus pandemic has been a boon to digital banking, as more users turned to digital-only challenger banks — and the digital services available at traditional institutions — to conduct their financial transactions amid lockdowns. Neobanks like Chime and Current managed to fund their customers’ accounts with the government-backed stimulus checks days ahead of traditional banks, garnering praise and positive media attention. Apptopia’s report, however, shows that European digital banks are lagging behind their U.S.-based competitors in gaining market share in the U.S.

According to Apptopia, the top 10 digital-first banking apps in the U.S. recorded 16.33 million installs during the first half of 2021. 

The firm’s data shows that despite the entrance of several overseas-based neobanks, some of which are dominating the European market, foreign challengers still have much ground to cover to catch up with U.S.-based digital banks. 

N26, which launched in the U.S. in 2019, came in 10th in the number of downloads for the first half of 2021 with 170,000, according to Apptopia. The Berlin-based digital bank has invested $29.9 million toward its U.S. expansion efforts, and said it plans to reach break-even status by the end of the year. 

In addition to its expansion in the U.S., the company is also aggressively eyeing the Brazilian market, and recently obtained a banking license in the South American country. 

Amid its international growth efforts, the company has also reversed some of those expansion plans. The neobank shuttered its U.K. operations in April 2020, citing challenges associated with Brexit and reports of low user engagement.

Revolut, which launched in the U.S. last year, didn’t make the top 10 list, coming in 11th in downloads for 2021's first half, according to Apptopia.

The London-based bank, which claims to have 15 million customers worldwide, appears to be bullish on the U.S. market. The company applied for a banking license through the California Department of Financial Protection and Innovation, and launched Revolut Business across all 50 states in March. 

As it looks to grab its share of the U.S.’s digital banking market, Revolut's small-business offering could help it differentiate itself from Chime and Current, which are vying for consumer accounts. 

Revolut has said its business banking service has amassed over 500,000 sign-ups in Europe. Meanwhile, it is reportedly chasing $1 billion in funding. The neobank’s advisers are in talks with tech investors, including Japan-based SoftBank's Vision Fund 2, for an investment between $750 million and $1 billion, according to Sky News.

Financial institutions and financial market infrastructures (FMIs) rapidly adopted work-from-home models in the pandemic. But the move raised the level of cyber risk, as essential employees at banks and other financial centers adopted virtual computing networks and embraced third-party service providers such as cloud banking. It could leave the organizations vulnerable to potential risks due to a single point of failure, according to a July report by the Financial Stability Board.

The frequency of malicious cyber activity — including phishing, malware and ransomware — exploded over the past year. Incidents jumped from about 5,000 per week in February 2020 to more than 200,000 per week by late April 2021, according to the report, which cited data from the Financial Services Information Sharing and Analysis Center. Threat actors targeted bank employees and customers with malicious activity.

In many cases, banks and FMIs invoked business continuity plans that involved wholesale shifts in network security, including the wide use of virtual private network infrastructure and often unsecured Wi-Fi access points, the report said. Banks also had to shift millions of customers from in-branch banking to mobile app-based transactions or telephone banking.

The FSB's report was designed to help the banking and financial services industries bolster operational resilience for financial institutions that made wholesale changes in how they interacted with customers and how they conducted financial transactions during the pandemic.

Many of the changes implemented by the banking industry took place with little to no advance warning. The global economic system is only now beginning to shift back toward in-person education and work, which will likely result in a new set of operational challenges for banks.

"The pandemic highlights the importance of putting in place effective operational risk management arrangements before a shock hits," the report states, noting that financial institutions need to plan for contingencies that may impact business continuity.

"Continued investment in and maintenance of cybersecurity, such as firewalls, antivirus software, intrusion detection systems and security operations centers are essential. At the same time, financial institutions need to recognize the human factor as a core element of the cyber security chain," the report said. 

The FSB in October published a toolkit that outlined a series of best practices for what it called Cyber Incident Response and Recovery. The report highlighted how financial institutions should prepare for a potential data breach or cyberattack, how to stress-test the system against such an incident and how to limit the potential damage from such an attack.

The agency released a discussion paper in November on regulatory issues related to outsourcing and third-party risk, to open up a public dialogue on issues like dependence on third-party cloud providers or supply chain risks.

The paper received almost 40 responses, with local experts raising the possibility of creating global standards to manage third-party risk, as well as other solutions to boost access to these technologies in emerging markets.