Category Archives: Banking

Subprime Blindness is holding back the next big break in fintech

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In December 2017 Bloomberg posted this infuriating story about a man who was hounded by phantom debt, and how his crusade took down a Bad Guy (recently sentenced to almost 17 years in prison). It’s a captivating story with a happy ending, but one quote really caught my eye:

Therrien says he paid back the debt promptly. He was offended by the Lakefront woman’s suggestion that he was a deadbeat. “I’m a person who believes in personal friggin’ responsibility,” Therrien tells me. “I signed an agreement. And I fulfilled my obligation.”

This quote demonstrates one of several key misperceptions of consumers in debt. It’s something I like to call “subprime blindness”, a deep seated lack of understanding of and empathy for the consumer’s experience, motivations, and psyche, and it has wide ranging effects on our ability to start, fund, and scale solutions for the debilitating debt problem in developed markets.

Subprime blindness usually takes one of two forms: on one hand the condescending “it would never happen to me” approach, looking down on people in debt. This group thinks of debtors as morally inferior, deficient people choosing to remain in debt. The other is complete disregard of the reason most people are in debt, assuming everyone can afford to pay their debts if they were only afforded a convenient way to do so. Many investors I talk to have a story about debt, usually missed copay or some lingering internet subscription. To the well off it’s clear that they, and everyone they know, would pay if they just got a polite message.

Neither approach is correct. The majority of consumers end up in debt because they lost a job, had a medical emergency, or experienced another significant life event. These are not careless spenders or malicious consumers who couldn’t care less about their debt. They are often trapped and are doing the best they can given dire circumstances. Subprime blindness stigmatizes being in debt and hampers any ability to offer long term solutions that improve financial health and build equity.

This is what TrueAccord is solving. Radically changing debt collection is just step one. Our product relies on a radical—yet simple—alternative to Subprime Blindness: that consumers in debt are experiencing a temporary difficulty, and treating them like valuable customers will not only lead to better debt collection results, but will also help them build equity to eventually exit the cycle of debt.

Working on risk and fraud prevention? Don’t dig your career into a hole

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I give this talk about Risk Management called The Top 8 Reasons You Have a Fraud Problem. I learn a lot from the way audiences respond to it, mostly from objections. Most commonly, objections tell me how risk managers paint themselves into a corner in day-to-day work, effectively limiting their ability to drive change or participate in key business decisions.

How do they do that?

First, they make losses their one and only benchmark. It’s easy to focus on reducing losses when the business is taking hits, it’s your job and it’s what’s expected of you. But overcompensating and focusing on aggressive loss reduction whenever possible, while rejecting troves of good customers, will not only limits your business’s growth prospects – it turns the risk manager into a single-issue player. Revenue enablement must be a core KPI for the risk team or it will lose relevance.

Second, risk managers focus on maintaining status quo. When one lacks tools and methods to control their environment, their first response is to try to make sure that nothing ever changes. It’s not the risk team’s job to say no to everything new; it’s their job to find a way to say yes. That’s where the technological and organizational edge is. Find ways to enable new business by shifting risk across your portfolio and finding detection and prevention solutions that support even the craziest marketing ideas. You may flail at first but long-term, you’re building an important muscle.

Last, they tend to distrust the customer. It makes sense – when faced mainly (and often solely) with the malfunctions of the operation, often caused by customers themselves, one tends to stop believing in people’s good intention. That starts becoming a problem when every product design process turns into a theoretical cat-and-mouse game where every possible abuse opportunity must be curbed in advance. You should let users be users, and that means that there will be breakage and there will be losses. Zero losses can easily be achieved by stopping all activity in your system; you should accept that some customers will be bad and find a way to detect these as they act in your system, rather than limit every customer’s ability to use your product.

As I often write, risk teams are multidisciplinary and must think about operations, data science, product design and more. Whenever one focuses on limiting risk instead of trusting users, challenging the status quo and enabling new business, they are contributing to turning risk into a control function, a technocratic add-on that doesn’t deserve a seat at the decision makers’ table. Make sure that’s not you.

(If you want to read some concrete advice on how to do that, take a look at my free eBook here)

Why did PayPal buy Braintree?

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(Pasting my Quora answer here)

PayPal wants to be anywhere payments happen and it seems to be willing to pay a good price for that. Beyond the standard dynamic where the leader buys one of its most affordable up and coming competitors, PayPal acquired a few nice assets:

– The Braintree team is strong, with multiple highly talented folks that are both well known in the industry (= strong advocates) and generally capable.
– The product is superior to anything PayPal has in gateway tech. PayPal acquired Verisign’s gateway a long time back but that integration was not synergistic. With new PayPal management and Braintree’s product, they can get better access to a large and growing volume of gateway payments. This is a good and needed complement to PayPal’s portfolio.
– Last but not least, PayPal bought a foothold in the upmarket – medium and large merchants that usually do not use standard PayPal products due to lack of UX flexibility and integration, as well as strong presence in mobile payments.

So, bottom line, PayPal acquired a team, a product and a market. A smart move.

BitCoin mass-adoption challenges

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Crypto currencies, specifically BitCoin, are touted as the next big thing in financial
services. A secured, encrypted, technologically advanced platform that can support
monetary transactions across the globe is a dream come true for a lot of financial
services innovators hoping for a borderless financial world. This wave of innovation,
while still nascent, bears a lot of advantages.

It’s important to note, though, that not everything is green in the realm of BitCoin. While
some disadvantages are obvious – exchange rate volatility and lack of sufficient market
making are two obvious ones – some are less obvious, and are sometimes mistakenly
presented as advantages by newbies to the industry. Specifically, I am referring to fraud
using or on the BitCoin platform, and misconceptions about its feasibility – while some
may think it is much safer than other means of payment, that is absolutely not the case.
With BitCoin’s no-recourse movement of funds, transactions are subject to two types of
fraud: supply side fraud, and social engineering. Their prevalence might hinder mass
adoption of crypto currencies and must be addresses by the ecosystem before those
can be used the proverbial “normals”, the majority of consumers.

When a consumer purchases online using a credit card, the merchant charging the card
isn’t protected from fraud the same way they would be if charging the card in the offline
world. No issuer, acquirer or card network provides any fraud protection and merchants
can easily be victims of stolen cards or “friendly fraud”, a term describing customers
making actual purchases then charging back alleging fraud, while keeping the goods.

Defending oneself from chargebacks is difficult for merchants and fraud constitutes a major line item in retailers’ financial statements. However chargebacks serve a purpose: they
protect consumers from fraudulent merchants, failure to provide service and other
issues. With no ability to reverse transactions, no consumer protection is possible,
hence more and more fraud is perpetrated by those who pretend to be merchants. As
merchants, they can sell a service or product while charging in advance, and never ship
the product (or never own it in the first place). Consumers who pay find themselves out
of their money and the product they were offered, with no ability to reverse a payment.
Thus, demand side fraud becomes much more appealing to fraudsters.

This lack of protection hurts consumer trust. It also amplifies the damage from each
fraud case. A single fraudster using a stolen credit card may shop for $1000 in stolen
goods; a single fraudulent shop can easily scam dozens and hundreds of consumers.

The other thing to consider is social engineering. Fraud wasn’t invented in the 20th
century nor is it dependent on credit cards. There is a reason why Western Union or
MoneyGram was and still is a favorite for 419-type (“Nigerian”) scams; it, too, has no
option to reverse a payment. Every complex system is as strong as its weakest link, and
BitCoin is no different; the human element is its biggest failure point. As the SEC brings
to trial a man accused of running a BitCoin ponzi scheme, it becomes obvious that no
encryption beats greed and no sophisticated technology beats lack of good judgement.
In that sense, BitCoin isn’t different than any other means of payment, for better or for
worse. It is just not any safer.

Crypto-currencies hold a big promise for a more sophisticated financial infrastructure,
but the discussion about them is still limited to a small group of techies. As the world of
those currencies expands to meet the average user, questions regarding consumer
protection and social engineering must be dealt with, otherwise BitCoin will fail to be
adopted. We cannot just trust the users to be sophisticated, as we have all consistently
demonstrated that as a crowd, we are not sophisticated at all. In a sense, the same lack
of a governing 3rd party guaranteeing at least some protection or recourse, justifiably
hailed as the platform’s greatest advantage, is also one of its biggest disadvantages.
That, too, needs to be a part of an informed discussion.

Why using Bitcoin is like abstinence, and other thoughts about cryptocurrency and financial systems

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Elad Gil has this brilliant post titled “6 Startup Ideas Every Nerd Has” with a poignant explanation of how these are thought out. As someone who works on macine learning I can tell you that idea #2 repeats itself too often. I, too, have dabbled with ranting about ideas I hear too often. There is yet another type of ideas, though – ideas that are essentially interesting and good but that are too deep in geekdom to be relevant. Cryptocurrency is one of them.

If you work in payments you can’t get away from cryptocurrency, and its poster child Bitcoin. Every talk of fraud in payments draws scoffs from random commenters; Bitcoin will solve your fraud problems, they say. Irreversible, anonymous, plain and clear. Objecting responders talk of Bitcoin’s (lack of) merits as legal tender and the probability that governments will accept a legal tender they don’t control, if only for money laundering control. Both miss the point: Bitcoin isn’t a contender in the race to replace money. Claiming that Bitcoin solves fraud is like claiming that abstinence solves STDs; at zero participation from the general public, proliferation of fraud in Bitcoin is as futile and unadvantageous as being a sexually transmitted disease is in a world full of monks.

If everyone used Bitcoin, there would be ways to defraud people out of it; from Man In The Middle to 419/Nigerian Prince scam to simple MLM, scams and fraud in eCash are as old as eGold. The human factor is the weakest link, and no cryptocash will replace that. Furthermore, the barriers to entry into cryptocash usage, even if it could solve the problem of fraud, are too high, and prevent wide acceptance. The crypto-community likes this difficulty so much, cherishes it so, that wide adoption is impossible. If you disagree, have your mom mine me some bitcoins. I’ll pay more than the $42 they’re asking for in Mt Gox. You know what? Just have her read through the documentation and explain them back to someone who isn’t you.

Is the system broken? No doubt. The problem isn’t in the way legal tenders are minted, though, but in two other places: identity brokers and financial infrastructure.

The brokers – the card issuers – own the financial relationship and data to underwrite consumers for credit. That’s one major part of the financial equation that let financial institutions dictate the rules of the game both online and offline. If you undermine that relationship you get access to one of the most significant relationships consumers in the developed world have. That’s why I love short term credit schemes like Klarna and prepaid card services like Card.com; the first creates a financial relationship from thin air by extending credit in real time, and the second encourages consumers to deposit some of their paycheck directly to their prepaid-supporting account. Both have the ability to disintermediate issuers.

The financial infrastructure is where I actually think cryptocurrency can be helpful. No matter what you do you can’t run away from the card networks or clearing houses; they are the backbone of money movement. Every dollar moving around ends up paying tribute to the eternal gods of monetary movement. What if Bitcoin didn’t try to become a replacement for money consumers are using, but rather create the first true cloud based clearing house, where newly created financial institutions trade reserves and foreign currency using the Internet, but securely, rather than using the current broken systems? That for me is a big promise, and one huge problem no one’s tackling. What it would require is large Bitcoin liquidity reserves, backed by real currency, and with a stable enough exchange rate to plan a 12 to 18 months window. If new lenders could borrow in Bitcoin from a central Bitcoin exchange, its way to becoming a de-facto backbone of a new breed of financial transactions will be much more probable. So far, it doesn’t seem remotely as available and stable as required.

The payments and personal finance world is broken, but it enjoys a distorted local maximum that a lot of energy is required to move away from. Simply waving an interesting idea at the public doesn’t work. Like flash players weren’t as popular before the iPod and Napster, while changing the music industry, crashed as a business, cryptocash is a precursor to something, but is still not it. It can go somewhere, but is still not there. We need to recognize that to be able to move ahead.

 

Don’t pitch me, bro: 4 common payment startup ideas that you should avoid

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You think I’m kidding? I’m not. The days of payment providers and payments companies set-up and grown the way they have, trying to replicate a PayPal model, are gone. Consumers don’t care enough and cannot effectively differentiate your service from others to really choose to sign up. I looked at that several times in the past.

Still I get pitched on ideas I find far fetched and, frankly, a waste of time for smart entrepreneurs. There are many possible smart, ground breaking and really difficult directions to take in payments; the following ones are not, and anyone who understands payments will advise you to stay away from them.

  1. The mobile wallet: Square (PayWithSquare) isn’t gaining traction. gWallet is failing. Serve isn’t taking off and ISIS is… well, you get the picture. Mobile wallets aren’t working: merchants are slow to adopt additional hardware that will allow them to accept these. NFC is years behind in adoption and many large and small players, including me, just don’t believe in it. Consumers are slow to adopt a solution that gives them no advantage over credit cards, and even giants with big pockets can’t get them hooked.

    Signing people up and getting to add their credit cards is impossible without high, unsustainable customer acquisition spend. No startup can grow this way.

  2. Micro-payments: I understand the rationale. Payments should be as easy as Liking something. People don’t pay for content because it costs too much. We can start from digital goods and charge a large percentage that will cover costs.

    It all sounds good until you realize that it doesn’t work. Consumers don’t pay for content by the pound since they are used to free content. Paywalls have limited success and even that success is always with big brands that spend millions on advertising, reducing market size to a minimum. More importantly, zero cost of goods sold – a blessing and a curse – allowed large take rates and supported many interesting business models, ones that cannot expand to any other vertical. Once you’re hooked on these sweet 30% (or 10%), you can’t really go to tangible goods with their lower margin and fraud and other issues. No payments company really grows out of that niche.

  3. Split bills: oh, the ever eluding perfect offline shopping experience. Entrepreneurs mean well – the experience does need a revamp. Is it really about not having to split a bill at a restaurant or the downtime of waiting for your check to arrive? As it turns out, these are very weak drivers to action when they are required to (again) sign up and add a credit card. It’s not that consumers don’t respond to call to action at those points; apps like OwnerListens prove that they do. They just don’t respond to THIS call to action. They want to do something, just not split the bill.

    The reason is simple: the actual shopping experience, while indeed a big issue, is just the tip of the iceberg when you approach it as a payment application. What you’re trying to build is the network of merchants and consumers, and you’re again faced with the two sided chicken and egg problem, with a weak call to action to consumers and not so easy integration for merchants. Adoption never crosses the usual suspects on Emerson street in Palo Alto, and even they are growing tired.

  4. Facebook Connect checkout: an alternative to the previous idea, here we have an attempt to streamline online checkout. This one fails not only because consumers are not too enthusiastic about giving their Facebook details in financial settings – they are not – but also since much like with the mobile wallet idea, they have a current option they like just as much. Credit cards work, and no incremental solution is going to displace them anytime soon.

The payments landscape is fragmented, commoditized and highly competitive. It is ripe for disruption, but that disruption will not come from new card-based services but from innovations in payroll, cross border trade, emerging markets, new identity trust authorities and other interesting ideas. Research those, and stay away from ideas that will take you nowhere. We need your energy focused on the right things if we are to really see a change in the coming years.

 

What Winning in Payments Should Mean, and How to Stay Away from the 0% Interchange Trap

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In my previous post about this topic I touched upon why the current trends in the payments market are not sustainable, nor are they really exciting. We know that the payments market is highly fragmented, and new players are introduced at an even growing pace, making it even more fragmented than ever. Over the years, the setup for how payments are made both online and offline allowed for a very details set of roles: issuers, acquirers, gateways, POS companies and so on. There’s one level, though, at which there is very little fragmentation: the underlying one.

Card networks are huge behemoths controlling a large piece of payments in the world. Before becoming public these companies were spawned and controlled by banks; and though retail banking is somewhat divided between a few large players, it is still not as nearly so as the payments market is. What do these players have that others don’t that makes them so special? One thing: the financial relationship with the consumer. When you have that relationship, one of two things (or both) happens: consumers loan money from you; consumers give you their money in the form of deposits. It’s a very straightforward litmus test, you either have it or you don’t. That trust relationship is what counts, and everything else is just UX. Every cent you move pays interchange or another fee to a player that owns this relationship with merchants and consumers; all they have to do is sit back and enjoy the ride (and in the case of online payments, without any risk).

Asking who’s going to win payments, therefore, is the wrong question*. Visa and Mastercard are, and retail banks along with them. The rest of the companies are (arguably) making money off of peripherals, from foreign exchange fees to (again, arguably, I don’t believe it’s catching on) coupons and loyalty programs. If you want to win in payments, substantially, you need to displace that trust relationship; you need to circumvent banks and card networks. This is what’s interesting, and this is the Holy Grail.

The good news is that it’s possible, and since Visa and MC are public it is even more doable than it used to be due to the separation between their incentives and the banks’. The bad news is that this is the real difficult problem to solve. You’re basically setting off to build a new type of banking. In the next post we’ll look at a few examples of why just building another layer on top of existing partners doesn’t work, and then explore a few ways to get there.

* Unless you actually mean “who’s going to get access to consumers’ data in POS, while treating money movement as a loss leader?”. In that case, your question is valid.