Fintech Newsletter: September 2019

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The rise of neobanks; Software for debt settlement; Corporate card wars; Amazon cashes in; Passive investing tops active; JPMorgan’s instant payments

Chime and the money-making model behind neobanks

Anish Acharya

This month, challenger bank Chime announced that it had surpassed 5 million active accounts. Like its neobank competitors, Chime charges no overdraft fees, monthly service fees, or foreign transaction fees. How, then, does the company make money? And why aren’t incumbents following suit? The short answer is that these challenger banks are exploiting a regulatory asymmetry in the interchange fees that they are legally allowed to charge.

There’s a reason neobanks are built on top of community and regional issuing banks. The Dodd-Frank Act of 2010 stipulated that the interchange fees charged to merchants should be “reasonable and proportional” to the cost incurred by the credit card issuer—approximately 5 basis points, in their estimation. However, the Durbin Amendment contained an important exemption: banks with less than $10 billion in assets, such as community and regional banks, can charge fees that are significantly higher—often 10 to 20 times higher. By collecting an interchange fee every time you use your debit card, neobanks like Chime can achieve significant gross margins.

As a result, we’ve seen an explosion in the number of neobanks to emerge within the past three years. Increasingly, they’re converging on a product offering that was pioneered by Chime: a checking account that lets customers access their paycheck two days early.

Clearly, that feature has resonated with Chime’s 5 million+ customers—but it has an additional benefit for the bank. In order to unlock that product value, customers are compelled to both set up direct deposit into those accounts and use their Chime debit card. That means each time they swipe, the neobank makes money.

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Software solutions for debt settlement

Angela Strange

Consumer debt, excluding mortgages, reached more than $4 trillion this year. There are many fintech companies already attempting to help consumers refinance and even automate paying off credit card debt. But what happens when consumers fall so far into debt that refinancing solutions are unavailable or insufficient?

At the extreme, the consumer can declare bankruptcy, but that might leave a mark on his or her credit report for 10 years and prevent them from accessing any form of credit in the interim. On the other hand, credit counseling can result in more favorable terms, such as lower interest rates, but usually doesn’t reduce the debt. In the large, murky middle is the sometimes seedy world of debt settlement.

In theory, debt settlement makes a lot of sense: it helps consumers pay off their debt and allows creditors to collect at least some portion of what they’re owed. But the challenge for creditors is that they can’t advertise settlement plans. Imagine this automated phone prompt: “Press 1 to pay your bill. Press 2 to only pay half of your bill.” Even those able to pay fully would choose option 2. This is part of the reason there are intermediaries. At the end of a successful settlement, the consumer has typically paid a lower percentage of debt, but has taken a significant credit score hit. The settlement agency, meanwhile, collects a hefty fee—up to 25 percent.

Because debt settlement is difficult to regulate, it is full of bad actors. For the consumer, the process can be terrifying, often involving multiple collection agencies calling several times a day. One promising alternative: transparent software solutions that show consumers their full range of options and the real downstream effects. By providing data-based payment plans, these products build consumer trust.

In an unpredictable economy, consumer debt is likely to grow, and timely payments will become more difficult to make. Already, smart fintech companies are wading into this previously ignored financial services backwater. By shining a light on the current challenges, we hope to see more entrepreneurial solutions challenging the status quo.

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Stripe and the corporate card wars

The corporate card wars are underway. Earlier this month, Stripe announced the launch of the Stripe Corporate Card—a competitor to Brex and Divvy Pay.

Improved infrastructure has made it increasingly easy for fintech companies to launch new products. As those products proliferate, we’re seeing increased competition for the best services associated with those products. Stripe and Brex are not only issuing cards, they’re also offering a suite of specialized software tools for employers to set, monitor, and enforce card usage. That means you might have one card for an office manager that can only be used at office supply stores, and another for an IT worker that’s limited to software subscriptions like Slack and Jira.

This additive layer of software is likely to pose challenges for traditional corporate card issuers, which have already been slow to digitize the onboarding process. (Most corporate credit cards still require business owners to fill out paper forms, complete with wet signatures.) The corporate card wars likely won’t be won simply by onboarding the most customers, but by building world-class software services for those users.

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Long live cash?

Seema Amble

With the US launch of PayCode last week, Amazon is making it easier for its American customers to pay cash for online purchases. Here’s how it works: Shoppers who select the PayCode option at checkout receive a QR code. They then have 24 hours to pay for their items in person at one of 15,000 Western Union locations before their items are shipped. Separately, the company’s Amazon Cash program allows customers to load cash onto their Amazon accounts at more than 100,000 establishments, like CVS and 7-Eleven. At a time when digital payments seem to be taking over, why the revived focus on cash?

Many assume that such cash-in/cash out networks are purely a developing world phenomenon. In fact, cash is still big in the US. Approximately 75 percent of payments in the US in 2017 were made in-person, and 39 percent of those used cash. In addition, lower-earning households are less likely to have access to credit or digital payment forms and shop online; 45 percent of American households make less than $50,000 in income. To be clear, this is still a profit-driven move by Amazon. The PayCode expansion allows the company to reach a broader demographic and compete against brick-and-mortar competitors like Walmart and dollar stores.

Does all this mean that cash is the way of the future? Probably not. Cash usage is still decreasing, and digital payment methods are on the rise. But increasingly, companies are realizing that they can reach a sizeable customer base by facilitating cash payments—both stateside and abroad. Outside the US—particularly in Latin America—cash for ecommerce is already a major part of the payment ecosystem. (In Mexico and Brazil, for example, 20 to 25 percent of ecommerce is paid for with cash.) It’s one reason that PayCode was already available in 19 other countries, prior to being introduced in the US.

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Passive investing bypasses stock picking

In the 1980s, Vanguard founder Jack Bogle proposed a heretical idea: as an investor, the best strategy is to minimize expenses and seek average returns. Last month, more than 30 years later, passive investing surpassed active investing for the first time ($4.271 trillion in index-tracking US equity vs. $4.246 trillion run by active managers, according to Morningstar).

We are now at parity, which has led some—including Michael Burry of The Big Short fame—to decry that we are in a passive investing bubble. But prices aren’t set by passive investors, they are set by active investors. Even a relatively small number of active investors can accurately set prices in a market, as the economist Burton Malkiel has argued.

Passive investing still has quite a ways to go, which has interesting implications for the industry. Since fees for passive investments are incredibly low (0.10% of assets, on average; sometimes even free), many asset management firms are pivoting to offer advice around personal finance, retirement, and tax planning—in-demand services that drive more revenue than selling commodity passive investment products.

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JPMorgan Chase takes on fintech with faster payments

Last month we analyzed the Federal Reserve’s ongoing pursuit of a real-time payments network. Now one of the largest financial institutions in the US is taking steps toward instant payments. JPMorgan Chase recently announced that it’s rolling out free same-day deposits to customers who use WePay, its online payment provider; the bank intends to onboard all its customers by the year’s end. This is a direct avenue for JPMorgan to tackle cash flow mismatch—the number one reason companies go out of business in the US.

As one of the few US banks that has also built a payment processor, JPMorgan Chase is uniquely positioned among incumbents to innovate on the payment front. Notably, JPMorgan is offering instant payments for free, while fintech challengers like Stripe and Square charge a fee for the faster service.

This represents a classic example of the tension between distribution and innovation: the battle for market share often comes down to whether the startup gets distribution before the incumbent gets innovation (a concept a16z general partner Alex Rampell delves into here). Fintech companies such as Stripe, PayPal, and Square have been edging into banks’ customer base and margins in recent years with the promise of faster digital payments. JPMorgan’s introduction of same-day deposits—as well as its acquisition of WePay—signals that some incumbents are not yet surrendering payments to the fintech wave.

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More from the a16z fintech team

Five Ways Fintech Startups Can Find Users
Customer acquisition is tougher than ever. Here are five overlooked ways new companies can acquire new customers. (Hint: It’s not Google or Facebook ads.)
By Anish Acharya

The Fresno Free-for-All Behind the Original Credit Card
On September 18, 1958, the first credit card was mailed to 60,000 Fresno residents. Chaos ensued.
By Alex Rampell

Fintech’s Second Wave: Lenders in Disguise
Why the new consumer lending business doesn’t look like a lender: it looks like a swipeable financial assistant.
By Anish Acharya

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