Fintech Fire Alarms: May, 2021

The 31 flavors of BNPL, Cash flow-based underwriting, and more.

Fintech moves fast and there's plenty of hype.

What's real? What should you pay attention to? What should you be worried about? What should be on your roadmap?

What's just smoke and what's fire?

Here are the five fintech trends, from May 2021, that should be setting off alarms in your organization.

1. Innovation: Coming to a Core Near You.

What happened?

  • Banking neo-core provider Q2 acquired the original direct deposit swiching startup, ClickSWITCH.

  • FIS and NYDIG partnered to enable FIS clients to let their customers buy bitcoin.

  • Jack Henry and Finicity partnered to give community banks open banking APIs. This follows a similar partnership between Jack Henry and Plaid.

  • Jack Henry joined the bank consortium open banking tool Akoya.

  • Thought Machine and Temenos both integrated Wise into their core banking products.

So what?

Remember when most banks didn't offer a mobile app or remote deposit capture? And then, almost overnight, it became strange to come across a bank that didn't offer those capabilities?

That's the impact that the big core banking system providers - FIS, Fiserv, and Jack Henry - can have when they finally make new capabilities available across their massive customer bases.

It happens slowly at first and then all of a sudden.

We are on the precipice of another massive wave of innovation hitting the financial industry thanks to the slow but steady work being done by the core banking system providers.

Crypto investing, international money transfers, and open banking are about to become table stakes.

2. Cash Flow-based Underwriting is Here.

What happened?

  • JP Morgan, Wells Fargo, US Bank, and others in the US plan to issue credit cards to consumers using data like checking and savings account balances. This capability will, reportedly, be enabled through integrations with Early Warning Services (EWS).

  • Petal, one of the original fintech credit card providers, announced its subsidiary, Prism Data, which will provide cash flow-based underwriting technology to other lenders.

So what?

Cash flow-based underwriting, in which a lender uses transactional banking data (provided through an aggregator like Plaid, Finicity, or MX) to evaluate the capacity of a borrower to handle a new credit obligation, has proven to be an effective approach for originating credit cards and short-term, small dollar loans.

Since it doesn't depend on credit bureau data or the FICO Score (which excel at evaluating character), cash flow-based underwriting is an effective tool for underwriting credit invisible consumers.

Fintech companies have succeeded in publicly pressuring banks to look beyond bureau-based underwriting, which has motivated the national banks to cooperatively use cash flow data to underwrite their common customers for credit cards.

The fact that this cooperation is being enabled by EWS rather than Plaid or Finicity or MX is fascinating.

3. Rewards Get Unpredictable.

What happened?

  • Credit Karma launched Instant Karma, a tool that rewards users by randomly refunding purchases.

  • Mythia, a recent Y Combinator startup, is building a debit card with gamified rewards for…you guessed it…gamers.

  • Brex launched crypto rewards for business clients.

  • SoFi is letting users redeem credit card rewards points directly into cryptocurrency.

So what?

Variable reinforcement, in which rewards are delivered in unpredictable patterns, tend to produce strong levels of engagement. This has been proven, experimentally, in behavioral science labs for decades and, anecdotally, in casinos for much longer than that.

Fintech companies are beginning to incorporate these variable reinforcement strategies in the design of their rewards programs, which simultaneously increases customer engagement (the Holy Grail of metrics for any fintech company) and lowers costs (it's cheaper to provide richer rewards less frequently).

Rewarding customers in cryptocurrencies, whose inherent volatility provide the desired unpredictability, is proving to be a particularly popular approach.

4. The 31 Flavors of BNPL.

What happened?

  • The success of BNPL providers like Affirm and Klarna has attracted a large number of (well-funded) imitators, all of which are focused on their own flavors of BNPL.

    • Air Travel

      • American Express launched its own buy-now-pay-later option for flights.

      • Fly Now Pay Later, a UK fintech for financing post-covid travel, raised a £10 million Series A.

      • Buy-now-pay-later provider Uplift partnered with Southwest Airlines for flexible flight payment options.

    • Expensive Necessities

      • Graviti, a Mexican buy-now-pay-later startup for appliances, raised a $2.5 million seed.

      • Sunbit, a buy-now-pay-later startup for critical everyday expenses, raised a $130 million Series D.

      • Walnut raised $3.6 million to provide buy-now-pay-later for healthcare.

    • B2B

      • Resolve, a B2B buy-now-pay-later startup that spun out of Affirm, raised $60 million.

So what?

This is what the unbundling of the credit card looks like.

With early pioneers in BNPL like Klarna and Affirm paving the way, the mechanics for BNPL are now easy to replicate and ready to be applied across a much wider set of use cases.

Use cases that focus on making essential services like healthcare more accessible have the potential to have a significant positive impact for less affluent consumers.

Use cases that focus on making shopping more fun and frictionless (which Klarna, Affirm, and Afterpay all already specialize in) have the potential to build on top of credit cards' worst legacy: encouraging consumers to take on unnecessary levels of debt.

While a certain segment of consumers will likely continue to prefer the simplicity and aggregated rewards provided by credit cards, it seems likely that a growing number of consumers will become accustomed to BNPL as a standard payment mechanism across verticals.

5. Fintech + DeFi = HyFi.

What happened?

  • Current and DeFi network Acala partnered to enable decentralized financial products within Current, with the bank acting as a validator on Polkadot.

So what?

This feels like one of those things that, with the benefit of hindsight, is seen as a watershed moment.

DeFi is a really exciting arena, where entirely new protocols for moving money and facilitating financial transactions are being built. Thousands of different experiments are being run in the world of decentralized finance every day without anyone asking for permission from banks or regulators.

The problem is that DeFi is, to put it mildly, not easy to understand or navigate for the uninitiated.

Fintech can help. Fintech companies specialize in abstracting away technical complexity to create beautiful, intuitive customer experiences.

Fintech started by building these experiences on top of legacy financial services infrastructure, but there's no reason they can't do the same thing on top of DeFi.

Call it Hybrid Finance or 'HyFi'.

Alex Johnson is a Director of Fintech Research at Cornerstone Advisors, where he publishes commissioned research reports on fintech trends and advises both established and startup financial technology companies.

Twitter: @AlexH_Johnson