Bank as API: Open banking in America

Bank as API: Open banking comes to America in 2020. An explanation by Adam Atlas Attorney at Law, fintech lawyer.

While the financial press is busy obsessing over WeWork and ignoring the anti-trust oligopoly forming in payments, let’s look at another topic with too little discussion in U.S. financial press: the Bank as API. Neobanking or open banking is all the rage in Europe. It’s not clear why U.S. banks have been slow to open their API’s, but one does sense the whiff of a lack of competition in U.S. banking, (a subject that is the central thesis of Thomas Philippon‘s excellent book, The Great Reversal, How America Gave up on Free Markets).

Now, in Europe, open banking starts from the premise that users of financial services have a right to compare like providers, access data and easily switch from one to another, a bit like phone service providers. In the US, the difficulty in accessing and comparing financial service data has created a market for non-bank solutions for accessing bank services such as Yodlee, providing consumers with account information, Geezeo connecting APIs of a limited set of participating banks, through to Synapse sitting between a bank and fintechs to enable fintechs to offer everything from DDAs to virtual cards with ease. There is now a run on picking up the technical slack of US banks coupled with the lack of competition in US banking that is driving a good number of new entrants. (Even we, quite shamelessly, picked-up neobank.law a year ago).

(Ok boomer,) US neobanking players fall into three categories.

1. Financial Institutions where APIs Come First. These are licensed US banks, trust companies or MSBs that position API access as a key distinguishing feature. SVBBBVAEvolve Bank and TrustPrime TrustDwolla and Bitgo. The opportunity for these suppliers is that they can serve large numbers of new clients via API with assistance from fintechs as agents. The risk for these suppliers is that they may each be operating dozens of different business models that present a challenge for 

2. Technology Platforms Between FIs and Fintechs. These entities avoid taking control or possession of transaction funds and remain primarily data-only gateways Examples include Plaid and Synapse. (Some financial institutions have preferred to own the IP to the APIs that connect to their accounts, a leading example of that would be Stripe). The opportunity for these entities is to earn a piece of transaction volume without having to pay the price of being regulated entities. The risk for these suppliers is that regulators will find them to be MSBs despite their carefully avoiding possession of transaction funds. Because of their tight integration with financial institutions, these platforms make ‘classic’ boomer gateways, like Authorize.net and  NMI, look quaint. 

3. Fintechs. These entities navigate gingerly between avoiding regulation by relying on their financial partners (see Item 1 above) and being regulated as MSBs. These 50 or so fintechs use APIs of the FI’s identified above to operate their businesses. We have indicated which are the most likely financial services that each has outsourced to the FI indicated and they include DDA, Card issuing, ACH, crypto custody and money transmission. The opportunity for these entities is to decrease the cost of compliance (using FI’s identified in Item 1), decrease the cost of development (using technology identified in Item 2 above) and focus on the business of selling their service. The risk for these entities is excessive reliance on third parties for compliance and technology and the risk that regulators will perceive them as MSBs, even though licensed financial institutions take legal liability for the movement of client funds.

Whether the OCC clamps down on FI’s in the space or state banking regulators deem tech platforms to be MSBs, there is an overwhelming momentum in the US neobanking space that is driven by real demand for competition and variety in consumer and business financial services that we think will be met ever more in 2020. At Adam Atlas Attorneys at Law, we provide commercial and compliance advice for US neobanks, such as they may be.

Do Non-US Payment Institutions need to comply with U.S. law?

Money services businesses (such as money transmitters, prepaid card program managers, currency exchangers and providers of virtual currency) (“MSBs”) that operate outsider of the United States are likely familiar with the laws applicable to them in their home jurisdictions. Given the electronic nature of many MSB businesses, it is altogether likely that a non-U.S. MSB will wish to provide services to residents of the U.S. without having accounts, offices or any other presence in the U.S. Doing so requires compliance with U.S. law. Whether a given MSB is an MSB for the purposes of U.S. federal or state law is a matter of U.S. law. At the federal level, MSB status in the U.S. is determined pursuant to the Bank Secrecy Act (“BSA”), its regulations (“Regulations”) and the Financial Crimes Enforcement Network, of the United States Department of the Treasury (“FinCEN”). FinCEN is the U.S. equivalent of, for example, the FCA in the U.K. or FINTRAC in Canada.

An entity that is deemed an MSB under the BSA has to register with FinCEN, for AML and transaction reporting purposes and may also be required to obtain money transmitter licenses from each individual state in which the MSB has customers.

Being entirely foreign to the U.S. and having no accounts, office or employees in the U.S. does not diminish the application of the BSA to an MSB that services U.S. residents. This information often comes as a surprise to the many thousands of non-U.S. MSBs that, de facto, service U.S. residents.

By way of example, the UK money transmitter in the flow of funds described below that takes funds from a U.S. resident and forwards those funds, as a money transmitter, to a payee or recipient in Germany, is required to be registered with FinCEN and licensed as a money transmitter in the state where the US payer is located:

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We provide more discussion of US MSB compliance at www.fintech.law.

This bulletin does not constitute a legal opinion and may not apply to your specific circumstances.

Adam Atlas Attorney at Law is licensed in the State of New York and advises on U.S. crypto and payments businesses from his offices in Montreal.

Competition in Payments

Competition in Payments

Our recent post to LinkedIn of the US Payments Family Tree generated record feedback. There is thirst for a above-the-tree-line view on who is who the payments landscape. Once upon a time, everyone read the Nilson Report that amazingly published regular figures on the volume of processing at each US acquirer. Divining competitors is not that easy anymore. Here are a few reasons why the competitive landscape is more complex and interesting:

1. ‘Big hat, no cattle’ processors. With bountiful capital (2017 fintech investments $31 billion2018 $39.6 billion and the first half of 2019, $27.9 billion), fintech startups have had the luxury of being unprofitable. Square and Stripe exemplify fintechs for which profit is a difficult question. Possibly profitless market-leaders like UberAirbnb and WeWork had investors mesmerized by the idea of losing a lot of money for a chance to capture a whole market. It’s hard to assess competition in payments when some of the ostensibly largest players do not answer to the real world of profit. All that glitters is not gold; some of the putative payment market leaders might not be real-world leaders.

2. Eventually, price matters. A lot of merchants operate on very thin margins, with pre-tax profits close to 3%. Processor fees such as Square 3.5%Stripe 2.9% and Shopify 2.9% are perhaps not sustainable even if they do excel at UI and service. Operating on ever-tigher margins and in a potentially recessionary economy, merchants might tire of easy-to-use, but expensive processing in favor of the old standards, like First DataWorldPayTSYS, Global Payments and Elavon. Expensive competitors might not last.

3. Processor Consolidation. Speaking of old standards, where there was once about 13 large US processors, now there are about half that number. The chart above keeps alive some of the old, now consolidated brands, to give you a sense of the dramatic reduction in US processing competition. The FTC has a large mandate, including its Bureau of Competition. If you are an ISO shopping for a processor, or a bank shopping for a processor for your card issuing business, or a merchant shopping for payment processing, the last year has seen a material reduction in the number of competitors for your business. The FTC has brought recent cases against fraudulent or dishonest processors, but it has yet to bring a case concerning the reduction in US payment processing. Perhaps the titans of US processing are circling the wagons in the face of competition from novel payment methods, such as crypto. Too much consolidation, however, is illegal.

4. Crypto Displacing Money Transmitters? Crypto, most prominently, Bitcoin and Ripple / XRP, have been promising to displace money transmitters and other payments businesses including. Greyscale, for example, promises to replace gold as a store of value with bitcoin, a service promoted through their now classic ‘drop gold’ video. More recently one FANG and a bunch of other gig-economy players created Libra, a kind of company-town scrip that promises more of the same. Meanwhile, the traditional remittance market and others under theoretical threat from crypto are posting losses and layoffs. Is Ripple’s investment in remittance player moneygram the reason? Probably not, but note that that investment might be fueled by excessively cheap capital in the form of Ripple’s own XRP issuance, and not necessarily by efficiency or long-term promise of profit.

5. Neobanking, Open banking, Payments as API. There was a time when a payor knew their financial institution and chose them for their brand, relationship and location. That time is over. Now, the financial service provider has been moved into the background in support of neobanking fintechs that provide the consumer-facing service related to bank accounts, card issuing, bill payment and other traditional bank services. Five examples from a growing list come to mind: Evolve Bank & Trust, a bank that is integrated with Synapse, an API platform, Prime Trust, a Nevada trust that provides both crypto and fiat custodial services, Silvergate Bank, a cornerstone of crypto banking now branded as being API driven, Cross River Bank, focusing on fintech with a history of supporting new lending models and arivalbank, that boasts reinventing the bank and an upcoming US launch. By outsourcing technology to startups and keeping the core banking function in-house, these financial institutions are perhaps in a strong position to challenge the older brick-and-mortar / brand-based banking incumbents. The key question for neobanking is, how far into the background will the OCC let financial institutions go.

At Adam Atlas Attorneys at Law, we advise on the commercial and compliance aspects of all of the above and more.