In Part 2, Yvette Bohanan continues the conversation from Episode 206 with the commercial practice team at Glenbrook. We cover some new topic areas, including banks, risk and fraudsters, and the investment community in this macroeconomic environment. Listen in to see what we’re watching, where we might see some blind spots, or where the next set of curveballs will be coming as we get into the back half of 2023.

Yvette Bohanan:

Welcome to Payments On Fire, a podcast from Glenbrook Partners about the payments industry, how it works, and trends, and its evolution.

Hello, I’m Yvette Bohanan, a partner at Glenbrook and your host for Payments on Fire. This is part two of our conversation with our commercial practice team at Glenbrook. I was intrigued by some of the responses and we went pretty long on our first part of this episode, so we decided to make a part two where we get into some new topic areas, including risk and fraudsters, what’s going on there, the investment community in this macroeconomic environment, and what we’re watching, where we might see maybe some blind spots, or where the next set of curveballs will be coming as we get into the back half of 2023. Joining me for the conversation are Bryan Derman, Chris Uriarte, and Drew Edmond. We’re going to pick it up where we left off and we’re going to start talking about banks. What do we see as opportunities and challenges playing out in the aftermath of Silicon Valley Bank, Signature Bank and so forth? What’s the climate if we’re taking the temperature in the banking stakeholder realm?

Chris Uriarte:

Yeah, so there’s a lot to be said on this topic for sure, and the breadth of topics to talk about here is quite large. But let me try to ground this a little bit in the payments in FinTech world. One thing that the SVB debacle did not help with was this sentiment that had already been building over the past year in the payments and FinTechs communities, and that’s this belief that banks have not been doing a good job at managing their portfolio risk, especially when it comes to third-party partnerships and sponsorships. So we’ve talked about this topic on this podcast before, but for our listeners, who need a little refresher, what we’re really focusing on is the type of sponsor banking relationships that exist between banks and their FinTech customers, those relationships that allow the FinTechs to perform regulated type of activities that are really core to their business.

So these activities can include things like moving money, or holding money on behalf of consumers, issuing cards, and this broad umbrella that we often speak about called BaaS or Banking as a Service. So we’ve seen the regulators really crack down on several banks in the past year through formal consent degrees. We’ve seen pending mergers of banks actually been stopped because of some of these risks. And we know that the regulators have quietly been entering the C-suites of some of the banks and telling them that they really have to clean up their act. And just a few days ago, which is very interesting, we saw sort of a Who’s Who of banking regulators release an official joint guidance as to how banks should be managing these third-party risks. So we know that this is very much a top of mind issuer for regulators. So if anybody thinks that the regulators have fallen asleep at the wheel on this, this is absolutely not the case. There’s things happening every single day.

And even this morning I woke up to find that the FDIC had issued a cease and desist order to a company called Money Avenue, which is a FinTech that’s sponsored by one of the top FinTech banks in the US. And I think what was interesting about that, the FDIC issues a lot of cease and desist orders, and there’s a lot of things that they’ll put out there in the market, but the way they went about this and the way that it was released to the market, I think was done in a certain way to make the banks and everyone aware that we’re looking at this stuff, and we’re looking deep into your portfolios here. So we’re continuing to pay close attention to what’s happening here and I’m confident that this won’t be the end of it. But really the net result is that banks are cleaning up their portfolios and making it a lot more difficult for some FinTechs to establish these types of sponsorship relationships.

Yvette Bohanan:

Which is interesting because, again, this is a 180 from where we’ve been the last decade, right?

Chris Uriarte:

Yeah.

Yvette Bohanan:

Where everyone was competing for the FinTechs business when the investors were throwing money, we’ll get to the investors here in a moment, but the pendulum’s always swinging. You just need to know where it’s at and when you think it’s going to start swinging the other direction. And what you’re saying I think is we’ve seen a very dramatic swing here in the last few months. Doesn’t mean they weren’t paying attention to it before, but this is the point where they’re actually announcing things, taking action, doing work against what they were observing for quite some time.

Chris Uriarte:

Yeah, for sure. For sure. And for our listeners that might have missed it, if you go back about maybe four or five episodes ago here, myself and Tarun Gupta from Jump Capital talk a lot about these challenges and what we’re seeing with the market dynamics related to FinTech bank sponsorship, so that’s a good one to pull up if you haven’t listened to it.

Yvette Bohanan:

Regulators are busy right now.

Chris Uriarte:

Very busy.

Yvette Bohanan:

This is just basic… It touches on things like open banking, it touches on FinTech innovation, this set of regulations. They also have the pricing stuff we were talking about with CCCA. They have digital currency systems that Bryan was bringing up at the beginning here of this episode. And interestingly, some regulation is welcomed by everyone, like all the stakeholders, when it’s clarifying, when it’s clarifying things. Most people want clarity so they know how to act and know what they have to do. Uncertainty stymies everything. So we have a lot of clarification coming out. And then we also have this slow roll against the new stuff too. And then we have, was it Sam Altman, who was in front of Congress a month ago asking, “Please regulate this.”

Chris Uriarte:

Right.

Yvette Bohanan:

Which you don’t hear very often.

Bryan Derman:

No different from the way the FinTechs played it, or if you go back to Uber, or people like that, sort of said, “Maybe we can skirt the regulations a little bit and we’ll be so big at a point that things will bend our way.”

Yvette Bohanan:

Right.

Bryan Derman:

You see it in the digital currency space where business models were built and are now being thrown into question because the regulations coming later and is not necessarily friendly. So I think maybe the AI group is reading that situation and saying, “Maybe we want to bring it along and not get surprised by it later.”

Yvette Bohanan:

Right, right. And it is definitely a different attitude out there right now on, all fronts. That has implications to investors. If you’re an investor, we always say regulation cuts both ways. The investment community is looking at this, the investment community is looking at the macroeconomic environment. What’s their perspective in all this? Because while they’re not directly in the value chain, they’re definitely influencing what’s going on in this space.

Bryan Derman:

They certainly do, and investors are famous for hating uncertainty. It’s hard to build a financial model when there’s a lot of uncertainty and hard to make big bets when there’s a wide range of outcomes possible. So regulatory uncertainty is not helpful. And it turns out high interest rates are never helpful in the investment world. And everybody’s readjusting to an environment where, how do you say it, money is no longer free, and that changes things. And it certainly made it harder for private companies to raise money. Probably made it a little harder for the investment funds themselves to raise money in this environment.

And it’s compounded by what’s happened in the public markets, the publicly traded FinTech stocks, and stocks generally have been pretty well pummeled by the interest rate environment, particularly for companies that were not yet profitable. And so if you’re a private market investor, looking at that environment saying, “I’ve got a group of companies that I’m already committed to and I need to keep them alive, and get enough funding into them, and keep their burn rates under control, so they have the opportunity to become what I thought they could become.” But in the meantime, the IPO market barely exists. The SPAC market, which provided a lot of exits over the past couple of years, is essentially non-existent now.

As an investor, I think you got to strap in, keep alive what you have, and then be very selective about where your opportunities are. But there are a lot of smart people in that business, they still manage a lot of money, institutional money, and so they’re always on the lookout for deals. And there are some big companies on the block that people are looking at. There are still interesting private companies coming along. Obviously, AI is not having any trouble attracting funding. So it’s just a more selective kind of environment, I guess a stock pickers market. What they say, “Everything won’t go up, but some things will.” And so people are sorting through that pretty carefully to figure out where their opportunities are.

Yvette Bohanan:

So I was reading, I know they hit pause on the interest rates, I was also reading some commentary that they’re also planning for hikes later down the road. They’re always hedging and cushioning things a little bit here in the communication.

Bryan Derman:

Yeah, the Fed had a pretty interesting week of taking their foot off the gas, but threatening to go back on, and that seemed to be credible. And somewhere in the middle of that, the stock market suddenly went into bull mode, and the S&P is up 20% plus from the lows last year. So confusing environment, from the standpoint of private investment and FinTechs. We’ll see if IPOs begin to happen again. It’s been dribs and drabs here.

Yvette Bohanan:

That’s usually a sign right?

Bryan Derman:

I don’t think we’re going to see the exit this year. Once it becomes clear that maybe the recession is here, or peaking, or over, and rates can start to come back down a little bit, then maybe things can get going back toward what they were in, say, 2021.

Yvette Bohanan:

So the cycle is there, it’s just slow?

Bryan Derman:

Yeah. And what will the timing be is always hard to know, but there’s so much innovation. There will be winners out there. Something’s going to happen with AI, hopefully it’ll be positive.

Yvette Bohanan:

Hopefully. So there’s innovation. There’s also fraud. Let’s talk a little bit about the fraudsters.

Bryan Derman:

Now there’s a growth industry.

Yvette Bohanan:

There is a growth industry, exactly.

Drew Edmond:

They’re doing great.

Yvette Bohanan:

They seem unaffected by any cycle that we have been talking about. And they’re using AI, so this is very interesting. Probably early adopters of it, I would say, badly.

Drew Edmond:

Mm-hmm.

Yvette Bohanan:

So e-commerce fraud hit 41 billion globally in 2022. It was up from 21 billion in 2021. That’s staggering. It’s projected to get to 48 billion in 2023. 30% of e-commerce fraud is now first-party fraud. And this is what I found a little eyeopening, and just for those that are in payments, but don’t get too close to all of the nomenclature of risk management and fraud, first-party fraud is people doing things, they are who they say they are, they’re just defrauding a merchant or a business as opposed to the rings, which we’ll get to the rings in a minute. But it’s the first-party fraud that I wanted to bring up here first, because I think it’s a sign of the times again. It’s a sign of the macroeconomic environment. It’s a sign of generational attitudes. So what are you guys hearing about when we’re talking with people about fraud mitigation and risks, and controls?

Chris Uriarte:

Yeah, so I think we should hit this friendly fraud, this first-party fraud issue, right on the head here because it is a really, really hot topic this year.

Yvette Bohanan:

I think the other… Friendly fraud, just so people know what we’re talking about, friendly fraud is… Well, it was never really friendly, but family friendly fraud is now being referred to in some cases as policy abuse.

Chris Uriarte:

Yeah. I think it’s moved under that umbrella. Yeah, exactly.

Yvette Bohanan:

Yeah.

Chris Uriarte:

Yeah. I’ve spent a lot of time in rooms with merchants and issuers, and really everybody in the ecosystem card networks as well, over the course of the last several months. And this continues to be a really hot topic of conversation. When Drew and I were out at the Merchant Risk Council conference in Vegas in March, there was a lot of discussion there. Several breakouts talking about it, talking about some of the rules changes that have come out on the Visa network for example. I just attended the Riskified Ascend conference in Nashville, just got back this morning from that. Big topic of conversation there. I was at the MasterCard fraud watch Round table two weeks ago, which was all issuers. Big topic of conversation there.

Everybody’s talking about this, so it is really an issue, and everyone is frustrated. Merchants are frustrated, issuers are frustrated. So you’re hearing them vent every single time that this topic comes up. And fraud managers are really struggling to figure out how they address this. Interesting, talking about statistics in growth, one of the things that came out of one of our panels yesterday from a study that MasterCard did, this is coming directly from MasterCard themselves, they said that their estimate of fraud losses associated with first-party fraud is probably over $50 billion in the last year. So that doesn’t really get built into the fraud number that you quoted, Yvette, because they’re looking at all sorts of different factors, what’s the total cost of this, based on the studies that they’ve done. But that’s just an incredible number. That’s really, really an incredible number.

Yvette Bohanan:

So that’s just first-party?

Chris Uriarte:

That’s just first party, yeah.

Yvette Bohanan:

US or global?

Chris Uriarte:

They didn’t state, I’m not sure what it is, but even if it was global, that’s still-

Yvette Bohanan:

That’s still incredible.

Chris Uriarte:

Absolutely, incredible. And just to go back to what you were saying earlier, the other statistic they quoted is that they are seeing a 30% year-over-year increase in fraud on the MasterCard network, and they’re seeing a 32% increase of chargebacks on the MasterCard network year over year.

Yvette Bohanan:

And just to be clear, this isn’t something that’s problematic just for MasterCard. We’re hearing this-

Chris Uriarte:

Not just for MasterCard.

Yvette Bohanan:

Anecdotally all over the place.

Chris Uriarte:

Absolutely. We’re hearing this all over the place. MasterCard just has been good enough to share some numbers with us and some of the public in some of these forums here. But both merchants and issuers are turning toward the payment networks, really asking them to step up and help. And Visa was the first to the table with a new framework that was introduced back in April, which they call Compelling Evidence 3.0. And I have to say it was met with a very, very tepid response from merchants, who most of them think it’s a little bit too restrictive and doesn’t really solve the heart of the problem here. But I’ll give Visa the benefit of the doubt, they were first to the table on this, they were first mover on this. They said it’s just a start. They said it’s going to evolve once they assess its successes and its shortcomings. So we’ll be keeping an eye out there.

And then what we did hear from MasterCard just yesterday is, they have been pretty quiet on this topic, but they’ve told me in public forums that they’ve had a task force working on this now for the past year, year and a half or so, and that we should be hearing some announcements from them on the topic sometime within the next month or two. So we know they’re working on it and it’ll be interesting to see what they have to say.

Yvette Bohanan:

Mm-hmm. And I imagine other networks are too, I mean this is-

Chris Uriarte:

Of course.

Yvette Bohanan:

One of the things that really struck me about this, particularly around first-party fraud or policy abuse, call it what you will, was that there’s an attitude in a lot of consumers right now, and maybe it goes back to our macroeconomic backdrop, maybe it’s something else, who knows. But basically people are saying that they think it’s okay to do this. And I think when you’re trying to curb something that apparently has gotten this far out of control, I mean 50 billion, that’s a lot, for first-party issues, you’re trying to change and modify consumer behavior, so they’re not doing these things anymore. They’re not doing return fraud, they’re not doing other stuff that’s harming the business, which ultimately ends up in higher prices back to consumers, which-

Chris Uriarte:

Absolutely.

Yvette Bohanan:

This loss isn’t just going to be loss that’s taken, at this level, in this magnitude. And some merchants, I think, are more impacted than others, depending on the industry.

Chris Uriarte:

For sure.

Yvette Bohanan:

So it has to be somewhat surgical on the part of the networks that are trying to deal with this. So it’s not an easy ask and it’s probably not something the networks alone can deal with, but they definitely are trying to help. Their role here is to keep this safe and usable for everybody, and if they start-

Chris Uriarte:

Absolutely.

Yvette Bohanan:

giving a lot of issues, with alternatives coming online, will merchants get more interested in looking at push payment methods that have less recourse, less opportunity for disputes, less opportunity for first-party fraud, because it’s a push payment mechanism. So this could play into a lot of adoption things that we’ve been talking about here.

Chris Uriarte:

For sure.

Yvette Bohanan:

Safety and soundness. Trust. It all gets back to it, doesn’t it? Reputational risk and eventually money. Okay, so given the macro environment that we’ve been talking about, just to sort of wrap this up, what are you watching most closely? Where do we see potential blind spots that could impact our clients? Just wanted to throw that out there. What should people be thinking about that? We started by saying… A lot of this stuff we weren’t contemplating a year ago. What should we be contemplating now that maybe, besides efficiency, that isn’t on people’s mind?

Chris Uriarte:

Well, since we are on the topic, let me stay with it, it’s risk and fraud. Risk and fraud, trust and safety, big big issues and things that we have to be aware of for this year coming. And you mentioned trust, and let me tell you the name of the session that I moderated yesterday, it was called Protecting Trust in a Changing World. And that tells you really in a nutshell what’s happening here, the world is changing. And listen, I’ve been focusing on risk and fraud in the payments industry for about 24 years, and I’ve seen a few economic cycles here. We know that when the economy dips or when there’s some level of uncertainty, fraud goes up.

But this year is particularly interesting in that we have the conversions of economic uncertainty with the introduction of new payment systems like we talked about earlier with FedNow, the continued growth of RTP, and this already explosive growth of fraud and scams that we’re seeing with authenticated push payment systems like Zelle. So all of this together might make for a rocky ride over the course of the next year. And I love this quote from our good friend Bryan Derman here, who often says that “there’s nothing more attractive to a criminal than a brand new payment system that moves money in real time and does it in an irrevocable fashion.” And that’s what we’re facing here with some of these new payment systems. So it’ll be interesting for sure.

Yvette Bohanan:

Drew, any closing thoughts here?

Drew Edmond:

I think the areas that I touched on earlier do speak, I think, to where we are in this macroeconomic environment. If we’re thinking about optimizing our payments environment as merchants for reducing things like involuntary churn, if we are looking at payment methods like Pay by Bank, that can be lower cost and potentially have higher success rates, I think from a merchant perspective in a merchant lens that’s kind of how I view what’s going on in their thought process during the environment that we’re in today.

Yvette Bohanan:

Bryan?

Bryan Derman:

My thought’s a little more micro but relates probably to what both of my colleagues have said. I’m keeping an eye on card surcharging. The ability to do that came in several years ago and everyone kind of shrugged. It was confined to a few verticals and people said, “Oh, merchants don’t really want to do that. They like to give their customers choice. If they can afford to do it, they like to add new payment systems, let the consumer do what they want to do.” That’s moving a little bit. Maybe this is a little bit of the year of efficiency, hitting the local dry cleaner and the barbershop, and all the places where you’re starting to bump into this. We talked at a few points in the show today about how it’s tough to change consumer behavior. If you really want to change consumer behavior quickly, one of the proven ways to do it is to implement a tax and that’s-

Yvette Bohanan:

Hit them in their pocketbook, as they used to say.

Bryan Derman:

Right. People will notice that, right?

Yvette Bohanan:

Yeah.

Bryan Derman:

Surcharging in a sense is the mirror image of rewards. And we know how powerful rewards have been in shaping payment behavior, and now we’ve got a group of merchants experimenting with negative rewards.

Yvette Bohanan:

Mm-hmm. Very much so.

Bryan Derman:

It’s not vastly widespread yet, but I feel it growing. It could change things, particularly in an environment where there’s a growing list of alternatives. If there’s a cost-effective push payment system out there that people are willing to use and they’re being guided away from their current behavior, I think that bears watching.

Yvette Bohanan:

Well said, Bryan. And again, thanks so much. That’s a great insight. That is a great insight. Thank you all. I have had such a good time talking with you and getting to do this episode with you, and I appreciate it, and I know our listeners are really going to enjoy it. If you all want to know more about what we do in our commercial practice here at Glenbrook, we will direct you over to our website glenbrook.com, where you can read more. We have case studies out there. We describe a lot of this in detail. And it’s always evolving, so check it out. Check out some of those podcasts we referred to, to get more in-depth information. And if the first half of 2023 is any indication of the second, we better hang onto our hats, right guys? So.

Bryan Derman:

Strap in.

Yvette Bohanan:

Thanks so much. Exactly. Strap in. It’s been great as always. Thank you all for joining us.

Chris Uriarte:

Thanks Yvette.

Bryan Derman:

Thanks Yvette.

Drew Edmond:

Thank you Yvette.

Chris Uriarte:

Take care.

Yvette Bohanan:

Take care everyone out there listening and until next time. Keep up the good work. Bye for now.

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