Satyajit Das: Fintech’s ‘Flim-Flam’ Innovation Games

Yves here. Please welcome Satyajit Das, who has decided to grace Naked Capitalism with a new post on the dubious enterprise known as fintech.

Das is a well-recognized derivatives expert who wrote one of the discipline’s important early textbooks as well as popular works, notably Traders, Guns and Money and Extreme Money: Masters of the Universe and the Cult of Risk.

One of Das’ many important observations: “No money is ever really made in financial markets. Markets merely transfer wealth.”

By Satyajit Das, a former financier whose latest books include A Banquet of Consequences – Reloaded (March 2021) and Fortune’s Fool: Australia’s Choices (forthcoming March 2022)

Investment in fin-tech (the untidy agglomeration of finance and technology) has reached a record $91.5 billion, double that of 2020. In the last quarter, there were over 40 fintech unicorns (start-ups valued at over $1 billion). The sector now attracts around 20% of all venture capital. But its looks remarkably like a repeat of the late 1990s, when investors made ill-fated bets on online finance. 

Fintech consists of traditional banking products conveniently packaged up and delivered via an Internet platform or App. Examples include payments (online payment firms like Square or Stripe); lending (supply chain finance (the late Greensill Capital); peer-to-peer lending; buy-now-pay-later (BNPL) or point-of-sale (POS) financing, such as Afterpay, Affirm, Klarna); and deposit taking (online banking start-ups).

Investors include armoured cash carrier chasing venture capitalists and asset managers, armed with other people’s money. The usual suspects are augmented by financial institutions fearful of digital threats to their businesses. Then, there are former senior bank executives eager to displace their former employers, find profitable homes for their large paydays and continue ‘God’s work’.

The Fintech recipe is simple: take a function, digitise it, toss in a little jargon – ‘financial engineering’, ‘technological disruption’. Season generously with mystique; add some high profile spruikers or fawning media endorsements. Stir and then serve.

The rules of the game are straightforward. First, disguise the true function. Exploiting disclosure loopholes,supply chain finance helps businesses treat borrowings as accounts payable on the balance sheet rather than debt, improving liquidity and reducing leverage.  Unfortunately, it leaves investors and creditors bearing bigger losses when the business finally collapse, as happened with Spain’s Abengoa in 2015, Carillion in 2018and NMC Health in 2020. BNPL is nothing more than unsecured personal finance.

Second, mask the true economics. For example, in supply chain financing and BNPL, the seller of goods or services receives the sales price less a discount immediately from the financier who is paid back in deferred instalments by the buyer. A 4% discount, a typical BNPL charge to the seller, paid back over two-months translates into usurious funding costs of over 26% per annum. It helps to obscure how the cost is borne. In the case of BNPL, the retailer not the purchaser appears to bear the financing cost -the discount. But if they want to maintain margins, business must put up overall prices, penalising cash buyers who effectively subsidise BNPL users.

Third, find an attractive demographic. Supply chain finance and peer-to-peer lending targets weaker borrowers. BNPL is aimed at younger, less financially literate clientele, attuned to a world of free everything. Appeals to ‘democratising capital’ can’t hurt.

Fourth, find a lightly regulated lacunae of finance. Pressure to embrace innovation and facilitate the flow of credit has led to the concept of a ‘regulatory sandbox’, where fintech firms can test ‘innovative’ concepts without stringent rules. For example, specialist supply chain financiers and BNPL firms effectively lend money without being subject to the rules applicable to regulated banks.

Fifth, increase risk to boost profitability, such as making risky loans, or ignore earnings altogether – few fintech’s are actually profitable. BNPL does not make money or lacks a clear pathway to profitability, onceinterchange, network fees, issuer processing fee, credit losses and funding are considered.

Sixth, ensure that the real risks remain unknown unknown. Supply chain finance is short term and inappropriate for funding long-term assets, such as plant and equipment, as GFG Alliance (Greensill’s most prominent customer) discovered. A highly concentrated loan portfoliowith large exposures to a few clients is not generally recommended ‘best practice’ banking. It is irregular for financial institutions to entertain large transactions with related parties. In Greensill’s case, it appears to have extended substantial credit to shareholders. It also allegedly funded non-existent future or expected receivables

Fintech lenders frequently undertake soft credit checks and minimal authentication. Former FSA chief Lord Adair Turner argued that the losses which will emerge from peer-to-peer lending will make the worst bankers look like lending geniuses.

Seventh, solicit investors paranoid about digital disruption whose phones are generally smarter than they are. The reasons for mental dysfunction don’t matter but look for: search for high returns and growth, befuddlement about rapidly changing technology, wealth and confidence gained from previous successes or shame at missing out on a ‘ten-bagger’ (10 times increase on investment), faith in unending state underwriting of asset prices and, of course, TINA (there is no alternative).

Branding as ‘fin-tech’ beguiles investors, allowing new businesses to attract capital at high valuations. Greensill’s genius was to persuade everyone that it had changed the business of traditional, staid, low margin, short-term secured lending against invoices and accounts receivable into something revolutionary. Softbank reportedly invested US$1.5 billion in Greensill, now presumably lost.

Eighth, raise a lot of cash and spend it to build market share. Improving banking technology is passé. Most fintech systems consist of an app or user interface sitting on top of clunky, antiquated systems, held together by duct tape. The focus is accelerating customer acquisition which businesses with a wider array of products might be able to monetise. The hope is to find this buyer before you run out cash.

The thing is that fintech could lower banking costs (the cost of transferring funds across borders is punitive) and provide basic, low cost financial services to a large part of the world lacking such access. Some emerging market fintechs do provide genuinely valuable mobile phone banking, micro-loans and simple trade finance for low income individuals and small businesses are. Unfortunately, they are the minority.

There are other issues. The growth of these businesses promotes a burgeoning shadow banking system whose problems can leach into financial markets, requiring tax-payer funded bailouts.  Greensill resulted in the failure of three small banks and investor losses of around US$3 billion. Exempting proper controls and compliance with regulations designed to maintain financial stability in the name of invention, a willingness to ‘break things’ and ‘fix them later’ is patently dangerous.

Worryingly for investors, the Fintech model may have peaked. For example, the Reserve Bank of Australia, in a decision likely to be adopted globally, will allow merchants to pass on the costs of BNPL services to customers. With surveys showing that most users would not use the service if there is a cost, a more even competitive field of play and increased competition from banks and credit card providers, Fintech’s future is dimming.

The world needs realinnovation but John Kenneth Galbraith was sceptical about the financial variety, seeing them as merely variants on old designs, novel only in the brief and defective memory of the financial world. Fintech illustrates how, given time, everything old is new again and everything new turns out to be a re-run.

©2021 Satyajit Das. All Rights Reserved. Reproduced with permission. 

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  1. Mikerw0

    The basic adage is true in these situations that if the early investors can make it through the exit before people figure out what is happening they can make healthy return and leave someone else holding the bag.

    The same phenomena is occurring in insurance. The argument is that the market is vast and ripe for disruption — an ill defined term that sounds good to people who don’t understand how the business actually works. These companies, e.g., Lemonade, race to acquire customers, use metric not typically used to evaluate the business and are highly self promotional. What they ignore is that these businesses are highly competitive, in acquiring customers they are being adversely selected against, that if the business is really to work they actually need to find a way to reduce the overall pricing structure which is very hard to do.

  2. vlade

    Most fintechs sell $100 notes for $99 (Uber model).

    There are some that are genuinely useful, but I’d say pretty much of those are labeled as “fintech” only because their investors told the so.

    Say I’m told that Starling bank (one of the few challenger banks in the UK that makes profit) in the UK is genuinely good for SME clients, but TBH, it’s still a bank, and the SME services with the large UK banks are so crap that being “good” is easy.

  3. Questa Nota

    Those rules of the game should be directed to your elected national pols, along with state critters. Ask them if they understand and can explain just what they think is happening to all of their constituents, and not just the donors or lobbyists. Where is some national platform journalist to dissect and expose, in the style of the old 60 Minutes or similar?

    Fintech motto: Tread water now, pay later.

    1. vlade

      Nope. It’s “tread water now, someone else pays later”. In fact, you could simplify it to “whatever you do, let someone else pay later for it”.

  4. lyman alpha blob

    Thanks for this. I deal with a lot of these new fintech companies and most of them are not “innovating” at all, but just looking to reinvent the wheel to get their cut of financial transactions. And I am constantly amazed at how much dumb money they have sloshing around. We had one recently who had purchased some services from us and contractually obligated us to accept payment through their own new payment system, which would then take a 1.5% discount off the invoiced amount. We didn’t know about the discount they were taking until after the price had been set – that somehow got lost in the fine print. I was very annoyed until I realized how much we had grossly overcharged them for the services to begin with, but they had signed the contract without batting an eye.

    At some point you’d think people would come to their senses and this nonsense would stop, but I’m not seeing any signs of it happening soon.

  5. Susan the other

    What a rats’ nest. And this is before the rolling blackouts become a regular event. I’m guessing the only reason this “fin tech” stuff works at all is because there are existing wide-spread financial systems established over decades and even hundreds of years in good faith, more or less. “The full faith and credit of the United States” comes to mind. And this is what is actually of value here. So there’s gotta be a way to protect things like “faith and credit” besides usurious fees and interest rates – which clearly do not work. That’s almost as nonsensical as taxing death. And Das hasn’t even mentioned crypto in this mix. What happens to crypto in big fin-tech transactions when accepted credit systems and currencies have been literally undermined? So the perennial question: Where the hell is adequate legislation? Money is really such a fragile thing – we should be a tad more vigilant because when we all finally get fed up and simply turn our backs on this crap it’s gonna be ugly.

  6. MonkeyBusiness

    This is a different kind of MMT. Magic Moolah Technology. “We’ll make it up in volume!!!”, we promise.

    Apparently Amazon is now using Affirm for BNPL, possibly to weaken Visa’s and Mastercard’s bargaining power.

  7. Shaw the Sceptic

    I could see a barrage of senior management staff jumping in the Fintech band wagon who are nearing the end of their career. It’s now so clear their necessity of serving the old wine in new bottle….speed and reach is something they are trying to improve however the underlying risk remains the same! Eventually it will increase the competition to a level which might be unsustainable for many operator and consolidation is bound to happen.

  8. michael aubert

    This seems like the perfect article to post my first comment (if memory serves). Feedback welcome because maybe I’m thinking about this all wrong. I come to NC to get information and ideas.

    I have been working in the Fintech industry since 2016. The main thing I have done is contributed (it takes many people) to the launch of 2 new banks in the UK. The reason why I chose to do this is: there are not enough banks in the world, not enough competition in the banking industry, which was an aggravating factor in the 2008 financial crisis. I try to do what I can to avoid or reduce the impact of the next one.

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