But what if the insurance company had made the opposite decision or a small business lender used similar data to determine loan approvals and pricing? What recourse would the small business owner have if they were suddenly refused credit? Would the business have the right to a transparent review of the data used to make the decision? Who controls the algorithm?
These questions are pertinent as we think about the next phase of innovation in financial technology. In the United Kingdom, regulators have implemented an Open Banking regime, which facilitates data sharing across financial entities and in which small businesses and consumers own their financial data.2 Their experience will begin to test important questions, such as who can use data and how, and perhaps, most importantly, what happens when lenders increasingly move from pre-programmed algorithms to machine learning.
A Black Box
In 2000, Google co-founder Larry Page said that, “Artificial intelligence would be the ultimate version of Google. The ultimate search engine that would understand everything on the web. It would understand exactly what you wanted, and it would give you the right thing. We’re nowhere near doing that now. However, we can get incrementally closer to that, and that is basically what we work on.”3
It is easy to imagine a dark side to the advances in artificial intelligence. In March 2016, inventor David Hanson brought his newest gadget to an interview with CNBC. What followed stunned the world, as Sophia, a lifelike robot built in the image of Audrey Hepburn, responded to Hanson’s question of “Do you want to destroy humans?” by saying, “OK. I will destroy humans.”4 Technology entrepreneur Elon Musk warned, “I’m increasingly inclined to think that there should be some regulatory oversight, maybe at the national and international level, just to make sure that we don’t do something very foolish. I mean with artificial intelligence we’re summoning the demon.”5
Economists have begun to explore the implications of artificial intelligence on innovation. They view artificial intelligence as a “general purpose technology,” which, like the semiconductor in our innovation story, has the potential to create significant advances in multiple industries.6 Artificial intelligence has the possibility of becoming a powerful enabler of innovation because it is actually an “invention of a new method of invention.”7 These economists also suggest that the winners are going to be those who have control over large amounts of unstructured data.
This raises a potential risk of artificial intelligence. If certain companies are allowed to have a monopoly over collections of data, this could adversely affect future innovation and the shared benefits it would bring. As we will discuss further in Chapter 11, future regulation needs to ensure that there is open access to data streams to power better insights for small businesses and other sectors.
In addition, as machines learn to identify who is more likely to default on their loans, the risk of discrimination and exclusion becomes significant. Most worrisome is the idea that data would be analyzed in a “black box”; that no one would know exactly what the machine was using to make recommendations or decisions. So, while the insurance company in our previous example could deliberately decide not to include frozen pizza purchases in its algorithm, a machine could discover the same correlation and—barring explicit rules preventing it from doing so—include it as a pricing factor. By the same token, a machine might identify a risk factor that happens to correlate strongly with race, gender, or the characteristics of other protected classes. Machines that lack intuition and situational awareness could create serious problems.
Black box models are not un-auditable; they’re just incomprehensible, but it is possible that artificial intelligence could make them comprehensible and monitor or control them. Both companies and regulators will need to develop new technological methods to untangle the inner workings of the algorithms of the future. Even if automation is developed that is capable of detecting discrimination and other bad outcomes, it seems likely that human oversight of these important issues at companies and by regulators will be required as well.
The Small Business Bank of the Future
Traditionally, small business loans and services have been conducted by banks that also serve consumers, do real estate transactions, and have other important lines of business. The idea of a bank or other financial entity focusing exclusively on small business is a somewhat novel concept in the financial services market. Yet, such an entity will likely have a competitive advantage in developing the small business dashboard and associated integrated credit activities we have described.
The small business dashboard and the intelligence that powers it do not have as much in common with consumer systems as one might think. A consumer might be focused on repaying student loans, consolidating credit card debt, or planning for college, a vacation, or retirement. Although there are analogs in the world of small businesses, their basic activities and worries are different. The concerns of small business owners revolve around the inner workings of their business: if it is making a profit and whether the cash flows match the required payments.
Another way for a bank to specialize even further is to cater to a particular subset of small businesses differentiated by their industry, geography, or size. Given the heterogeneity of small businesses, such a focus might be a winning formula. Live Oak, a forward-thinking bank founded in 2008, began by lending almost exclusively to veterinarians. They followed on with funeral homes and chicken farms. This early specialization gave them unique insights into the particular activities and creditworthiness of each chosen small business segment. Kabbage began with online eBay sellers. Other lenders have specialized in women or minority-owned businesses or government contractors.
The small business bank of the future may not even be a bank in the sense we think of them today. It could be an online entity that conducts its transactions through a traditional bank, or it could be one of the current platform players such as Amazon, or a financial services competitor such as American Express, Capital One, or Visa. The beauty of the innovative boost that the fintech wave has given to small business lending is that all of these competitors are considering their options. And most are doing it with a new appreciation of the particular needs of their potential small business clients, and a desire to serve them well.
The Future Role of Relationships
It might seem at first that in a new era of technology-enabled underwriting, processing, and advising, there would be no place for relationship lending. But this will not be the case. Small business problems are so particular, and entrepreneurs are so different, that relationships will remain important, if they can be built and maintained affordably.
Community banks have historically held a competitive advantage for small business loans, largely because of their relationships with their small business customers, where they provide advice and counsel. These conversations help create customer-product fit—getting the small business a loan of the right amount, the right duration, and the right cost, so they can successfully use it for the intended purpose and repay it. Under pressure to improve their profit margins, community banks have been forced to move away from relationships, particularly with the smallest businesses, as these personal activities are costly to build and maintain.
Who will fill these needs in the future? The Small Business Administration does an important part of this work, counseling over one million small businesses a year using a vast network of Small Business Development Centers and SCORE volunteers.8,9 Community Development Financial Institutions (CDFIs) have historically provided access to credit to underserved borrowers through personal relationships and advice.10 They are valuable players, but they cannot meet the marketplace’s needs given their limited funding.
The answer is likely that both human and artificial intelligence in combination will provide a new set of solutions. The small business owner can use automated intelligence to understand their needs and get credit as their situation permits. But they also will need access to a personal conversation or relat
ionship, to help them make more complicated decisions.
JPMorgan Chase has taken this two-fold approach. In addition to billions in fintech investments, they are investing in face-to-face services. In 2018, the bank announced it would open 400 additional branches and launched the Chase for Business BizMobile™.11 This bus parks in a designated area and invites small business owners in to have a conversation about their marketing strategies and financing needs (Figure 8.1).12
Figure 8.1 Chase for Business BizMobile™
Source: Chase BizMobile teaser, June 14, 2018.
One could imagine that Alex, our coffee shop owner, would also have the need for a trusted human advisor to supplement the bot that proved so helpful. Although the human advisor could be part of the platform and in a different location, it does seem more useful if they knew the local situation. In an optimal future small business ecosystem, new intelligence for small business owners, easily accessible loan products, and human advice and counsel will all be part of the mix.
* * *
The small business bank of the future might be a large or small bank that is already part of the landscape today—it may be a platform or fintech lender, or it may be a new entity that does not currently exist. There may only be a few of these “banks” or there may be many, each serving different industries. As the innovation cycle progresses, a shakeout process will likely occur along the way, where the successful firms will be those that understand the needs of small businesses and serve them in a streamlined way. Thus, in this future state, small businesses will be the ultimate winners.
© The Author(s) 2018
Karen G. MillsFintech, Small Business & the American Dreamhttps://doi.org/10.1007/978-3-030-03620-1_9
9. A Playbook for Banks
Karen G. Mills1
(1)Harvard Business School, Harvard University, Boston, MA, USA
Karen G. Mills
Email: [email protected]
It was a cold, winter day in January 2017 as Eastern Bank CEO Bob Rivers stared out the window overlooking downtown Boston, reflecting on Eastern’s recent innovation adventures. Rivers had just become Eastern Bank’s Chairman and CEO, starting his career as a bank teller 35 years earlier and working his way up through the ranks in several banks, before becoming Eastern’s President in 2007. Rivers had seen the signs of disruption—technology seemed to be taking over the world and banking was no different. Now the bank was at the end of a three-year internal innovation project designed to bring new technology solutions to its customers. Eastern Labs had developed a hugely successful, fully automated small business lending product that was recognized as an industry leader, and had strong adoption by Eastern customers.
Rivers was proud of what they had accomplished. Eastern Bank was by all accounts a traditional bank. Founded in Salem, Massachusetts in 1818, Eastern was the oldest and largest mutual bank in the country. Being a mutual bank meant Eastern had no shareholders, and was instead owned by its depositors—a model that restricted the bank’s capital stock to retained earnings. Begun as an attempt by some wealthy New England merchants and ship owners to provide access to capital for those in the community to build homes, Eastern Bank originally opened once a week—on Wednesdays from 12 to 1 PM. It offered a 5 percent passbook account and a precursor to the modern home mortgage. In addition to repaying the principal and the interest on their loans, borrowers incurred one additional “fee.” They had to volunteer at the bank in order to help expand the hours. This community focus and the mutual ownership structure had been part of the fundamental identity of Eastern Bank for almost 200 years.
Through most of the 1980s and 1990s, Eastern operated as a traditional community bank, serving the New England region with a large branch network, specializing in small and middle-market business, consumer banking, and insurance brokerage. In 1997, Eastern began a massive expansion push, aiming to double the size of the bank within ten years. More than a decade later, as the nation emerged from the worst financial crisis since the Great Depression, Eastern found itself in a relatively fortunate position. With few risky loans on its books, it had escaped the crisis with minimal losses and without closing a single branch. As the crisis came to an end, Rivers realized that Eastern had the capacity to meet the needs of small businesses whose credit had been constrained during the crisis. As Rivers put it, his team felt they had “both an opportunity and a responsibility to step up.” They decided to focus on Small Business Administration (SBA )-guaranteed lending and, within six months of ramping up their small business operation, Eastern was the top SBA lender in Massachusetts, and eventually became a top-10 SBA lender nationally.
But Rivers was still worried. Small business lending was a core part of their business, but fintech disruptors were providing a better customer experience and processing the loans faster than Eastern’s manual process would ever allow. Determined to compete, Bob Rivers and Chief Information Officer Don Westermann decided to take a walk around Kendall Square, home to Massachusetts Institute of Technology (MIT), where many of these fintech entrepreneurs were incubating their companies. With few connections in this field, Rivers and Westermann cold called people and took meetings with whomever they could find. Rivers ultimately wanted to find someone to transform Eastern’s technology, arguing, “We should worry about people putting us out of business, but we should also put ourselves out of business.” One day, Rivers picked up the Boston Globe, and noticed that PerkStreet Financial, an online bank headquartered in Boston, was struggling to make ends meet. Once thought to be the future of banking, PerkStreet was closing after just four years in business. But the talented innovator behind PerkStreet piqued Rivers’ interest. He picked up the phone, called his network in Kendall Square, and asked if they could put him in touch with PerkStreet’s CEO Dan O’Malley.
By the time Rivers called, O’Malley had already been searching for a bank with whom to partner for about one month. He believed that his project at PerkStreet would have been more easily executed within a bank rather than through an independent entity. After three months of negotiating, O’Malley officially joined Eastern Bank as their Chief Digital Officer, responsible for the bank’s product team, customer support, and “Eastern Labs”—the new innovation group located in the lobby of Eastern Bank’s headquarters. With a $4 million annual investment from the Board, Eastern Labs began running a series of tests. Initially, they simply set up a basic web page and used the customer support team to reach potential customers by phone and email. Once a customer applied, their information was processed manually within two hours, cutting turnaround time dramatically without having to build an automated system. As O’Malley said, “We decided to fake it until we made it.”
But having an innovation team work inside of a traditional bank was not easy. The process of experimenting with new products was messy and involved risk. For example, in O’Malley’s first test, he wanted to run what he called a “universe test,” approving loans for anyone who applied just to see if there was a demand for the faster, online process. One team member’s response was, “So you want me to open the window, take taxpayer-guaranteed money and just hand it out to anyone who shows up. That’s the stupidest idea I’ve ever heard.”
Even those who did not work with Labs felt its influence—after all, they saw it in the lobby every day. Some felt that the money and attention going to Labs could be better spent supporting their day-to-day operations, or on other new projects such as developing the mobile banking application on which they had been previously focused.
Despite all of this tension, Labs developed a successful product. Over three years, $12 million, and multiple tests, a project that began with a basic web page ended with a product that fully automated Eastern’s small business lending and improved customer acquisition through digital marketing, all while meeting the bank’s regulatory and internal underwriting requirements. O’Malley saw an opportunity to sell the product to other community banks and believed this combination of automated loan processing and improv
ed marketing gave the product unique appeal. As he put it, “Real-time loan origination reduces back office costs but doesn’t itself drive growth. Growth comes from automating sales in new [digital] channels.” Eventually, O’Malley spun out the product into its own company called Numerated Growth Technologies, in which Eastern Bank had an equity stake.1
The Future of Small Business Banking
Eastern Labs was seen as a success story, and other small banks started to take notice. If a 200-year-old mutual bank could innovate like this, perhaps they could, too. Or perhaps they could take a product like Numerated and integrate it into their existing systems. Banks also began to realize that the processes being digitized were processes that already existed within their own institutions. While the impetus to automate them may have come from the outside, banks had a range of options to adapt, from building their own new products to partnering with a fintech company.
One of the key attributes that helped Eastern Bank succeed is that they had long focused on serving small businesses. As banks think about the future of small business lending, it will no longer be enough for them to treat small business lending as an add-on to their consumer business or a subdivision of their larger commercial lending departments. The successful small business lenders of the future will make small business its own area, creating the customer experiences and innovative products that small businesses will see from new competitors, and come to expect and demand.
Fintech, Small Business & the American Dream Page 13