The story behind Square’s bank charter application

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WASHINGTON — The payments processor Square has big plans in banking — but even after filing an application to charter an industrial loan company, it still doesn’t see itself as a competitor to most financial institutions.

In an interview, Jacqueline Reses, the company’s head of lending, talked at length about Square’s plans for the new bank, which would be headquartered in Salt Lake City, capitalized at $56 million and wholly owned by Square.

But she made clear that, though the application has already stirred opposition from community bankers, Square’s aim remains helping small businesses that are generally not receiving credit from traditional financial institutions.

“Over 67% of our [customers] can't get financing anywhere,” she said. “And so we are their sole source of financing. … We think that enables us to serve an underserved market in a way that very few others have.”

Some of the company’s ambition to reach untapped markets can be seen in the ILC’s board of directors, which includes Marla Blow, the founder of a Washington-based credit card company targeting underserved consumers, who previously worked at the Consumer Financial Protection Bureau developing the agency’s priorities on prepaid and credit cards.

But the firm also has ambitious plans to use the data it acquires from payment processing to open up new avenues of lending.

Following is an edited transcript of the interview.

Why did Square decide to apply for an ILC bank charter?

JACQUELINE RESES: The purpose of Square, first and foremost — when you think of the very first transaction that was taken by the company over eight years ago — is to help empower small businesses and the underserved to participate in the economy.

From that original vision, Square built an ecosystem that started with payments, and broadened beyond to invoices, payroll, capital, in our case, analytics, customer services and marketing services, [and] point-of-sales. So it's a broad ecosystem that helps small businesses have the power that a large company, with a very sophisticated point-of-sales system, could have.

And so, an ILC will help us offer small-business loans to our seller community and allow Square Capital to also offer deposit products to that community as well.

Tell me more about how you decided to enter into the lending business.

We serve millions of sellers. And across the spectrum of opportunity that we see for millions of sellers, one of the biggest struggles we see is helping them manage cash flow, and helping them support the growth of their business.

And as part of that, the first loan product was created, such that we could help offer financing to small businesses that, for the most part, can’t get it anywhere else. Our average loan size is $6,000.

We think there are a lot of products that will serve that purpose, for our sellers across a broad ecosystem, and so that's why we started with loans. I think, beyond that, when we think about deposits, it's also another service that we see for our small-business community.

There are 28 million of them in the United States, and we see a huge opportunity to keep going deeper in serving our market and to offer services through the lens of our seller with the goal of trying to improve their business, which in turn we think helps support the growth of Square.

As you expand into other types of financial services, who do you see as your primary competitors? Banks? Other tech companies?

We see two primary types of competitors — if you want to call them that. What we really think about as the alternatives [to Square] is: friends or nothing. Don't grow your business. [Or], you want to go to the most trusted people in your life for that financing. And we think we're an alternative to that.

Over 67% of our sellers can't get financing anywhere. And so we are their sole source of financing. And, we think we're able to serve that need effectively because of our data, from the data processing business, and because of our ability to apply machine learning and data science to assess risk. And we think that enables us to serve an underserved market in a way that very few others have.

How exactly do you use data from your transactions arm to support your lending decisions?

We have extraordinarily unique data in order to do two things. First, determine who is eligible — out of our seller base, and in general. And the second use of our unique data set is to determine the right size of a loan. Both components of using data are incredibly important. [That] is an unusual asset for Square, relative to everyone else.

On the data set, we have millions of sellers that provide real-time insights into their business that we are able to underwrite off. We see payments processing data and transactions data. We have all kinds of risk signals that help us understand who should be eligible.

The second piece is right loan size. We are able to, based on the transaction data, project forward to what we estimate a business will achieve in revenue. Therefore, we are able to underwrite a right-size loan to provide the right financing to support the stability and growth of a business.

And for those who are underserved, it enables them to have the support they need without overfinancing their business operations. We have models which give us guidance on what is affordable. And we think that's a unique data asset that is a powerful indicator for success and growth and also a very strong signal for us to analyze credit.

What are some of the data points you put into your model?

We have scores of signals that we use. It ranges from everything from transaction size, number of transactions, whether transactions match the type of business that the sellers in, the hours they're open, the velocity of their performance within a given workday.

Risk signals include whether the payments that are being processed and the business locations are being processed from some unknown location, whether the transaction sizes are relevant and [whether they are] being processed at the right time of day.

Those signals are real time, and they're active constantly. They're not six-month-historical, one-year-historical, one-time checkpoints. They are active and ongoing, because these are Square sellers who have typically been on our system for over two years.

What does your customer base look like?

There are two types. First is [businesses that are] on Square. That's almost the entire loan population that we facilitate.

Second, about a year ago we announced a partnership with Upserve, which is essentially a point-of-sales supplier that is very similar to Square. [But] they operate in the restaurant space. External partners like Upserve provide us with their anonymized payment-processing data so that we could do largely the same thing that we do with our own core data set.

When we pursue partners outside of Square, we're very focused on the data sets that the partner is able to provide. And, we really are in general focused on access. We're able to get small businesses — that sit on almost any point-of-sale platform — access to the type of financing that we offer our own Square sellers.

What do you respond to critics who say fintech firms have to follow less stringent data protection and privacy rules than banks?

That is largely irrelevant to us. We have our own proprietary data set that we use that is from Square's system.

And we have on our information security and risk team a significant presence that actively monitors fraud and risk.

If you go and look at Square’s annual report, you'll see that we have industry-setting fraud rates overall. [Transaction losses in the second quarter were estimated at below 0.1% of total transactions volume, according to the company’s latest quarterly report.]

If regulators don’t approve your ILC bank charter application, what will you do?

Today, we operate through Celtic Bank, which is an ILC. They're a great partner — we like to work with them, and we will continue working with them.

In addition, we also pursued state licenses. We started that over a year ago.

But, frankly, in order to serve the population that we pursue, we're primarily focused on the goal of expanding access to capital, and we hope that we can get the ILC approved because we think it's the most appropriate regulatory framework for us to grow the business. We would just like to have that direct regulatory relationship with the body that oversees the type of business we are.

If you do get the bank charter, do you plan to branch out into other financial products?

The FDIC is very prescriptive about making sure that you operate per your business plan.

And so, we essentially are taking what relationship we have with Celtic today, and looking to pursue a direct relationship for that business with the FDIC in our own ILC.

To obtain a bank charter, you have to comply with the Community Reinvestment Act, a law against redlining that is not necessarily well adapted to online-focused companies such as yourself. How did you develop your CRA plan?

What we tried to do was one, acknowledge what we do overall as a company. Because we're a technology-driven company with a national presence, and a purpose which is very local, Main Street and underserved-small-business in focus.

And then, we also wanted to be prescriptive to the exact requirements of a CRA plan. And those plan requirements are related to the bank's assessment area, which is essentially the geographic area near the bank's main office in Salt Lake City, Utah.

So we described very specific plans related to how the CRA plan actually works per the FDIC's guidance. And then we also made note of the broader economic mission that we pursue for Square overall — even though that's not something that is inside the umbrella of the CRA-specific guidelines. We highlighted both in our plan.

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