Fintech Success = Innovation + Engineering + … Compliance?

Among many bankers the compliance function has traditionally been seen as a source of friction. They make innovators jump through extra hoops to design the services bankers want to offer. And sometimes they just say “no.” It’s a longstanding pain point.

Yet I have found that many of today’s leading fintechs have come to see the role of the compliance officer as critical to long-term success. Not all of these companies have had uneventful journeys. But they have achieved some measure of success and they often credit their compliance leaders for a part of that. Indeed, some see a good head of compliance as being as important as a good head of engineering.

Let’s look at the evolving role of compliance in fintech, and at the lessons traditional players could learn from their experience.

Looking Back at Fintech’s Roots and How It Changed the Game

Financial services is a massive industry. Most of the current revenues are earned by banks, but fintech revenues are expected to grow a lot faster. By one estimate fintech revenues are expected to grow to $1.5 trillion globally by 2030.

For some context, let’s look back on the history of fintechs, which effectively began in the wake of the 2008 financial crisis. Prior to the crisis, compliance teams in financial services were not empowered. After the crisis, the pendulum swung in the other direction, and the compliance function gained too much power within traditional banking companies.

At the same time, the regulatory framework for building products tightened as the government quickly closed the gaps. Anything that touched money within the traditional banking industry needed to follow stricter federal and state regulations. There was no business without it. Remember, the crisis gave birth to the Consumer Financial Protection Bureau, which continues to expand its jurisdiction.

As banks stopped innovating in the face of mounting regulation, this resulted in the birth of many big fintech companies of today. They did not have the same compliance constraints as banks.

They hired inexperienced but hungry — and innovative — compliance officers. These new teams innovated alongside technical and product teams to unlock new markets and revenue.

If innovative banks had not been constrained, there would be fewer companies today like Stripe, Lending Club, Block (previously Square), Wealthfront, Betterment, etc.

Fintechs Weren’t Using Traditional Compliance Thinking

As tech innovation met regulatory compliance, founders challenged the way compliance was done. New compliance officers took a different approach than their bank counterparts. They stayed rooted in the goals of regulations but innovated on the implementation. Over the last 10-15 years, financial products have become increasingly simple to use because of this innovation in the implementation of regulatory controls.

Every financial product we use online today once required a lot of paperwork and in-person visits. Hundreds of billions of dollars of new value get created when new technology products are built while keeping compliance at the forefront.

LendingClub brought personal loans online. The company IPO’ed at a $10 billion valuation — and later the company acquired a bank.
Block’s Cash App (and others) helped make payments frictionless. Public and valued at ~$50 billion at the time of this writing.
Stripe made accepting online payments simpler, easier and faster. Private and valued at $65 billion.
Wealthfront made it easier to manage wealth through a simple interface. Private with over $50 billion in assets under management.
Wise simplified cross-border transactions with low fees. Public with a $10 billion market cap.

None of this would be possible unless a 10x compliance leader set the right tone at these companies. The conversations between engineers and a great compliance leader are the polar opposite of conversations with a mediocre one. Most tech people I know love working with compliance leaders who understand regulations well and work on solutions rather than trying to reduce their own risk.

As I look at fintech companies, I find that the successful ones treated compliance as a first-class citizen like engineering. One of the first few hires at these highly valued companies was a head of compliance or someone equivalent. The right compliance leader sets companies on a path for scale.

With the growth of embedded fintech, the abstraction of regulatory compliance has become table stakes. Large software companies are increasingly earning more revenue through fintech products, even higher than software as a service revenue. The trend of embedding fintech products will grow exponentially and will demand improved compliance as a result.

Some First-Person Experience in the Fintech Trenches

I know there’s another side to this. Not every fintech exhibited the same respect for compliance. Some startups used the playbook of “don’t ask for permission, ask for forgiveness.”

In some areas, we saw that such attitudes backfired and not being compliant or being shortsighted resulted in enforcement actions by regulators. The startups raised funding but had to immediately suspend operations or wait for regulatory clarity.

Most of the compliance world only knows the conventional wisdom developed at banks and other heavily regulated institutions. Most of these institutions operate with manual compliance teams and the strictest interpretations of regulations. But it doesn’t have to be that way.

At Stilt, I personally took on the responsibilities for compliance for the first few years. We were building products for the immigrant population in the U.S., a seriously underserved segment. Serving an underserved market presents challenges with inadvertent discrimination and disparate impact (even though such efforts are well intentioned). Learning the goals of regulations and working with the right legal and compliance partners helped us achieve our goals. We were examined almost a dozen times by various regulatory authorities and they never found any material shortcomings.

This gave us confidence in our infrastructure and compliance controls.

At the end of 2021, we launched a first of its kind Lending as a Service product called Onbo. It was an alternative to bank sponsorships. Onbo could work only because we spent many months building the right compliance infrastructure. We grew to a few million dollars in revenue in less than six months primarily because we got compliance right. In 2022 JG Wentworth bought this online lending platform.

Over the last few years, we have seen startups itching to innovate on products to solve problems for the underserved population. But the strict regulatory requirements makes it impossible to build a business without focusing on compliance.

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How Coping with Compliance Could Change in the Future

Being compliant is not cheap. It requires many resources and can feel like bureaucracy. It can slow the pace of innovation and forces all products to look much the same.

I have been in many conversations with other fintech founders. One thing they recognize is that the cost of compliance must be weighed against the cost of potential fines.

A few years ago, I spoke on a panel at an event at the San Francisco Federal Reserve Bank with a couple hundred regulators listening in the audience. I was asked about the biggest accelerator for innovation in the fintech industry. I responded “regulations.” I shared the view that technology is already far ahead of what’s needed to build great products and improve financial inclusion. New regulations that allow responsible innovation would be the biggest growth factor for the financial services world.

The latest wrinkle for compliance is artificial intelligence. It is completely changing the game. In this new age of AI, being compliant will become easier in many ways. All companies will have a superhuman compliance co-pilot that’ll help them navigate the regulations, help manage oversight on teams, and fix potential issues before they are examined by the regulators. AI will also help maintain a healthy compliance culture internally.

The premise of evaluating compliance as a cost center would change to using compliance to get ahead in the market. Building products in a compliant way not only result in larger value creation but also sustainable innovation.

Steps Banks Can Take from Fintechs’ Playbook

As banks move forward with adopting technology, they can also learn better compliance practices from fintechs. A few areas where banks can improve user experience and provide value:

• Embed compliance in product design: Incorporate compliance insights during the initial stages of product development to navigate regulatory challenges creatively and efficiently, enabling quicker market entry and innovation.

• Invest in compliance technology: Utilize artificial intelligence and automation tools to streamline compliance processes, reducing manual efforts and increasing accuracy, which can accelerate product development and reduce compliance-related costs.

• Target underserved markets with compliant products: Develop compliant financial products tailored for underserved segments, such as immigrants or low-income households, to tap into new revenue streams while addressing financial inclusion.

About the author
Rohit Mittal is an advisor and investor in financial services and other companies, including in the credit card and buy now pay later areas. He was CEO at Stilt, a fintech serving the immigrant market. He is by training an engineer.