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Rampant Check Fraud Problem Puts The Challenge In Challenger Banks

What is a bank?

Seems like a simple enough question, but in an era of digital-only challenger banks with lofty valuations and purpose-built missions and products, the answer can be slightly more complex.

Challenger banks, Ingo Money CEO Drew Edwards said, have done a great job of appealing to a younger, digital-first, digital-only consumer with their slick mobile apps and debit-like products for spending against the store of value deposited into those accounts.

The real test of challenger bank stickiness and their ultimate success, Edwards contended, will rest with their ability to solve two separate but related issues: giving those consumers the money out capabilities — like bill pay and peer-to-peer (P2P) — that provide utility and sticky behaviors and tackling the money in fraud problems that prevent many of them from converting would-be customers who show up at their digital front doors.

Expanding The Utility Of Challenger Banking Platforms

His generation, Edwards said, opened their first bank account with a traditional bank, had their paychecks deposited there, set up bill pay, established a savings account there and probably got their first credit card there too — and they stuck with that institution. Over time, different accounts at different financial institutions (FIs) were added to the mix — perhaps for mortgages, auto loans, investments and higher yield savings accounts, now even crypto — but were largely incremental to that primary bank account, not instead of it.

Among the main selling points of a challenger bank, Edwards explained, are the easy, fast and intuitive processes to establish an account, often in a few minutes. It’s a far cry from the “old days” of account opening at traditional FIs, which even today remains friction-filled at so many banks.

When it comes to challenger banks, the rub is how to fund those accounts.

A bank-to-bank digital transfer isn’t an easy or obvious solution when the money in comes from a different bank. And mobile deposit capture has become a magnet for fraudsters — even more so recently with unemployment and stimulus check fraud. Edwards said challenger banks have been forced to play defense and approve a smaller percentage of customers, many of those who show up at their digital front doors with checks as their funding source.

Embracing Network Data To Fend Off Fraudsters

Check fraud, Edwards was quick to point out, isn’t just a challenger bank problem. It’s an endemic problem that costs traditional banks about $25 billion a year in annual losses.

The difference is that traditional banks have joined forces to fight back via entities like Early Warning and The Clearing House. Networked data on bad actors is a highly effective tool in stopping serial fraudsters from moving bank-to-bank. Fool one bank once, he said, and the power of networked fraud data means that they won’t be so lucky when they show up at the bank down the street.

Challenger banks aren’t quite there yet, and Edwards said that bad actors are having a “field day” going from one bank to the next because there there’s no network force field at a challenger bank-wide level to stop the spread of fraud.

In the absence of a network-level, system-wide view of check fraud, two things happen. Bad actors get bigger at the expense of those banks because they can, or challenger banks deny new account openings over fears of fraud. The only way to control risk, expand the scope of services and grow their customer base is accessing data at the network level to control fraud.

“Every [challenger bank] has to participate in the same data sharing,” Edwards said. “The solution requires great risk management and machine learning technology across millions of data points that can stop bad money in and bad money going out not for one of them, but for all of them.”

The Challenge Of The Challenger Bank

Although the financial services ecosystem has spent much of the last decade unbundling banking services, the pendulum is moving the other way as all financial services players are adding features and functionality in a move to rebundle banking in a different image.

A year ago, Edwards said he was still on the fence about the challenger bank movement as it was still a possibility that these firms would end up being acquired and removed from the market by big players like Chase and Bank of America.

Today, he said he doesn’t think a lot of exits due to acquisition are the most likely outcome. As challenger banks bulk up their services around their initial core offerings, they seem prepared to go the distance.

In his view, there are still many places where a more traditional banking experience remains “kludgy.” Bill pay, for example, through a bank can be filled with friction, which is why 75 percent of bank customers don’t use bank bill pay services. P2P is limited by the reach and ubiquity of the bank’s P2P network — with that reach today at roughly 40 percent of all banks — with a user experience that can be confusing even for receivers in network.

Challenger banks can also be in a better position than the big banks when it comes to starter credit, he said, because the big banks are still using more traditional credit underwriting and credit scores, which makes it hard for many consumers to get credit unless they fit into a bank’s credit risk box.

But it will require that challenger banks up their game and provide the services that consumers expect of their banks: take money in, store money, lend money, enable money out — safely and securely.

With a few exceptions, challenger banks don’t check many of those boxes. There are many product and service gaps that need to be closed if challenger banks hope to grow along with the evolving needs of their customer base. And unless they can crack the fraud problem, their future growth prospects will remain uncertain.

“If they get these two things right, [challenger banks] can make a big difference and present real competition to traditional banks,” Edwards said.

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