Hi guys. Welcome to the Fintech Coffee Break. I’m your host Isabelle Castro, and today I shared my coffee break with Michele Alt, Partner and Co-Founder of Klaros.
Klaros is an advisory and investment firm focused on innovation in Financial Services, helping clients navigate the difficult regulatory landscape facing financial institutions as they develop for the future.
I sat down with Michele to talk about the recent Silicon Valley Bank crisis and what her view is for possible regulation and innovation and its wake.
Isabelle Castro – Hey, Michelle, good to have you on the show.
Michele Alt – Hey, Isabelle, thanks for having me.
Isabelle – I’m glad to have you on. So to begin with, I want to know what gets you up in the morning.
Michele – Well about three cups of coffee. After that, what really energises me as having a big puzzle to solve. I love really thorny and complex projects that require multidisciplinary teams and a diversity of approaches to solve. And I know that’s really nerdy, but I get really excited trying to thread my way through complex regulatory issues on behalf of our clients.
A great example, of course, are the myriad issues that are flowing from the SVB and other failures. At Klaros. My firm we’ve been fielding many, many calls in recent days that require our team has deep expertise in banking operations, risk management, bank resolutions and regulatory powers. It’s been exhausting but very, very interesting.
Isabelle – Yeah, I can imagine. We’ll get into that in depth in this interview. But to begin with, well, first of all, how did you come to found Klaros, what was the journey?
Michele – Well, Isabelle, I get asked about my journey a lot these days. And that’s probably a sign that I’m getting old. But in retrospect, my career unfolded in a way that looks very deliberate but really was spurred by a stroke of luck.
I had the opportunity, when I graduated from law school, to serve as a judicial clerk at the US Court of Federal Claims. And at that time, the court was handling very high-profile litigation stemming from the SNL crisis. And from there, I was just hooked on banking and regulation. As I said, pretty nerdy. I know.
From there, I moved on to the OCC, and I can’t imagine a better education and financial regulations. I had a first-row seat in many of the most impactful matters, banking, and regulation over the years, including during and after the financial crisis. And after we were mostly finished at the OCC with the Dodd-Frank regulatory implementation, I began to wonder how banks were coping with all these new regulations. So I moved to Chicago to serve as OCC district council there, rather than remain in sort of the ivory tower of DC. And I quickly learned that the answer to how banks were doing post-Dodd-Frank was not very well.
They were completely overwhelmed and often frustrated by the apparent lack of understanding in DC on the impact of all these regulations. So I left the government and went into consulting, I joined predatory Financial Group, and I enjoyed being able to help clients solve problems rather than just create them. But I also quickly learned that too much consulting for my tastes was focused on relatively short-term solutions to broader problems. And rather than play cleanup with my clients, I wanted to help them strategize for success. And that led to Klaros, which I founded along with my brilliant partners, Konrad Alt. Yes, he’s my husband, Brian Graham, Adam Shapiro, and John crane.
Isabelle – Wow. Okay. And yeah, as you said, I mean, you must be coming invaluable for a lot of people right now in the current kind of SVB crisis. So in the wake of this, where are we with regulation? What do you think the outlook is?
Michele – Well, I think it’s a little too soon to tell. But I will say that after this past weekend, banks should prepare for additional regulation and increasing regulatory scrutiny of risk management, particularly interest rate risk management, and sort of a “duh,” but that’s definitely in the offing and certainly overdue.
Regulators are going to need to address the underlying drivers of the SVB failure, which were losses on bad interest rate and a high level of uninsured deposits, right, and there are a variety of regulations that could be revised or implemented to address these issues. But it’s really important to remember that SVB was mostly a simple failure of bread and butter, interest rate risk management, and the regulator’s had plenty of information available to see that failure of interest rate risk management, plainly. That’s probably a topic for another time. But certainly there’s going to be a lot of questions asked about what the regulators were aware of and why they didn’t act sooner.
One thing I fear is, though, is that the recent failures will be cited by regulators as a reason to further resist innovative business models in the banking system. But again, SVB didn’t fail because it was too innovative. SVB failed, because it was too lax, and regulators were apparently not paying sufficient attention.
Isabelle – Okay, what is your opinion on the general regulatory landscape for financial institutions? Are they sufficient for financial institutions? Even though SVB was lax, should it have been lacking, or are building blocks there?
Michele – So my opinion is banks are among the most heavily regulated entities in our economy. I don’t think you’d find a bank anywhere saying they should be more heavily regulated. Right? It’s a very complex system. And we have very intense, typically, regulatory, supervisory oversight of the banks.
Isabelle – And what effect do you see this having on kind of a wider scale, this orthodox regulation, the regulators now?
Michele – Well, I think it so far, has served to increase the barrier to Fintech entry into the regulated bank perimeter. I think there are many interesting questions now arising in light of recent events. You know, banks have incredible competitive advantages, right? They have, first and foremost, the privilege of lower cost funding and payment system access. And in light of this past weekend, they certainly have access to a very favorable Fed liquidity facility. And I think there will be increasing pressure on the government to just announce they are covering all insured deposits, henceforth.
So imagine the advantage that a bank can say, no matter what your money is, as good as the government guaranteed backing it. That’s, that’s quite significant.
Isabelle – Okay, and there’s this whole idea of regulatory capture I’m not sure whether this fits into this. But if you could tell me a little bit about what that is, why it’s happening, and where you see it’s most prevalent at the moment.
Michele – Yeah, so, um, regulatory capture. Again, banks don’t want to share their competitive advantages with new bank entrants, particularly with fintech entrants that have so far taken market share by doing a better job at serving customers. Right. And no one who works in this area is naive about the influence incumbent banks have on the regulatory agencies. But it’s a shame, particularly in light. President Biden’s Executive Order promotes competition in the American economy. And all the regulators’ concerns about concentrated market power, that we have this regulatory capture dynamic, and there are many ways in which regulatory capture can play out.
Where I personally see its effects are in the de novo bank chartering process, the process for chartering a new bank. When the regulators stop an applicant from entering the business, the banking system, they effectively reward incumbents by stifling competition.
Isabelle – What effect would this have on the smaller banks, the Neo banks, fintech in general?
Michele – Yeah. So smaller banks, and fintechs, you know, certainly have a competitive disadvantage over as compared with large banks, which many perceive as safer. And, you know, because they are perceived to be too big to fail. Actually, I think the government’s actions over the weekend to step in, and guarantee deposits may be evening out that perception, although, again, as the V was very large. So that might be helpful for small banks competing with big banks.
For fintechs, competing with banks, I think it’s they’re certainly at a disadvantage, given what I said earlier about the potential for the government to back all deposits in banks, not just those under $250,000.
Isabelle – I imagine that would have quite a lot of knock-on effects for the government in general, though, if they would be able to implement that.
Michele – Well, you know, I think, yes, because the assumption is, there won’t be a complete collapse of banks, you know, there’s no reason to fear that. So I don’t expect the government will have to rush in and provide support to every American depositor. I just don’t see that as likely. But again, it is incredible the confidence that the government action will inspire and bank depositors is wonderful, but will create a significant competitive advantage for banks over fintechs.
Isabelle – I realize that now, this question is quite a difficult one to answer. But where do you see the financial landscape going over the next few years? And what do you hope we will achieve?
Michele – That is a difficult question to answer, I think there any factors going on. Talk about a big puzzle. Right. A lot of moving pieces as possible. And I think one of the most interesting things to think about is what is the Fed going to do?
I think one of the stark lessons is increasing rates in an effort to stem inflation comes with an impact to banks, that can be very significant. Right?
As you know, one of the key problems that SVB faced, and in fact, many banks faced, is losses on bad bets that they took on interest rates, right? They purchased bonds, when interest rates were near zero, and they made loans at those rates, those are understandable things they did. But now with the steady interest rate increases, there, they faced a lot of challenges.
So I think that’s an interesting space to watch for. How is the Fed going to kind of balance these concerns?
I think on a regulatory front, I predict we’re going to see hearings very soon involving the regulators. I think it’s amazing, just shocking. The word shocking, keeps being used with connection with the SVB, Silvergate, and Signature failures. And why that’s so shocking is not just that that has happened fast. Right? These happened to well-capitalised well financially positioned banks with no apparently relevant enforcement action history. How did that happen?
So I think we’re gonna see lots of heat on the regulators.
I also think, and I’m sure you’ve seen this, Isabel, there’s a lot of support for narrative taking shape right now that this wouldn’t have happened to SVB. If only the regulators had not rolled back certain protections in Dodd-Frank in 2018, right, and a big thing they’re talking He about there is about is the enhanced prudential standards applicable to banks over $100 million. One of the changes in 2018 was to change that threshold to $250 billion. And so there’s a lot of talk about that being the cause, and the need to revisit that change in and threshold on the enhanced prudential standards. In my opinion, that’s a bit of aiming a bazooka at a much less significant and complicated issue, which again, in this case was sound, interest rate risk management.
Isabelle – In this kind of context. What do you think financial institutions, banks, or any kind of financial institutions within this context? What could they do to maintain and accelerate innovation within this kind of uncertain time? Do you think?
Michele – You know, I would have had a really simple answer have we spoken last week is about what I would have said banks should focus on partnering with fintechs to drive success. There are many examples of success with this approach, including prominently banking as a service model.
I also would have said fintechs should seek to acquire banks in order to take advantage of the competitive advantages we’ve been discussing.
Today, I would say that, in addition to those strategies, fintechs should also consider de novo charter applications, although this is an uphill climb. Regulators have expressed concern recently about the low rate of new bank formation. And I think recent events showed everyone the payroll of fintechs, serving many customers while relying on a single bank partnership.
Isabelle – And what are you advising your customers like the broad one of the main things that you’re advising your customers at the moment in the wake of this weekend?
Michele – Wow. So, you know, it’s Tuesday, as we’re recording this, yeah, we spent, we spent Friday, Saturday and Sunday. advising our customers, which are primarily FinTech, is about that banks, although we’d certainly serve banks as well. But we spent three days talking about how they could best prepare to quickly report on their deposits. That’s still good advice. You know, the FDIC is just not going to write a blanket check. They need to document the insurance, insured status and, and uninsured status out there various deposits that they placed with SVB and the other banks.
Those calls have ceased as of Sunday night when the government announced they would step up and cover all of the deposits. So what we’re seeing are a lot of questions from the VC community. On what kind of what to do with these lessons. Right. We’re fielding questions.
We’re just starting to field questions again about Hmm, how do I become a bank? Exactly, you know? And for our bank clients, we are certainly talking about how they can make sure they’re doing a good job on risk management, particularly interest rate risk management.
Isabelle – What is your favourite quote and why?
Michele – Oh, gosh, I’m so I’ll be a little colorful now. But my late father was a very colorful and skeptical person, and He used to say, quite often, he would cut to the chase on various political issues of his day by saying, “That’s some bullshit.” And my shorthand for that, which I often use in texting my children, is TSBS. Right.
It’s important to always keep your eye on really what is really happening. Right. And is the narrative that you’re reading? Or hearing accurate, or at least does it present a full, full picture? So, you know, a healthy skepticism combined with an interest in the true analysis of complex issues of the day, I think, serves us all well.
Isabelle – Yeah, I would agree, especially in this current climate.
Now, you have your curveball question. That wasn’t even the curveball question. If you could turn into another person for the day, who would it be and why?
Michele – Okay, Lady Gaga,
Isabelle – Lady Gaga. I like that.
Michele – Because she’s so incredibly cool. And she can even look cool and an old pair of black jeans at the Oscars, so and I can’t sing it all. So I would like to sing like Lady Gaga and be able to carry up carry off an outfit like that and still seem cool.
Isabelle – I love that. I love that that is a very good answer. How can people get a hold of you?
Michele – They can reach out to me at the Klaros group and on LinkedIn.
Isabelle – Okay, perfect. Well, thank you very much for your time and for coming on the show. It’s been lovely to have you.
Michele – Oh, it’s been my pleasure, Isabelle.
Isabelle – As always, you can chat with me on my personal LinkedIn or Twitter @IZYcastrowrites.
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That’s it from me. Until next time, enjoy your downtime.
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