Disrupters partner up with the financial establishment

Employees at MasterCard thought they saw a drop-off in credit card volume last spring at one of their merchants, a legal services provider. Checking further, they found they had a new competitor, Behalf, a startup small-business lender backed by two venture capital firms that makes credit decisions in just a few seconds.

But rather than play defence, a reaction banks and credit card companies were likelier to have not that long ago, MasterCard engaged Behalf and worked with the startup to help arrange for its customers to use MasterCard’s system to pay their vendors.

The MasterCard-Behalf alliance, which has not been publicly announced, is an example of how entrenched financial players facing challengers armed with new technology are increasingly seeking to work with them.

The new attitude comes as disruptive businesses are being taken more seriously. Lending Club, for instance, which competes with banks and credit cards by matching borrowers and lenders on the Internet, went public in December at a valuation of more than $8 billion. Two months earlier, Apple introduced ApplePay, a mobile payment service that uses existing bank and credit card systems, though it raised the specter of future upheaval. “At first, we saw the banks and credit card companies were aware of the disruption but didn’t realize the scale it would reach,” said Shmil Levy, a partner at Sequoia Capital, one of Behalf’s venture backers, along with Spark Capital. More recently, he said, “we are starting to see the banks trying to cooperate instead of being displaced.”

Investing in start-ups

A year ago, MasterCard created a division to engage with financial innovators, making a handful of investments in startups.

In October, MasterCard announced a partnership with Zwipe, which makes a credit card with a fingerprint sensor, and in November, it bought a stake in a company now called Nymi that makes a wristband that uses a heartbeat to authenticate a user’s identity. In December, it invested in Dynamics, which makes cards with buttons and displays that allow users to, for example, pay in different currencies or choose credit or debit. In recent presentations to Wall Street analysts and investors, MasterCard has also talked about or shown soft-drink machines and washers and dryers with links to its mobile payment system.

"We are open to any and all conversations," said Garry Lyons, the chief innovation officer in Dublin for MasterCard. Although "disruption is a potential threat to established companies," he added, "we're open to working with new emerging companies" to serve customers' needs. He said MasterCard and its customers could both benefit from "access to external thinking".

Last month, American Express opened a new technology hub to expand its presence in Silicon Valley, focusing on innovations in big data, cloud computing and mobile payments. Citigroup has a venture capital arm that has invested in companies "with the potential to disrupt and transform" financial services. And in August, Wells Fargo inaugurated a "start-up accelerator" to invest in companies that are developing tools for the financial industry.

Some of the upstarts have openly vowed to feast on the incumbents' longtime way of doing business, which relies on legacy systems and faces heavy regulatory scrutiny. The lingering hangover from the 2008 financial crisis also curtailed their ability to lend, especially to small businesses. "There's a tremendous amount of incumbent inertia," Pat Grady, a Sequoia partner who is backing Prosper, another online lending platform, said in mid-2013.

Game-changer

Matt Harris

, a venture investor who focuses on financial services technology at

Bain Capital

Ventures in New York, said that banks’ attitudes had shifted from disdain five years ago to a greater willingness to “partner with the disrupters” in the past 18 to 24 months. The first catalyst, he said, was the advent of Square, a Silicon Valley mobile payments service started in 2010.

“That got everyone’s attention,” he said.

He added that Lending Club and dozens of other similar online marketplaces threatened banks most directly because, in theory, they offer loans at rates below those of creditcards and offer investors returns above what they get on bank deposits.

Unlike an earlier round of profit-seeking venture initiatives during the dot-com boom 15 years ago, Harris added, the current round “seems largely driven by a fear of missing out, and the knowledge that entrepreneurs are gunning for what had historically been their exclusive province.” He added, “This is more like ‘Barbarians at the Gate.’”

As they engage with would-be competitors, the incumbents insist that they are keeping their eyes open.

"We now exist in a world of what we call 'frenemies'," said Leslie Berland, head of digital partnerships at American Express. "Many companies that we work with may pose challenges as well as opportunities."

As American Express works with partners in mobile payments, social networks and online retailing, she said, the card giant must consider, “more than we ever have before, what do we control, what does the platform control” and how to keep access to data needed to service and reward card holders and merchants.

Deborah Hopkins, the chief innovation officer at Citigroup who also heads Citi Ventures, put it another way.

“We do something we call the Pac-Man analysis of the models that are nibbling, maybe starting to chomp,” she said, “and how can we embrace them, how can we learn from the entrepreneurial ecosystem?”

© 2015 New York Times News Service