Death of Innovation? A Banking Startup's Swift Demise

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If death certificates were given to failed financial services startups, the certificate for TandemMoney might list the cause of death as "unwelcome scrutiny from federal banking regulators."

The South Dakota firm had partnered with two banks to deliver its concept-a prepaid debit card that let customers borrow short-term money so long as they set aside $20 in savings every month.

TandemMoney wanted to be seen as an innovator that helped wean people off high-cost loans.Instead it will be remembered as a cautionary tale-its downfall a reminder of the pitfalls for companies that are trying to develop consumer finance products, especially those geared toward the underbanked market.

Though the goal of expanding access to financial services has many backers, support for how to best do so is splintered, with strong disagreement over where to draw the line on consumer protection.

Some advocates for the unbanked saw TandemMoney's savings requirement as an intriguing innovation. But other consumer watchdogs denounced it, calling it a payday loan in disguise.

In July, the Office of the Comptroller of the Currency took action against one of TandemMoney's partners, Urban Trust Bank of Lake Mary, Fla., ordering it to prepare an analysis of the risks associated with its prepaid debit program.

According to BankTalk, the blog that broke the news of the company's shutdown this fall, concerns about the regulatory scrutiny led investors in TandemMoney to pull out.

Trent Sorbe, who was TandemMoney's president, blames the company's demise on regulators. Responding by email to questions from American Banker, he calls the firm's closure "another unfortunate example of a regulatory environment that discourages innovation, scares away private capital, and ensures that banks will never threaten the grip nonbank lenders have on the provision of small dollar consumer credit."

Sorbe would not say how many customers the company had, or answer other questions about why it shut down.

TandemMoney's fall came fast. It was only in September 2011 that the company was featured at Finovate, a national conference highlighting young, technology-oriented firms in the financial sector.

TandemMoney used the marketing slogan "Financial Freedom Starts Here." It won accolades from some advocates for the unbanked, because its approach acknowledged that low-income borrowers often find themselves trapped in a cycle of debt that prevents them from building their own rainy-day funds.

A potentially more problematic aspect of TandemMoney's concept involved its relationship with the banking system.

The company's prepaid card was offered by Urban Trust Bank. The direct deposits were supposed to flow into that account, while the savings account and line of credit were provided by Premier Bank of Rock Valley, Iowa.

Splitting the customer relationship between two banks allowed TandemMoney to work around federal restrictions regarding the garnishment of debt repayments from bank accounts where customers receive government benefits. But the set-up may have raised alarm bells with regulators.

The National Consumer Law Center, a nonprofit advocacy organization, voiced a more fundamental objection to TandemMoney's business, though. It argued that prepaid cards should not be allowed to have credit features at all.

"We believe that prepaid cards ought to be prepaid," says Lauren Saunders, a lawyer for the NCLC.

She worries that prepaid cards with lending features are being used to evade laws in states with restrictions on payday lending. TandemMoney's pricing also had concerned Saunders, who notes that customers who did not keep borrowing or saving would get hit, after four months, with a $5-per-month inactivity fee.

And although the concept's savings requirement had some attractive aspects, she says, it didn't always appear to mitigate the cycle of debt, and in some cases exacerbated the situation.

"The word innovation gets thrown around a lot to insulate bad practices, and we need to encourage the right kind of innovation, and not the wrong kind," Saunders says.

But Sorbe defends TandemMoney's concept as a financially healthier alternative to payday loans, which he says are structured to trap borrowers.

Adam Rust, who as the author of the BankTalk blog wrote several posts about the TandemMoney saga, expresses a general opposition to the commingling of credit and prepaid features in the same financial product. But he regards the savings requirement that TandemMoney came up with as a positive innovation.

"They had an idea that perhaps will be revisited," he says.

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Comments (3)
Blaming those damn regulators is far easier than admitting an idea is flawed, isn't it?
Posted by TJR Easton | Tuesday, January 15 2013 at 12:53PM ET
If the promoters of the scheme would not even answer American Banker's questions, why are you defending them in your mag?
Posted by williama | Tuesday, January 15 2013 at 1:28PM ET
Thanks for your comment/question. We're not defending them; just reporting on them ... and pointing out that innovating sometimes means running afoul of regulation, and that regulating sometimes means clamping down on innovations.

-Heather Landy, Editor in Chief, American Banker Magazine
Posted by hlandy | Tuesday, January 15 2013 at 1:47PM ET
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