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The Robinhood Checking Account Was Doomed To Fail

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OBSERVATIONS FROM THE FINTECH SNARK TANK

By now, you've probably heard of the financial services industry's version of the Payless Shoes prank: The Robinhood checking account with a high-end 3% interest rate on account balances that a lot of people were tricked into thinking was real. According to a Forbes article:

"Robinhood’s checking and savings accounts have no account minimums, no monthly fees, no overdraft fees and no foreign transaction fees. The new Mastercard debit card can be used for free at 75,000 ATMs around the country, and Robinhood will start shipping the cards to customers in January. Cash in the [accounts] is insured up to $250,000 by SIPC, according to a Robinhood spokesperson."

The game plan was to invest deposits in the account in Treasury securities. With short-term Treasury yields well below 3%, the startup brokerage firm expected to take losses on the account.

[I'm reminded of the episode of The Office where Michael Scott starts his own paper company and his accountant tells him that the price he's planning to charge will result in a loss. When asked how he expects to make a profit, Michael replies, "We'll make it up on volume."]

Turns out that the Robinhood account wasn't insured by the SIPC, though. After being mocked by the fintecherati for being nothing more than a money market account (and perhaps some scolding from regulators and a snoozing compliance department), plans for the checking account were shelved.

The Account Never Would Have Succeeded

It's just as well. It never would have succeeded for one obvious reason and one less obvious reason.

The obvious reason: It would never have been profitable. Consumers aren't dumb. If everyone else in the market is offering 1.5% interest rates (or lower), consumers figure that a 3% offer has to be an introductory offer or come with strings attached.

Robinhood claimed that the 3% rate wasn't an introductory offer. That's crazy. Unless--and until--rates rise, the company would have been looking at huge losses on the accounts. Profitability of the account would have been hammered by:

  • Declining interchange rates. As far as I can tell, the account didn't come with strings attached--i.e., requiring account holders to make a minimum number of purchases with the debit card. The longer-term trend in interchange rates is downward, making interchange revenue a shaky strategy to hang your hat on.
  • Reward costs. Want to get people to use your payment card? Offer better rewards. In reality, Robinhood's 3% interest rate was the reward. Despite being a superior deposit rate, it's not necessarily a vastly superior reward in light of credit cards from Bank of America card offering 3% cash back on gas purchases, and from Capital One card offering 4% cash back on restaurant spending.
  • Delivery and support costs. More than half of Millennials have their primary checking account with one of the four Megabanks. Why is that? Because those banks offer superior interest rates? Hardly. Because megabanks are kinder, gentler banks appealing to Millennials' sense of civic duty? Yeah, right. There are two reasons why Millennials bank with megabanks: 1) They don't really care who they bank with, and 2) Megabanks offer superior mobile banking tools. Robinhood would not have attracted the Millennials who bank with megabanks for the first reason. And it would have been hard-pressed to match keep up with the mobile banking innovations coming from the megabanks. Mid-size banks spend roughly $9 per active online banking customer per year and another $4 to $6 per active mobile banking customer per year. Do you think Robinhood took those costs into considerations when it slapped a 3% rate on its account?
  • Marketing costs. For sure, Robinhood would have attracted some consumers with a 3% interest rate. After all, look how well Goldman Sachs has done with its Marcus product which has offered superior rates and has amassed roughly $25 billion in assets. But Goldman spends about $80 million a year marketing Marcus. Does Robinhood have that kind of money? They would have needed it. According to consumer research conducted by Q2 and Cornerstone Advisors, about eight of 10 Younger Millennials (i.e., those in their 20s) and seven of 10 Older Millennials (in their 30s) and Gen Xers have never heard of Robinhood.

The Account Flies In The Face Of Emerging Consumer Behavior

The less obvious reason is that--despite the fact that 94% of US households have a checking account--the importance of a checking account in consumers' portfolio of financial accounts has diminished.

Checking accounts have become "paycheck motels"--temporary places for people's money to stay before it moves on to bigger and better places. Consumers get paid, and through direct deposit, put their paycheck in a checking account. But that money often leaves the account to go to:

  • Health savings accounts. Nearly 25 million Americans have a health savings account (HSA) with more than $44 billion sitting in those accounts. That’s $44 billion that used to go into checking accounts, but now gets diverted—typically in the payroll processing process—before the money even gets to the checking account.
  • Person-to-person (P2P) payments apps. In 2018, Venmo will process more than $64 billion in P2P payments, with Square Cash doing about $30 billion. Users of these two services leave so much money in those “accounts” that both services are branching out (pun intended) into other types of banking products.
  • Merchant apps. Got the Starbucks app on your mobile device(s)? Got money in the account? Of course you do. So do millions of other people. A conservative estimate is that there's $2 billion sitting in those accounts. It could be double that. And now other merchants are realizing the profitability of that strategy. The result: More money coming out of checking accounts.
  • Robo-advisor tools. Consulting firm AT Kearney estimates that by 2020, consumers will have more than $2 trillion sitting in robo-advisor accounts. Perhaps the more interesting and relevant prediction is that half of that will come from funds currently sitting in deposit accounts. Ironically, the success that Robinhood has had with its brokerage account is the result of this change in consumer behavior.
  • Saving tools. While banks offer savings accounts (with near zero interest rates over the past few years), new providers have launched savings services that actually help people save money. According to the Q2/Cornerstone research, consumers have opened roughly 7.2 million accounts at savings tools providers like Acorns and Stash and will use them to save about $5.6 billion in 2018. In contrast, consumers have opened only 3.6 million accounts with Neobanks like BankMobile, Chime and Varo, and have just $1.7 billion in those accounts. A superior rate is great but people want help saving money--at whatever rate they can get.

There's A Bigger Issue Here

The Robinhood account announcement isn't an anomaly. In the same week, another Neobank called Good Money launched. The firm--touting a 2% rate on savings, free ATM withdrawals, no overdraft fees and even ownership in the bank--promotes itself as a "socially progressive financial services provider."

Beyond the similarity in account features, there's an underlying philosophy--I would call it a malady--common to Robinhood and Good Money, as well as a number of fintech startups:

Bank Displacement Syndrome, the belief that traditional banks can be displaced with nothing more than a digital checking account.

It's fine to aspire to disrupting banks and inventing new financial products and services. But fintech startups may be vastly--and dangerously (for their own and their customers' financial health)--overestimating consumer demand for their services. Why?

  1. There is no huge mass of disgruntled bank customers just waiting for something new to come along. In fact, JD Power has found that Millennials' satisfaction with large banks is on par with their satisfaction with smaller institutions.
  2. Younger Millennials are not the ones opening Neobank accounts. Time and again, fintech founders refer to the opportunity to serve young Millennials who reportedly need help managing their financial lives. The problem with that view: Of the 3.6 million Neobank accounts, half were opened by Gen Xers, 38% by Older Millennials.

Bank Displacement Syndrome will be the downfall of some of today's fintech startups. Fortunately for Robinhood, the firm already has a viable service in place. Other Neobanks may not be so lucky.

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