May 13, 2022

3. Michael Dowling, Mode Eleven - Building Banks

Michael Dowling




Mode Eleven Bancorp

My guest today is Michael Dowling, co-founder at Jewel, the first de novo Bermudian bank in 50 years, and CTO at Mode Eleven Bancorp here in the US. Michael has been at the forefront of designing bank technology for over a decade. He brings a unique perspective on how building a bank is different than building other types of startups, the role for banks with crypto and stablecoins, why banks and startups should partner rather than try to go it alone, and how banking can play a vital role in revitalizing local communities. Please enjoy this conversation with Michael Dowling.

Jared Klee: Hey, Michael. Welcome to the show.

Michael Dowling: Hey, Jared. Thank you.

Jared Klee: I wanted to start the conversation on banking. Most of the conversation happens from a tech angle.

Yet you've now spent well, most of a career building banks from the ground up. Why banking? Why does banking even matter? Why not just go focus on the tech instead?

Michael Dowling: In banking, the entire technology problem is one of scale. It's about processing incredibly important life transactions for other people so that they can engage in commerce quickly. The entire process around that has to be fast and it has to accommodate millions and millions of interactions per second. That's interesting.

And you are going to touch millions and millions of people in banking as well, because whether they have a simple checking account for paying bills, or it's a mega national corporate dealing with treasury management problems, you're going to be touching a significant amount of the population with whatever solutions you may be coming up with in banking.

That's why banking. I want to create products that touch people in some way that improves their life in some way and improves the problems of scale in that part of their life. If money is our blood of society, banks are the hearts. That seems like an important thing to focus on.

Everyone likes to talk about banks because that's where the money is. So clearly go into banking because money. Okay. Well, sure.

You borrow money at one cost and you lend it out at another cost. You know, that's easy. There's a whole bunch of complications in there as well. You still put in a significant amount of work, sweat, blood, tears to get that business going. It doesn't just kind of happen.

Jared Klee: Why not just go set up a PayPal? What's the fundamental difference there between a service like a PayPal and its many peers and the highly regulated space of banking.

Michael Dowling: PayPal looks and acts like a bank for everybody. Right. But they're not a bank. PayPal is storing that money somewhere. Can you guess where they're storing that money?

Jared Klee: I'm assuming at a bank.

Michael Dowling: Okay. So behind all of this stuff Behind challenger banks, like Chime and Mercury, behind apps like this PayPal, behind Venmo, behind all of these things. Can't believe I'm saying this, behind Circle and USDC, behind GUSD all of that stuff, are banks. Banks act as the core regulatory and operational infrastructure for managing value.

That has to be there. Now, what banks are terrible at, and a lot of it is because banks spend a significant amount of capital on compliance, operations, et cetera, to stay within the boundaries of law and regulations and to maintain safety and soundness in our system.

They have a difficult time allocating resources to things like amazing user experiences. Although there are exceptions to that rule, by the way. But as a general rule, banks don't do that and they don't know how to do it. Product development, technology development, it's a specialized skill.

So what we're seeing is that banks are sticking within their core competencies, building solutions to handle scale, and then selling those products, scaled products to other providers, PayPal, Venmo, USDC, et cetera. And let them handle the user experience, let them handle value added services on top of that.

But at the end of the day, if it deals with money and it touches money and it's, by the way, other people's money, you need to keep that safe and sound. There's regulations that govern what that means. And we have to do that. So let's rescue the PayPals from the majority of those regulations. Keep them in these banking institutions, let them handle the money management.

Jared Klee: When you talk about the scale, the ability to affect millions of people, it's not just that direct relationship of: hey, I know I have an account at that bank and I'm opening your app every day. You have that indirect exposure to those consumers who might be coming in through a money services business, might be coming in through a quote- unquote mobile banking, neo bank that under the covers, they're not actually banking. They're just doing the user experience, user service side of it.

Michael Dowling: To be fair, they're doing more than user experience. They're also adding value added services. A lot of these fintechs, some of the value added services that they're trying to provide are things like earlier access to paychecks if they do direct deposit. This is not a new concept, but how it's delivered is kind of new.

There's also different ways of handling overdraw type of experiences. The FinTech can manage those services. They can have different procedures in place for managing overdrawn accounts, including how the fees are allocated, if any. They can manage that and take that away from the bank. That's value add.

It's more than just a user experience. And I think we're seeing kind of an acceleration of what those value added services could be. That's kind of where the crypto stable coin things are going because they give the appearance of very, very, very fast settlement and the interaction of using them in automated smart contracts.

That's great. That's a value added service, but at the end of the day, they're still a bank behind there. There's still somebody managing the system itself.

A stable coin is nothing more, nothing more than a really, really up to date balance statement from a bank. Now there are some other attributes to it, obviously, right. I can adjust to my balance relatively quickly. The second one is I authenticate to my own wallet, I don't authenticate to the bank. That's the difference.

Why in the world would, I want to be an issuer without a banking license? And we saw that actually a stable coin started to come in. Right? Stablecoin issuers went back and forth on do we just hold cash? And by that, I mean, hold cash at the bank or do they go and buy things like, oh, I don't know, commercial paper of various flavors and kinds and so on so that they could make some money on the back end or treasuries, right, which would be what a bank would probably do.

At the end of the day, you look at this, take a step back and look at this. These are banking activities. This is what banks do. And there are rules. Regulations, very, very established practices around how to manage all of this.

I don't want to be an issuer without a banking license. The bank is still the one that's holding the cash. The best I could do is make money on, I suppose, some form of interchange as you move money, but that's not sustainable. Part of the promise of crypto was cheaper transactions. So if we're bringing back the transaction fees here, I'm not sure exactly what we're solving for.

But as the bank and the bank as the issuer, all you're really doing is saying instead of a bank statement that you get on mobile banking, or let's go back to the nineties on your bank statements we're going to put it on your phone and you can change that balance and authenticate on your own device.

That's powerful and very interesting, but at the end of the day is a bank's activity. Now that I'm just talking about the issuance of stable coins, the redemption of stable coins, but now we're going to get into what about the transfer of stable coins? The value added services that could be provided?

Think about the treasury management applications. That could be really cool. That's where technology companies again, should be coming to the play, should be coming to to develop interesting solution. But it's still a bank in the backend.

It's really only a bank that should be issuing those types of assets with technology companies creating the innovative solutions around them.

Jared Klee: Now you've been deeply involved in the stable coin space. There's a proposed new bank in Bermuda called Jewel that you're one of the co-founders, I believe you're behind the design of most of the technology system. Why Bermuda of all places to go launch?

Michael Dowling: One reason is as we started to look at what a bank structure for a stable coin would look like, we also had to take a look at current regulations in the United States, current regulations in the European Union, Japan and et cetera.

The interesting thing about Bermuda is that they passed, I believe in 2018. The DBA act and it provided a general framework for how financial and non-bank financial institutions within Bermuda, how they should treat digital assets on their balance sheets. That also provided the monetary authority in Bermuda, the authority to license banks that primarily do business in crypto. That was critical to the creation of a bank.

Again, this is in 2018, 2019 general area, there was no such framework in the United States for this. Anything that anyone was doing in the United States, similar to what Jewel is trying to do in Bermuda, they're really taking giant risks.

In fact, I did take one of those giant risks. And the risk that you're taking there, you have education with regulators to talk to them about what it really is that you're doing, and you have to do it in a way that is educational. But also, you have to speak with authority on how it affects the system itself. You can't just say crypto fixes stuff. You have to actually point it to real problems. Then you have to work with legal teams of all different shapes and sizes. And of all political persuasions and et cetera, in order to craft regulations or possibly legislation that allows you to do what you're doing.

It's a long haul and a very expensive and capital intensive one. And if you are not a billionaire yourself, it's a difficult thing to do without private investors. And private investors getting involved in a Denovo bank in the United States is itself a bit difficult. You clearly want some kind of FDIC insurance if you're going to do a banking institution in the United States, somewhat weird not to have that, especially if you touch consumer money. FDIC is very clear about how you must treat investors before formation, before your bank is formed.

The FDIC requires you treat all your investors before formation the same. That means no Series A B, C, D stock. None. They all have to be priced the same before formation. Only after formation can you have different price stock for capital raising. That's kind of a non-starter for a lot of investment houses, right?

In Bermuda, the situation was slightly different. They did not have those restrictions. And in Bermuda, there was a framework already in place that the bank can fit an application in. It took some time, but Jewel did work with the Bermuda authorities closely on the design of the bank itself, its compliance systems, and it's risk management philosophy, which is key here.

As well as they also consulted on the technology design at a pretty low levels, actually. I was really impressed that a regulatory agency went so deep into technology design as part of an application. And through that process, Jewel revised its business plan and got their conditional approval in October.

And so they're in the final phases of getting this bank formed and launched. I'm really proud of that team.

Jared Klee: That's a two year journey, even with a regulatory framework, to get a bank off the ground to the point where it can apply for conditional approval.

Michael Dowling: And I'm going to tell you right now, the ups and downs during that process were extreme. We went through periods where we weren't sure if payroll was going to be made. But again, Do we want to be real? Do we want to be an institution that has proper oversight, making sure that other people's money is safe and sound and that we are interacting with other financial institutions in a safe and sound manner.

That's what we're really gonna go after. I don't want to not have the regulatory framework around me while working with other people's money. There's just too dangerous.

Jared Klee: What you're articulating is a fundamental difference from a venture back startup versus a bank. And it's not one's right, one's wrong. It's the problem you're solving for. When you talk about venture backed, the folks who are building the better customer experience, the value add services on the front.

Yet, they're building a company on other people's money with the hope of reaching scale. But the nature of that business is most of them will fail in the attempt to reach scale. What you're talking about when you say other people's money is: priority number one is not to lose it. It's not to get huge, it's to not lose it.

You're starting from a totally different base of how you build a company.

Michael Dowling: That's correct. Your first product as a bank is risk management. That's it. You have to determine as an institution, what is your risk tolerance? Can you identify the risks in your business plan and then how do you plan to mitigate those risks?

That's essentially what regulators want to know. That's the framework you have to have in your head every single day. Is the activity that I'm involved in, does it meet my risk threshold? If it does or does not, what is the potential impact to my client's funds, other people's money, if things go awry. And when, and if they go awry, note I'm saying when, what do we do to keep it safe and sound? And that's essentially the business of banking.

A banks real job is to find a way for people with a certain type of asset, some fixed asset, like real estate equipment, what have you to inter operate with the balance sheet of another company. What I mean by that is when the two want to purchase with each other. What are they purchased with? They don't purchase wood, slices them, their land, and they don't purchase with slices of farm equipment.

The bank steps in the middle, takes a lien on the property at either end, and allows the two to interact with cash. And this is some of the most fundamental misunderstandings of banking. Everyone likes to say banks, just print money, willy nilly. It's totally false. It's backed by the collateral of the loan, which creates the money.

So if the loan isn't repaid, the collateral seized, which essentially repays the debt, now the money has disappeared. The bank's role is to make sure that in that process, we are looking at all the risks of this process. What if this person is borrowing too much? What if this person doesn't really understand the quality of the collateral on the other end, which is also part of the bank's job to understand the quality of the collateral, manage the risks around that. That's what real banking is. That's what separates a bank from a trust as well. We have to remember that.

Jared Klee: What's the nature of the businesses that Jewel is getting involved with and to use your word, what's the nature of the collateral and how has that manage behind the businesses that Jewel intends to pursue?

Michael Dowling: Jewel has two fundamental obligations. In the United States, I think we call it community re-investment obligations. But for Jewel, it needs to serve as Bermuda in addition to the rest of the world. But Bermuda is first.

They're also only four banks in Bermuda. There have been only four banks in Bermuda for 50 years. Jewel is the first in 50 years to come onto the scene. And so what it wants to do in terms of the collateral, obviously there's land within Bermuda and it's going to get involved in some mortgage activity there.

But there is a new asset that starting to become more legitimate. And that's this digital asset thing. Now I'm going to make a separation here between stable coins as currency, pure play digital assets, Bitcoin Ethereum, sheba inu, and real-world assets tokenized on a blockchain. Jewel wants to take certain collateral in the form of pure play digital assets, and those are the ones that have the most liquid market have the most utility and it wants to lend against those assets.

Let's say Bitcoin would come onto the bank's balance sheet or through a sub custodian, and the bank will lend against that. And again, that's allowing people that have large amounts of crypto capital to be able to convert that to cash, to use in commerce down the stream. That's what banking does.

How much money gets lent based on how much of those tokens are pure play cryptocurrencies come in is just dependent on the asset itself. So for example, Bitcoin being as volatile as it is, you have to lend as if it's security, as if you're talking about stock and that's usually done at 200%, right. But for something like a house or real estate, it's different, you can probably lend up to 80% of that value.

Jared Klee: Jewel was not your first rodeo in the banking world. You hinted at this with a de novo bank in the US. What was that vision for the de novo bank in the US and how did that play out.

Michael Dowling: I found a couple of other partners and we started to go down the road of doing a Denovo bank based on the idea of being a banker's bank for other banks. sure everyone has heard of a bank core processor. If you haven't it's the heart of the bank. It is the software system or set of systems, which process transactions for that bank and then sends them to other banks and yada yada, yada.

One problem with that is with these systems is any kind of change you want to make to them, for example, you want to add a new asset or you want to add new types of transaction codes, or what have you, it's a process. It's a big risk management process that can take years. So if we know that and we think stable coins are going to be a big deal, and we know that stable coins should be managed by banks, how do we do this and accelerate the process.

And the thought was create a banker's bank that works only with other banks and the bankers bank itself holds nostro accounts at each of those other domestic banks and through depositing into these nostro accounts and withdrawing into them, the banker's bank can issue and redeem stable coins on behalf of that bank, to those banks' customers without those banks customers knowing about the banker's bank. Because again, with these banks, you don't want to get in the way of their customer relationships. That was the idea.

Domestic correspondent relationships are well-known in the United States. Well-tested, have a set of best practices. We know how to deal with nostro accounts domestically. The structure itself was something that other people could consume, understand, doesn't require core processor changes for those other banks.

We worked with legal teams of various flavors and sizes to get it right. And we worked with the regulators very closely. We even worked with the innovation group at the time. Then we went up to licensing with Steve Lybarger and all of them to try and talk about this kind of a bank. We got pretty far, I'm really proud of the work that we did there, but at the end of the day, it's really hard to raise money for research, which is what it was becoming.

We were essentially a research arm for our regulators. Not by request, but because we had to, in order to, execute on this idea. That would be fine. I suppose it'd be an easier sell if I could say well, earlier investors get this much of the bank at the very beginning. And then as you make progress, you know, it becomes less and less and less valuable, but you cannot do that with an FDIC insured bank.

And ultimately I failed at fundraising. And I learned a lot of lessons through that. It's really important as a bank to stay in your lane, to make sure that you're doing all the things you should be doing as a bank to make things safe and sound.

When I look back at that experience, besides being a little green at fundraising and potentially a little naive about what could be done there. The other big lesson I learned is even saying that the bank should just be the issuer for all other banks was too broad. It was too ambitious and I needed to scale that down even further.

And those are the lessons that I've applied to my advisory work with Jewel and then over at Mode Eleven.

Jared Klee: I'm guessing, given how you're describing it, Mode Eleven is taking a different path than what was attempted with Frank Financial.

Michael Dowling: Mode Eleven is really focused on developers. It wants to focus on the activities of being a bank and it wants to enable other institutions to be able to provide really innovative financial services to their customers while using the bank as a core utility.

At the end of the day, how have banks have evolved? A lot of the evolution is not by regulations, not by money management, not even the technology used to record money. None of that has really been a change at banks. What has been changing are the channels of interaction.

So leading all the way up until the eighties and nineties, it was the branch. The branch was your interface to the bank. Then ATM's kind of came into play. Then debit card. And online banking and et cetera, et cetera, et cetera.

Our interface for Mode Eleven is APIs. That's it, plain and simple. We provide our fintechs easy APIs to create financial services. We take care of the operational pieces and the compliance pieces. Let the innovators do what they're really good at. We did things differently as well. A lot of banks want to also get into this and that's exciting by the way, that's going to create so many amazing financial products for people as more and more banks get into this. It's just so net good.

Our approach though, on this is somewhat unique, we put the investment in technology. There's a difference between banks with technology groups and FinTech focused banks. The key difference is how the development team is accounted for. In almost all banks, technology is a cost center. They're going to talk about the costs of technology, which includes the personnel, et cetera.

At Mode Eleven, that's not how it's accounted for. Developers are revenue generators at Mode Eleven, and the channel is APIs. So we build APIs, we build channels and that directly increases the revenue of the bank. That's where we're a revenue generator. We are fanatical I think is the right word around automation at every step in our operations. So there's where we affect our bottom line as much as possible.

And then the technology group of Mode Eleven is intimately involved in community reinvestment in unique ways. In that case, it's hitting all three big pieces of a bank. Where's revenue, where do we keep costs under control? And then how do we reinvest back into the communities in which we serve?

It's amazing that we were able to do this. But that's ultimately what Mode Eleven is trying to accomplish here.

Jared Klee: For Mode Eleven, how is it getting involved in those local communities?

Michael Dowling: Mode Eleven, which by the way is just a recent name. The bank before Mode Eleven, the parent company called Hewlett Bancorp, and the bank underneath it was called Summit National Bank. This bank served local rural communities in Wyoming, Idaho, and Montana. It actually serves a critical function in each of those communities, by being only one or two, maybe three banks in some of these cities that provides financing to agriculture, agribusiness and the like.

I'm not making this joke more than once on your podcast, Jared, but I have to make it. Cattle is a common piece of collateral here. The cow-lateral.

Anyways. Um, Okay. Uh, The bank continues to service these communities actually as a part of our agreement with regulators to be able to do some of these really interesting FinTech businesses. We said we're going to continue to serve if not expand in those areas, because it's critically important that we continue to provide those businesses financing.

So The really cool thing about Mode Eleven is that we have local presence still, branches in these communities, and we can continue to help and service those communities with normal banking. And then as an organization in total, if we are successful in what we're doing, the communities are going to benefit the most from that. So even though the bank itself was very hyper-local, it's now becoming more national, that national presence will help those local communities. It's a really cool setup. I'm excited about it.

Jared Klee: Michael. I love it. So as we wrap up, I want to ask you one question and then a closing question. You started off talking about how banking allows you to scale and service and engage millions of users, do things at scale that you couldn't before, and that's wonderfully rewarding. And now you're closing on building a bank that had a presence, it's now scaling to millions of users, but the meaningfulness of being able to continue to engage at small scale in local communities.

Just talk to me the personal drive of what it means to be able to keep working, what's really an old school way of thinking about banking of the beating heart of these local communities.

Michael Dowling: I mentioned before during the pandemic, we saw a giant demographics shift and we also saw a big shift in behavior. There has been a dark side to that. The tokenization of everything. And by the way, this is independent of crypto. It's really about financialization, tokenization, everything, whatever you want to call it.

I get that greed is a part of our psyche and greed does drive human behavior. By focusing on that we can provide incentives that help control the greed. I get that. I feel like those incentives have become somewhat perverse lately. And I think this is an opinion more than anything, but we are awfully hyper financialized and hyper focused on finance. And I think we all have to remember that finance is a tool. It's the blood of our economy, but it is not the muscles of our economy. We have to build the muscles, the businesses that provide direct value to people.

I only bring that up because the one thing I'm really proud of, especially in Summit, now Mode Eleven, is actually putting the local communities and what they need to do to survive. Remember, our food comes from local communities like this. A lot of our energy comes from local communities like this. We need this. This is like level zero fundamental needs of humanity.

We have to remember to work with these local communities, understand what they actually need. Do they really need stable coins that they just need basic banking services to perform their jobs? Can stable coins help them? Do they need special loans? Would they prefer to interact with their bank using something like chime, et cetera? And then what can we do to help increase the flow of commerce in these communities to make them more efficient?

These are all things that affect real human activity that we really depend on. And that is something I'm really, really proud of. It's about enabling local communities to empower themselves, create new businesses, be innovative in that area. I'm proud to be a small, small part of that.

Jared Klee: That really brings what banking's all about home. Closing question, Michael, same question for everybody. What's the biggest win you've had? That could be personally, that could be at work, anywhere you want to take it.

Michael Dowling: I lost my company. That is the biggest win ever. It was a gut punch. It destroyed my ego. It tore me down, got depressed. It was terrible. And it was a nightmare, but you know what, it taught me so much in such a short period of time. Experience and knowledge that I look back on as incredibly valuable. And there's really only one way to get that experience and that's by failing and then picking yourself up, wiping the dust off and moving forward.

Maybe that comes easy for some people. It didn't for me. And going through that process was just enlightening.

Jared Klee: It's an awesome answer. Michael, thank you for coming on.

Michael Dowling: My pleasure, Jared. Thank you for having me.

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