Sex toys and bank examiners

Here’s a colorful anecdote I came across in the comments of an interesting Hacker News thread:

Six months and several million dollars processed later, Stripe informs us we’re going to be deplatformed because Wells Fargo (their banking partner) had reviewed our account (apparently because of its volume) and determined we violated their standards because of the nature of the toys.

We did a bit of back and forth where Stripe suggested we alter the colors available (seriously) to assuage Wells Fargo’s puritanical concerns, and Stripe insisted it wasn’t their moralizing, but rather Wells Fargo (paragons of fucking virtue as they are), but we weren’t willing to compromise on the nature of our product or have our product’s options or colors dictated to us by one of the most corrupt banks on the planet.

We ended up deplatforming and moving to a high-risk processor who was willing to match our competitive Stripe rate. That processor sucks and their fraud protections are weak and their interface is garbage, but they’re not telling us how to run our business.

When I shared this on Twitter, people were very surprised, and that in turn surprised me. Yes, the specific details in this case are funny, which is why I tweeted it, but it’s par for the course of what merchants on the fringes of the mainstream deal with. Before I give you my perspective, though, I have to answer the first question most people asked: What was the offending color? Well, according to the merchant, here is the message Stripe sent them:

Our banking partners recently notified us that they are no longer willing to support the sales of realistic sex toys. I understand that your products were designed to depict the body parts of mythological and fantastical creatures, and we have indicated this to our banking partners in an effort to advocate for continuing to support your business here on Stripe. As a result of these discussions, our banking partners have agreed that they are willing to continue supporting your business as long as you are not selling products that are colored such that they might be mistaken for human flesh.

With that out of the way, here’s my take. I believe Stripe when it says they didn’t want to do this but had no choice. Stripe is an incredibly user-first company, and from what I know of the people there, this is not what they would choose to do. In fact, what I wanted to highlight in sharing the anecdote was how beholden payment service firms like Stripe or Coinbase are to their banks. Without a willing bank providing access to the payments system, they have no business, and they’re rarely doing so big that they can stand up to the banks.

So why does a bank like Wells Fargo care about the color of sex toys? Well, in this particular case, who knows? Maybe it was just an especially prudish rogue executive flexing their muscles because why not. But in general, why do banks care about fringe merchants as long as their business is legal and lucrative?

The first thing to note is that fringe merchants are often not that lucrative since they’re probably correlated with higher numbers of chargebacks, etc. It might be easier and more cost-effective for a bank to prohibit a whole class of merchants than it is to police them. But that seems like a problem that can be outsourced to partners like Stripe who are well-positioned to do that kind of policing profitably.

What better explains seemingly irrational “derisking” could be the fact that banks also have someone they’re afraid of: their regulators. More specifically, though, it’s their bank examiners. Most people don’t know this, but large banks have government employees called examiners located on-site in their offices literally looking over their shoulders.

Just last month OCC chief Brian Brooks penned an op-ed lamenting that COVID lockdowns have kept examiners out of bank offices, and promising they’ll be back. Here are a couple relevant snippets:

In his 1971 book “Silent Messages,” Dr. Albert Mehrabian posited that a vast majority of a speaker’s credibility is conveyed through nonverbal cues rather than by spoken words. …

Now apply that concept in a complex discipline that requires individuals to identify risk and to assess personal motivation, which also requires the close analysis of thousands of datapoints arrayed across a variety of disciplines. That is the challenge of a bank examiner, whose work relies on open, honest and effective communication.

That communication and the relationship between examiner and banker work better in person. And because of that, bank supervision remains a high-touch business. …

As former vice chairman of a bank, I saw firsthand the value of on-site supervision. What I appreciated most was how accessible examiners were and being able to simply speak with them any time — in the hallway, cafeteria or conference room.

Examiners are there to look out for risk and ensure the safety and soundness of banks, and they can do this precisely because they don’t share the same incentives as the bank. However, their incentive might be to avoid risk at almost any cost. That’s because they’re not rewarded for taking a risk that pays off, but will get dinged for risk-taking that blows up. The result is that completely legal activities will go unbanked because examiners see them as too risky (or even politically problematic as we saw with Operation Chokepoint).

And here’s the insidious thing: An examiner doesn’t have to be explicit that he wants a bank to cut off a perfectly legal business. As Brooks points out, body language goes a long way. All an examiner has to do is start asking question about a particular customer or class of customer. No matter the answers, he can just keep asking questions and demand to see more documents, etc. At some point, doing business with those customers isn’t worth the hassle with the examiner in the office next door, and so a line of business is “derisked.” And yet the examiner never said the bank couldn’t take the risk on the legal business; they were just asking questions. Next time the examiner frowns or raises their eyebrows at the mention of a particular business, the bank executive will think twice.

In reaction to my tweet, many said this highlights why we need cryptocurrency, and that’s true. As I’ve written at length, if we are to preserve the individual privacy and autonomy necessary for an open society, we need digital cash as an escape valve from intermediated payments. That said, cryptocurrency exists today and fringe businesses are barely using it. If asked, they would much rather use Stripe. I don’t think it’s heresy to say that Bitcoin has much to improve before it can be a serious payments option.

Which leads me to a provocation. If what you care about is not not inflation-hedging or state control, and instead what you want to optimize is the ability of people and businesses outside the mainstream to be able to freely and easily engage in legal commerce without having to worry about the whims of banks or other intermediaries, then what you might want to wish for is a token-based, bearer, and anonymous digital dollar from the Federal Reserve. Official U.S. digital currency with those features could solve the problem of unjust derisking of edgy users. You could sell whatever legal product to whomever you wanted and in whatever color.