Overview
I was not prepared to enter the fintech space, mostly because I had no plans to do so coming out of college. It felt like a repetitive, tedious, and stressful kind of software development. I could be building rockets or robots or whatever.
It's probably fair to say that I backed into fintech. As I grew in my role, I found myself onboarding other junior engineers that that were just as unprepared as I was.
What's particularly fun about fintech is that two people can come in with opposite assumptions about the same problem, but for both of those people to be fundamentally incorrect.
Below, I'm documenting a list of things that surprised me or my colleague at least once.
The First and Greatest Falsehood: Finance People Are Like Software People
One long-standing stereotype about finance people among tech people is that finance is rigid, rules-based, and logical. They're nerds like computer scientists are nerds, and they fundamentally value working in an unambiguous system of rules.
This is barely true in tech, but I one of the more common assumptions I see engineers make when entering the finance space is somehow more rigid than a console application. In reality, finance professionals are often frustrated with the artificial constraints imposed in their ERP or its penumbra of integrations.
What's more, finance professionals are inherently more deadline driven than developers. For developers, deadlines are more or less an imaginary construct imposed for subjective reasons. In finance, timeline could be driven by governments or business owners with real legal consequences. If you join a fintech company, prepare to have your calendar blown up very often in very material ways.
Loans
Broadly, I define a loan as borrowing something of value from someone. This doesn't have to be money: it could be time, labor, a stock, a property, etc.
The interest on a loan is always a positive number.
Recently, government interest rates neared record lows. The United States even toyed with lowering rates to 0%. That's free money from the government.
The interest on a loan must be at least zero.
Very rarely, someone will pay you money to borrow money from them.
The world really got its first taste of negative interest rate loans during the 2008 financial crisis as governments treasuries began charging their customers for the privilege of lending money to their government.
Why would anyone sign up for that deal? Holding money can be expensive, even when it's digital. You might trust the government to pay back its money one way or another if you don't trust the banks to do the same.
In the real world, when all other investments are showing a negative return anyway, your best best might be to just take the lowest loss you possibly can. Often, that comes in the form of a loan where you pay someone to borrow from you.
Loans are issued by banks.
This fallacy one is more obvious. You can loan your buddy $30 for pizza, and he can pay you back when his his next check comes in.
If you lend a buddy $10,000 to fix his truck, even without a signed agreement, you could take him to small claims for an unpaid debt.
One of the more interesting and common scenarios is around subsidiary loans. It's common for large corporate entities to want to transfer cash to a subsidiary through a loan, and there are two main reasons...
- The "subsidiary" is actually in the process of being bought, and they need a capital influx before the deal closes.
- They want to give their subsidiary capital without that sudden cash influx counting as taxable income.
In a lot of cases, you can lower your corporate tax burden by issuing a loan, and then later, you can strategically decide who takes the tax hit by repayment (subsidiary) or loan forgiveness (parent org).
Outside of the corporate-to-corporate scenarios, you can also find modern peer lending platforms where the loans are issued by individuals or groups of individuals, but managed by a non-bank entity.
Loans are issued by government-regulated institutions.
This is a little blurry because you need to understand some nuances. Some loans do not require a lot of government scrutiny or regulation, and frankly, many things count as loans whether the government knows that loan exists or not.
Loans are issued by exactly one legal entity lender to a different legal entity borrower.
Large corporate loans are usually issued by more than one bank or investor at a time, where one bank takes the role of raising that capital and tracking repayment. The loan investors don't have to be other banks, but everyone gets a share of the interest payments proportional to the amount of principal they invested. This is called a syndicated loan.
Sometimes, the original lender of a loan may sell a portion of the loan to other investors, creating multiple beneficial owners of the loan even though the borrower still interacts with the original lender. This essentially becomes a new syndicated loan when it started out as a simple relationship between two legal entities.
Loans have a one fixed interest rate.
This is a less common falsehood because most people understand variable interest rates, at least by the time they graduate college.
Many loans, especially mortgages, credit cards, and some personal loans have interest rates that fluctuate over time based on a benchmark interest rate (like the prime rate) plus a margin. This can lead to changes in monthly payments throughout the loan term.
Loans with variable rates are based on authoritative rate schedules.
While prime rate is used as a benchmark for variable-rate loans and is usually based on some sort of interest rate defined by the a government, the prime rate itself is set by individual banks and can vary slightly between institutions.
On a more intriguing note: the London Interbank Offered Rate (LIBOR) was once a key benchmark for many variable-rate loans. Basically, the London regulators would call up major banks (daily, on the phone) and ask them what their overnight interest rates where. That was, until, the UK discovered that the banks they surveyed could sort of fudge the numbers up and down, then make trades based on how much they thought they skewed the average.
Now hypothetically, if there were an authoritative schedule, you could grab it from some well known XML data feed... but your success may vary on that front.
Central bank loan rates are set by a common algorithm or formula.
Surprise, there's no formula. There might be some formulas, but those formulas usually are digested by a human along with the position of the stars, the direction of the wind, and the taste and temperature of the office coffee.
From a developers perspective, good luck predicting that with any accuracy. If someone gets a data feed from that coffee machine, be sure let me know.
Loans terms last at least one day
- Overnight loans: In the interbank lending market, banks often borrow and lend funds to each other overnight to manage their daily reserve requirements. These loans have a term of just one day.
- Day trading margin loans: Brokerage firms may extend margin loans to day traders, allowing them to borrow funds to buy securities intraday. These loans are typically repaid by the end of the trading day, making their term less than 24 hours.
Loans always are a listed as a liability for the borrower and an asset for the lender.
- Loans with negative interest rates: In rare economic situations with negative interest rates, the borrower effectively receives payments from the lender. In this scenario, the loan could be considered an asset for the borrower as they are receiving a financial benefit.
Loan default happens as soon as a borrower fails to make a scheduled payment.
- Grace periods: Many loan agreements include a grace period (often 10-15 days) after the due date during which the borrower can make a late payment without being considered in default.
- Cure periods: Even after a missed payment, some loans offer a cure period (e.g., 30 or 60 days) during which the borrower can bring the loan current and avoid default by making all missed payments plus any late fees.
Any automated process that forward to collections or marks a loan's asset value as 0 should take note.
Changes to loans must be reflected on the promissory note.
While your legal team would very much prefer for you to involve lawyers in your agreements, the real world isn't that tidy. It's common for two trusted partners to update the terms of an agreement via email exchange. No paper, no signatures, no encryption keys, no notary... just two pals coming up with a new way of doing things on the fly.
As one contract specialist I worked with would say, "If anyone's actually looking at the terms of the contract, you've already lost."
Once a promissory note is signed by all parties, a new legal document must be created to describe those changes.
- Loan modification agreements: If the borrower and lender agree to modify the terms of an existing loan (e.g., change the interest rate, extend the repayment period), they can execute a loan modification agreement that amends the original promissory note without needing to create an entirely new document.
- Addendum or rider: Sometimes, minor changes or clarifications to a promissory note can be made through an addendum or rider that is attached to the original document and becomes part of the loan agreement.
- Handshake agreements: In certain business contexts, particularly between long-standing partners or in situations where time is of the essence, executives may agree to modify loan terms verbally or through a simple email exchange, with the understanding that a formal amendment will be executed later. While not legally binding in all jurisdictions, these "handshake agreements" can demonstrate a level of trust and flexibility between the parties.
More broadly, this is why "smart contracts" have struggled to become mainstream. The degrees of freedom humans want in their ability to change and negotiate a deal is unmatched by your typical developer's imagination. Coding a smart contract for anything other than the most basic and pedestrian financial instruments is a fool's errand. The average corporate exec will quickly reach for pen and paper if that's the only alternative to a negotiation blocker.
The lender of record for a loan does not change during the loan term.
- Loan sales and assignments: Lenders often sell loans to other financial institutions or investors in the secondary market. This transfers the ownership of the loan and the right to collect payments, even though the borrower may continue to make payments to the original lender as a servicer.
- Mortgage servicing transfers: It is common for mortgage loans to be sold or transferred to different servicers (the company responsible for collecting payments and managing the loan) multiple times during the loan term, without any change in the underlying loan agreement.
The borrower of a loan does not change during the loan term.
- Loan assumptions: In certain situations, a new borrower may assume the responsibility for an existing loan, taking over the payments and becoming the new borrower of record. This often occurs in real estate transactions where the buyer assumes the seller's existing mortgage.
- Loan co-signer release: Some private student loans offer co-signer release options after the primary borrower meets certain criteria (e.g., making a certain number of on-time payments). This effectively removes the co-signer from the loan agreement, leaving the primary borrower as the sole borrower of record.
When the lender of a debt changes, it is documented.
Check your wallet for me. Do you happen to be carrying a pocket-sized interest-free bearer demand loan forces the borrower to pay you back at any time up to the total principal amount with nothing more than than?
If you have a Starbucks gift card (or any gift card, really), the answer is yes.
There's a good chance you became the debtor without even buying the debt, and I'm pretty sure no one informed Starbucks of the transfer.
Take the results of your automated document queries with a grain of salt.
As an aside, Starbucks is famous for their gift card financial engineering. They regularly pay off bank or investor loans that have interest with their "interest free" loans from customers. What's more, they can legally write off some of the gift card debt to 0 every year because it's understood that gift cards get lost or underutilized.
The enforceability of loan repayment does not change over time.
- Statute of Limitations: In most jurisdictions, there's a time limit (statute of limitations) within which a lender must take legal action to collect on an unpaid debt. Once this period expires, the lender may lose their right to enforce repayment through the courts, even if the borrower still owes money.
- Bankruptcy: If a borrower declares bankruptcy, the enforceability of certain debts, including some loans, may be significantly reduced or eliminated, depending on the type of bankruptcy and the specific circumstances.
- Legislation: Governments can and do change what types of loans are legally enforceable. For example, in the US, it could be possible in the future that student loans can be dismissed during bankruptcy. Or, perhaps, loans above a certain interest rate could be forbidden, rendering some existing loans unenforceable without renegotiation.
Loans issued from one private individual to another private individual are maintained by the individuals (or their personal accountants).
- Loan servicing companies: Even for private loans between individuals, a third-party loan servicing company may be hired to handle tasks like collecting payments, managing escrow accounts (if applicable), and providing customer service. This frees the lender from the administrative burden of managing the loan.
- Escrow agents: In some real estate transactions involving private loans, an escrow agent may be used to hold funds, disburse payments, and ensure that all terms of the loan agreement are met. This provides an added layer of security and impartiality for both the borrower and lender.
This is more of a personal story rather than a professional one, but a friend I worked with had taken out a home loan not from a bank, but from a wealthy older relative. That relative (sadly) passed, at which point my friend discovered that they had put a provision that the loan would would be forgiven in the event of their death. This young married couple, within a year of closing, found themselves owning a house in Houston with nothing left to pay but income tax on the value of the forgiven principal. Talk about a starter home!
Loans are repaid on fixed schedules.
Stripe loans: repays a total amount based on stripe income
Intra-company loans: In some corporate structures, a parent company may extend a loan to a subsidiary without a strict repayment schedule. Interest may still accrue, but the actual repayment may be flexible and dependent on the subsidiary's financial performance or other strategic considerations.
Interest compounds monthly.
Daily compounding interest: Many savings accounts and some loans calculate and add interest on a daily basis, leading to faster growth of savings or accumulation of debt compared to monthly compounding.
Credit card interest: Credit card interest is often calculated and charged on a daily basis, even though the minimum payment may be due only monthly. This can significantly increase the cost of carrying a balance on a credit card.
The loan issuer transfers the entire principal to the borrower at the beginning of the loan term.
Tranched Loans: In complex financing structures like leveraged buyouts or project finance, loans may be divided into multiple tranches with different risk profiles and repayment priorities. The disbursement of funds for each tranche may be contingent on certain milestones or conditions being met, leading to a staggered release of the principal amount. In real estate development, construction loans often disburse funds in stages as the project progresses, rather than providing the full amount upfront. This helps manage risk for the lender and ensures that funds are used for their intended purpose.
Lines of credit: Lines of credit provide borrowers with access to a pre-approved amount of funds, but the borrower only draws down and pays interest on the portion they actually use. This offers flexibility and can be useful for managing cash flow or unexpected expenses.
Loans only have one interest rate that applies to the entire outstanding principal at any given time.
If you're thinking, "Well of course not, we already talked about variable interest," you're in for a treat.
Tranched loans often work like a corporate credit card. Every time the borrower needs cash, they can withdraw from the total available principal in the tranched loan. But if you follow the credit card analogy, which usually does have a variable rate attached, that same rate would apply to all of the outstanding principal.
In the case of tranched loans like the ones issued by parent corporations to its subsidiaries, each withdrawal could have it's own fixed rate based on that day's variable rate. Borrowers may have to calculate their principal repayments at the tranche level, with each tranche having its own unique interest rate.
Collateralized loans are tied to real assets.
Securities-backed loans: Investors can borrow against the value of their investment portfolios (stocks, bonds, etc.) to access liquidity without selling their holdings. This type of loan uses financial assets as collateral rather than tangible property. When you think "financial assets" you might think stocks or bonds that can be liquidated quickly, but it can also include things like purchase agreements, futures contracts, or a number of other contingencies.
My favorite real-world example was when a client wanted to update their software to allow high net worth individuals to create lines of credit backed by their term life insurance. In other words, some particularly wealthy people wanted to borrow against the cash balances of their life insurance savings that could not be accessed until a) they died or b) the term on their insurance came to an end, at which the cash balance was theirs. Bankers hate this one weird liquidity trick!
Borrowers need to pay back at least some of the principal throughout the loan term.
Interest-only loans: Certain types of loans, especially in commercial real estate or for short-term financing, may allow borrowers to make interest-only payments for a set period, deferring the principal repayment until a later date or the end of the loan term.
Negative amortization loans: In some cases, particularly with adjustable-rate mortgages during periods of low interest rates, the monthly payment may be insufficient to cover even the interest accrued, leading to negative amortization where the outstanding principal balance actually increases over time.
Borrowers don't need to pay off the full principal until the end of the loan term.
Demand loans: These loans, often used in business financing, can be called in (demanded to be repaid in full) by the lender at any time, even before the original maturity date, if certain conditions are triggered or if the lender deems it necessary.
Borrowers do not need to post additional collateral to a collateralized loan after the loan is issued.
Margin calls: In margin loans, where investors borrow against the value of their securities portfolios, a margin call may be triggered if the value of the collateral falls below a certain threshold. The borrower is then required to deposit additional cash or securities to maintain the required collateral level or risk having their positions liquidated.
Blanket liens: Some business loans may include a blanket lien on all assets of the borrower, allowing the lender to request additional collateral if the value of the existing assets deteriorates or if the borrower's financial situation weakens.
Loans are issued in currency.
Commodity-backed loans: In certain industries or regions, loans may be issued or denominated in commodities like gold, oil, or agricultural products, allowing borrowers to access financing directly tied to their business operations or hedging against price fluctuations.
Cryptocurrency loans: With the rise of cryptocurrencies, some platforms and lenders offer loans denominated in Bitcoin or other digital assets, providing an alternative financing option for those holding cryptocurrencies.
Loans are repaid with currency.
Debt-for-equity swaps: In corporate restructuring or distressed situations, creditors may agree to accept equity (ownership shares) in the company in exchange for forgiving a portion or all of the outstanding debt, effectively repaying the loan with an ownership stake rather than currency.
Barter transactions: In some cases, particularly in informal settings or developing economies, loans may be repaid with goods or services instead of currency, based on an agreed-upon value or exchange rate.
Loans are repaid exclusively by the borrower.
Co-signers and guarantors: In many loan agreements, especially for borrowers with limited credit history or income, a co-signer or guarantor may be required. These individuals agree to take on the responsibility of repaying the loan if the primary borrower defaults, effectively sharing the repayment obligation.
Loan insurance: Certain types of loans, such as mortgages or student loans, may require borrowers to purchase loan insurance. This insurance protects the lender in case of borrower default or death, and the insurance company would then be responsible for repaying a portion or all of the outstanding loan balance.
Loans have well defined term start and end dates.
Revolving lines of credit: Credit cards and some business lines of credit offer a revolving credit facility where the borrower can repeatedly borrow and repay funds up to a certain credit limit, without a fixed end date for the entire loan facility. The individual drawdowns within the line of credit may have specific repayment terms, but the overall facility remains open-ended.
Evergreen loans: These loans, often used in corporate finance, automatically renew at the end of each term unless either the borrower or lender chooses to terminate the agreement. This provides ongoing access to capital without the need for frequent refinancing.
Loans are one-directional.
Loan participations: In loan syndication or participation arrangements, multiple lenders may contribute to a single loan, blurring the lines between who is the "lender." While there is usually a lead lender or agent bank managing the loan, the borrower may effectively have multiple lenders with varying ownership stakes.
Securitization: In the process of securitization, loans are pooled together and transformed into tradable securities. The original lenders effectively sell the loans to investors who become the new beneficial owners, making it less clear who the ultimate lender is from the borrower's perspective. You'll recognize these from the 2008 financial crisis.
Debts are documented with at least one obvious record tied to that specific debt.
Informal loans: Loans between friends or family members may be based solely on verbal agreements or simple IOU notes, lacking formal documentation or clear records. These can still be enforced in court in the right situations.
Shadow banking: Certain financial activities, often referred to as "shadow banking," involve lending and borrowing outside the traditional regulated banking system, with less transparency and potentially fewer official records associated with the debts.
Accrued expenses: Companies often have accrued expenses, such as unpaid payroll or utilities, which represent debts owed but may not have a specific, formal document associated with them. They are typically tracked in accounting systems and reflected in financial statements. In other words, you may have debts that are more implied rather than stated. Unpaid employee labor is generally treated as a high-priority-albeit-interest-free debt if a company declares bankruptcy.
Unrealized revenue: In some cases, businesses may recognize revenue before it is actually collected, creating an accounts receivable balance. This represents a debt owed to the company by its customers, but it may not have a single, explicit document associated with each individual transaction.
Bank Accounts
Bank account ownership can be tied to one specific individual or legal entity.
- Joint accounts: Many banks offer joint accounts that can be owned by multiple individuals, such as spouses or business partners, allowing them to share access and control over the funds.
- Trust accounts: Trust accounts are established for the benefit of a designated beneficiary but are managed by a trustee, who may be an individual or a legal entity. This creates a separation between ownership and control of the account.
Bank accounts are maintained by the bank of record.
- Correspondent banking: In international transactions or for smaller banks, a correspondent bank may be used to facilitate transactions and hold accounts on behalf of another bank. This means the account may be technically held at one bank but managed or accessed through another.
- Custodian banks: For investment accounts or certain types of assets, a custodian bank may hold the assets on behalf of the account owner, providing safekeeping and administrative services. While the account owner retains ownership, the day-to-day management and record-keeping may be handled by the custodian bank.
Bank account numbers are unique.
This one caught me off guard. In a few systems I've worked on since, bank account numbers were often assumed to be useful as primary keys in SQL. You could hardly assume they were a composite key when combined with the lending institution.
Bank account numbers are numbers.
Wrong again!
Account numbers aren't the only situation where I've specifically asked the engineers to not enforce a specific format on an input field. They aren't the only situation where that request has been ignored. But I'll be darned, corporate treasury certainly does love raising escalations 11pm before month end close when they can't enter a new account number they just got today.
IBANs are international.
This is for my European colleagues... the US is not with the program.
"Can you send me the IBAN then?"
"There is no IBAN."
"The field requires an IBAN."
"Then the field requires a European bank account, and I cannot help you."
US bank accounts: Not all countries use IBAN (International Bank Account Number) for their domestic bank accounts. In some countries, like the United States, domestic accounts may have different numbering systems or formats.
SWIFT/BIC codes: For international transfers to countries that don't use IBAN, the SWIFT/BIC (Society for Worldwide Interbank Financial Telecommunication/Bank Identifier Code) is often used to identify the bank and branch involved in the transaction.
Accounts only contain one currency.
Multi-currency accounts: Some banks and financial institutions offer multi-currency accounts that allow customers to hold and transact in multiple currencies within a single account. This can be useful for frequent travelers or businesses operating in multiple countries.
Foreign currency accounts: Individuals or businesses can often open separate bank accounts denominated in a foreign currency, allowing them to hold and manage funds in that specific currency.
Accounts are owned by one legal entity at a time.
Beneficiary designations: Many accounts, like retirement accounts or life insurance policies, allow the account owner to designate beneficiaries who will inherit the assets upon the owner's death. This creates a future ownership interest for the beneficiaries even while the original owner is still alive.
All accounts support wire transfers.
Savings accounts: Some savings accounts, especially those designed for high-yield interest or with specific restrictions, may not allow outgoing wire transfers or may limit the number or frequency of such transfers.
Prepaid debit cards: While technically accounts, prepaid debit cards may have limited or no wire transfer capabilities, focusing primarily on card-based transactions or ATM withdrawals.
Accounts support ACH.
International accounts: While ACH (Automated Clearing House) is widely used in the United States for electronic payments and transfers, it may not be directly supported for accounts held in foreign banks or financial institutions. International transfers often require alternative methods like SWIFT or wire transfers.
Certain investment accounts: Some investment accounts, particularly those focused on specific asset classes or with certain restrictions, may not support ACH transactions directly. Transfers to or from these accounts might require alternative methods or involve additional steps.
Accounts support SWIFT.
Domestic-only accounts: Some basic checking or savings accounts offered by smaller banks or credit unions may not be directly connected to the SWIFT network, limiting their ability to send or receive international wire transfers.
Sanctioned countries or individuals: Accounts held by individuals or entities located in countries subject to international sanctions may have restricted access to the SWIFT network, making it difficult or impossible to send or receive international payments.
Banks are incentivized to develop APIs.
Legacy systems: Many banks still rely on outdated and complex IT systems that are difficult and expensive to integrate with modern technologies, hindering their ability to develop and deploy APIs efficiently.
Regulatory compliance: The financial industry is subject to stringent regulations and security requirements, which can create challenges and additional costs for banks when developing and exposing APIs to external parties.
Customer retention: Banks may be hesitant to fully embrace open standards for data sharing as it could make it easier for customers to switch to competitors, potentially reducing their customer base and profitability.
All banks have public contact information of some kind.
Private banks: Certain exclusive private banks catering to high-net-worth individuals may rely on discreet communication channels and referrals rather than widely publicizing their contact information.
Banks have liquidity to cover their deposits.
Bank runs: In times of financial panic or uncertainty, depositors may rush to withdraw their funds from a bank, creating a liquidity crisis even if the bank is fundamentally sound. This can lead to temporary restrictions on withdrawals or, in extreme cases, bank failures.
Fractional reserve banking: The modern banking system operates on a fractional reserve basis, meaning banks only hold a fraction of their deposits as reserves. While this allows for efficient credit creation and economic growth, it also creates a vulnerability where a sudden surge in withdrawals could exceed a bank's available liquidity.
FTP is a legacy data transfer format.
ACH file transfers: While ACH (Automated Clearing House) transactions are increasingly moving towards web-based interfaces, many banks still rely heavily on FTP or SFTP for exchanging ACH files with their customers and processing partners. This demonstrates that even in the modern financial landscape, FTP continues to play a critical role in core banking operations.
Secure file sharing platforms: While newer cloud-based file-sharing platforms offer enhanced features and collaboration capabilities, many financial institutions still prefer FTP/SFTP due to its established security protocols, compliance with industry standards, and compatibility with legacy systems.
XML is a legacy data transfer format.
SWIFT messaging: The Society for Worldwide Interbank Financial Telecommunication (SWIFT) network, which handles the majority of international financial transactions, still relies heavily on XML-based messages for communication and data exchange between banks.
Regulatory reporting: Many financial institutions use XML to generate and submit regulatory reports to government agencies. This highlights its continued relevance for ensuring compliance and transparency in the financial sector. XBRL is commonly used in Europe for tax compliance.
Banks follow a standard financial reporting format.
International variations: While there are global accounting standards like IFRS (International Financial Reporting Standards), different countries or regions may have their own specific regulations and reporting requirements for banks, leading to variations in the format and content of financial statements.
Specialized disclosures: Depending on a bank's size, complexity, or specific activities (e.g., investment banking, asset management), additional disclosures or supplementary schedules may be required beyond the standard financial statement format. This adds nuance and can make it challenging to directly compare financial reports across different institutions.
Two Banks can communicate electronically because of some set of published standards to which they both adhere.
Proprietary networks and messaging formats: While there are industry-wide standards like SWIFT for international transactions, many banks also participate in proprietary networks or utilize custom messaging formats for specific types of transactions or data exchanges, limiting interoperability with non-member institutions.
Consortium-based standards: In some cases, groups of banks may collaborate to develop and adopt their own set of standards for communication and data exchange, creating a closed ecosystem that excludes non-participating banks and potentially hinders innovation or competition. Examples include:
The Clearing House: A banking association and payments company owned by some of the largest commercial banks in the US, it operates a real-time payments network with its own set of standards and protocols
Early Warning Services: A fraud prevention and risk management network jointly owned by several major banks, utilizing shared data and proprietary technologies.Zelle: A popular peer-to-peer payments network developed and operated by a consortium of major US banks. While it facilitates fast and convenient payments between customers of participating banks, it operates on its own proprietary infrastructure and standards, limiting its reach and interoperability with other payment systems.
Currencies
A country has one official currency.
Multiple official currencies: Some countries, particularly those with historical ties to other nations or with significant trade relationships, may officially recognize multiple currencies as legal tender. For example, Zimbabwe has adopted a multi-currency system that includes the US dollar, South African rand, and other major currencies alongside its own Zimbabwean dollar.
A country has at least one official currency.
Some countries, particularly smaller ones or those with close economic ties to a larger neighbor, may not have their own official currency and instead rely entirely on a foreign currency for all transactions.
Examples include Ecuador, El Salvador, Panama, Kosovo, and Montenegro.
A currency's value is fixed to some real underlying asset.
This can be a misconception among some, who think you can still walk into some federal building and ask for silver or gold in exchange for your dollar. The value of USD is not fixed to any standard thing today, so it's value is whatever someone else thinks it's worth in a given context.
A currency's value is not fixed to real assets.
Commodity-backed currencies: While rare in the modern financial system, some currencies historically have been directly linked to the value of a specific commodity, like gold or silver. This "gold standard" or similar mechanisms aimed to provide stability and limit inflation but also restricted a government's ability to manage its monetary policy.
Currency pegs: Some countries may choose to peg their currency's value to another more stable currency, like the US dollar or the euro, to maintain exchange rate stability and facilitate trade. However, this requires maintaining sufficient foreign reserves and can limit a country's independent monetary policy.
All currencies are issued by a sovereign state.
Bitcoin made this a bit more obvious, but historically, many countries experienced privately-printed paper currency. Usually, that private currency was issued by a private bank (somewhat analogous of a cashier's check today). This private currency was a hot topic in the early days of the United States.
All currencies can be divided into base-10 fractions.
Non-decimal currencies: While most modern currencies use a decimal system (divisible by 100), some historical or less common currencies may have different fractional units. For example, the pre-decimal British pound was divided into 20 shillings, and each shilling was further divided into 12 pence.
Cryptocurrencies: Certain cryptocurrencies, like Bitcoin, are designed to be highly divisible, allowing for fractions of a unit to be used in transactions. This facilitates micropayments and greater flexibility in pricing.
Japanese Yen and Icelandic Krona: These are examples of modern currencies that do not have any subunits or fractional denominations. Prices are typically rounded to the nearest whole unit, and transactions involving smaller amounts may be handled through alternative means like electronic payments or loyalty points.
Exchange Rates
Currencies have one well recognized cost in reference to the another currency at any given time
Bid-ask spread: In the foreign exchange market, there are always two prices for a currency pair: the bid price (the price at which a buyer is willing to purchase the currency) and the ask price (the price at which a seller is willing to sell the currency). This spread creates a slight difference between the buying and selling rates, meaning there isn't a single, universally agreed-upon cost for a currency in relation to the US dollar.
Market volatility: Exchange rates fluctuate constantly due to various factors like economic news, geopolitical events, and market sentiment. This means the cost of a currency in relation to the US dollar can change rapidly throughout the day, and there may not be a single, stable reference point at any given moment.
Black market: I intentionally avoided these kinds of examples, because anything statement about following the law is false for criminals. That said, there are countries that are very protective of their currencies (i.e. China) who have whole legal frameworks to ensure those currencies aren't traded outside official systems. Cryptocurrency came along and made those black markets much more efficient, revealing a major spread between the "official" value and the market value.
Ledgers and GAAP
Errors are corrected by altering the original record.
Hard no, but easy to correct with software metaphors.
When submitting a change to your git repository, you might introduce a bug. Whenever possible, you correct that bug by creating a new version of the most recent change. Going back to the version where the bug doesn't exist could have unintended consequences (undoing a database schema migration, for example, or breaking a working change that the UI team was expecting to stay in place).
The same is doubly true for finance. If an error is discovered in a ledger, the original record stays unchanged. Instead, a correction record is inserted.
For example, let's say we accidentally recorded the sale of a product twice. Later, we would subtract the error value from our revenue in the month where the error was discovered. You would not delete the duplicate record.
The reason for this is to maintain some historical state (for audit or tax reasons), and avoid recalculating every transaction up to that point. You may need to have that historical record for more mundane reasons anyway, like calculating the error in loan interest or currency exchange rates to settle a matter with a third party.
Time
Years have 365 days.
I'm not talking about leap year. That would be too easy. I'm not talking about leap seconds either. I'm also not talking about time smearing.
I'm not even talking about cultural calendars like you would find in China or the Middle East.
Months have different numbers of days.
Related to the above, it is common and appropriate for amortization schedules to assume the each month has 30 days.
Financial records within a legal entity adhere to the same calendar.
That would be too easy! Like we talked about with loans, each one could have its own calendar defined in the terms of the loan. Your finance team may have marginal control over which calendar gets used for any particular financial instrument.
Ownership
One share of stock is owned by exactly one individual or legal entity.
There is exactly one authoritative record who owns what stock of a given company.
The original Die Hard movie centered around a fascinating plot in that the villains were not breaking into a vault to steal money. What they came for were bearer bonds.
The number of shares a person owns does not change unless that person buys or sells their stock.
Stock splits or merges!
The number of shares owned by an investor changes if more stock is issued.
Dilution, obviously.
Valuations cannot be negotiated.
You'd think there's a clear ethical standard to holding to one's guns if your whole job is to find a well-established value of a given asset -- a value that's defensible anywhere and everywhere. That you would die on that hill.
Alas, it's common for a sort of unofficial conversation to happen between an appraisal firm and company stakeholders that goes something along the lines of...
Appraiser: "We think your startup is worth $100 million."
Corporate: "Try again."
Appraiser: "Here is your valuation at $200 million."
Corporate: "Just what we projected!"
That conversation follows one line of logic in which the valuation is being used to raise new capital based on some more optimistic views of that company's future.
Much like entropy, private valuations are ever increasing. That said, you might want to start low...
Owners of a company want their shares to be worth more rather than less.
This is a weird one, and depends on who you're talking about. In the United States, there are small business provisions that can save you capital gains tax on your shares of a small business (up to $10 million at the time of this writing). You take advantage of this by paying an income tax to the IRS on your shares today rather than paying for that tax later, when they're worth more.
But this is about capital gains and not capital value. If the goal is to get as much of that $10 million tax advantage, you would prefer for that stock to basically be worthless at first when you pay taxes on it initially, then let it mature into something valuable. If your shares were valued at $10 million at the start, you might not even have enough cash on hand to pay those taxes.
CEOs want shares of a company to be worth more rather than less.
This is another tricky one. In some cases, you want institutional investors where the value of your stock is far out of reach of the average Jane and Joe. Perhaps you prefer the advice and control of financiers who you feel would be better equipped to understand your long-term vision, paying little attention to the Reddit day traders.
However, if you hate institutional investors (because they're boring and stodgy) and you would prefer for the average Jane and Joe to be the final say (because you're incredibly popular on Tweetstagram and those minority investors think you are an actual god on Earth), you might want to make sure all your shares are within reach of your fan base. Doing a stock split could open up two opportunities:
- The average citizen investor gets more democratic access to the products or services you provide, or
- The skepticism held by your mature institutional investors is strangled by the potential losses if they were to piss off your core fan base.
The number of shares issued by a company and the number of shares with legal standing are the same number.
Treasury stock: Companies may repurchase some of their own issued shares, which then become treasury stock.
While these shares are still technically issued, they are not considered outstanding and do not have voting rights or participate in dividend distributions. Therefore, the number of shares with legal standing (outstanding shares) is lower than the total number of issued shares.
Restricted stock: Employees or other insiders may receive shares of company stock that are subject to vesting schedules or other restrictions, limiting their ability to freely trade or sell those shares. These restricted shares are still considered issued but may not have full legal standing or voting rights until certain conditions are met.
Shares of one kind are always traded in whole, even units.
- Many brokerage platforms now allow investors to buy and sell fractional shares, enabling them to invest in expensive stocks or diversify their portfolios with smaller amounts of money.
- Stock splits and reverse splits: Companies may split their shares, increasing the number of outstanding shares and reducing the price per share, or do a reverse split, reducing the number of shares and increasing the price per share. These actions can result in fractional share ownership for existing shareholders.
Math
The default way of doing floating point arithmetic (IEEE 754) is sufficient to calculate balances, interest, taxes, or exchange rates.
When developing software for the finance world, especially the corners that deal with very large numbers, you'll often be asked to check the output of your application against the version an accountant made in Microsoft Excel. The problem with that is that Excel is wrong, and if your numbers match, your application is wrong too. What's worse is that neither you nor the accountant will notice, possibly not for decades.
Excel performs floating point calculations like you would in out-of-the-box C on the CPU arithmetic hardware, adhering to IEEE 754. The 754 standard is ubiquitous, stable, and fast, but it has a well documented series of limitations on accuracy. Excel, like most software packages, defaults to IEEE 754, and is therefore inaccurate by its very nature. Good luck explaining that to your accounting team. Or rather, send them this article...
What's the alternative? Use arbitrary precision floating point toolkits instead. In C#, you'll find this as the Decimal data type. Other languages may not support this out of the box (C++/ECMAScript), so you'll need to find a third party library to set things right.
https://en.wikipedia.org/wiki/List_of_arbitrary-precision_arithmetic_software
Now you have a second and potentially worse problem -- your app produces correct numbers that don't match the Excel model.
Have fun explaining to your accounting team that that not only is this particular Excel model wrong, but all Excel models are inherently wrong, and every Excel model they've produced in the last 30 years stands cowering in the shadow of your technical brilliance. Good luck with that!
Rounding is done by going up at 5 and above, or down at 4 and below.
The rounding we're typically taught in school is easy to remember and easy to apply. However, it has some challenges in the real world. The numbers you're rounding in practice usually have some kind of bias. In the US, for example, we typically see store prices like $4.99. This is not a material difference from $5.00 for one purchase, but if you round out all your sales across a year to the nearest dime or dollar, you'll quickly find yourself over-representing your income one missing cent at a time. You don't have a lot of $4.01s to balance it out.
Instead, a better approach is to use what's called "banker's rounding" or "round to even" in which both 74.5 and 73.5 round to 74. This method enforces a sort of balance on financial transactions that we wouldn't naturally get. (Coincidentally, the computational approach to this is also defined in IEEE 754. Perhaps its trying to atone for its arithmetic sins?)
Withing naming names, I was part of a project that discovered a long-standing rounding error dating back at least to 1996. The error was present in loans totaling trillions, and spanning multiple decades, continents, currencies, legal entities, and tax jurisdictions. After explaining this to the finance team, followed by months of review very quiet review, the finance team determined the error was not material.
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