DEEP DIVE is a series of in-depth articles on FinTechtris that explores a particular fintech leader, discussing its history, products / services, and how it has grown to be an industry leader.

July 31, 2020 is now a historic date for the FinTech industry as Varo (a 6-year old neobank in the US) was approved for a national bank charter by the OCC (Office of the Comptroller of the Currency) — officially becoming the first fintech to become a bank.

In the early days of FinTech back in 2010, fintech companies were seen as disruptors in banking, who competed directly with financial institutions. This milestone is the first sign in the last decade that this can now happen, and instead of fintech companies collaborating or partnering with banks, these technology driven firms can actually (fully) replace them.

The process took over 3 years (starting back in July 2017), additional capital requirements, and over 5K pages of application materials (which included applications for FDIC insurance coverage and the bank charter request) — FDIC approval came earlier this year (Feb. 2020). Varo had been operating as a neobank through a partnership with Bancorp Bank (its partner bank).

“The ability to operate as a full-service national bank gives Varo more freedom to deliver the kind of innovation and allyship that many Americans have never had from their bank before. We are excited to lead a new wave of financial inclusion by offering fair, transparent, intelligent, and comprehensive financial services to all.”

Colin Walsh, CEO of Varo (FinTech Magazine)

profile on Varo

Varo was founded by Colin Walsh (who spent his career in financial services with companies such as GE Capital, American Express, Wells Fargo, and Lloyds) and Kolya Klymenko (who has background in product and engineering, and worked at LendingClub) back in 2015. The early-stage company focused on millennials, younger generations, and underbanked groups who had struggled in building a relationship with traditional banks.

As an early neobank in the US, the fintech has no physical presence (such as bank branches) and interacts with clients digitally (usually through its mobile app). The need to have a top digital presence early on, had the company target a simple and premium user experience that served as a key differentiator for the new neobanking segment.

Varo was able to issue deposit accounts and cards through its partnership with Bancorp Bank. This is the same industry model used by other neobanks due to complex licensing and regulatory standards. Varo’s app has over 4M downloads since its launch. The fintech offers three types of account (Current, Checking, Savings) and other banking benefits, such as exclusive partner offers, no fees for banking, and high-yield interest rates.

The neobank had a vision for becoming its own independent bank from the start. The journey would be lengthy with unknown barriers in the application process and no guarantee of approval after investing significant time and capital.

Varo initiated discussions for the banking license in 2016 (a year after the company launched) with the goal of having the charter by 2020. Fast forward to mid-2020, and the fintech has made it happen. Just before the announcement from the OCC last week, the company closed a $241 million Series D (led by Gallatin Point Capital, LLC and The Rise Fund). The new funding will grow new products under the approved bank charter.

varo’s next move with its bank charter?

The ultimate question throughout the industry — what comes next? The bank charter allows Varo to move independently without the need for bank partnerships. The company will purchase its 2M customer base of users from its partner bank (Bancorp) and migrate them over to its new platform. Once this transition is completed, Varo would become an all-inclusive financial services solution for its clients — offering its own line of exclusive banking products that can now include affordable lending programs (credit cards, loans, advances, and eventually residential mortgages). The fintech can reach various segments of users, not just ones in search of a low-cost deposit account — but a wide scope of customers interested in bringing their entire financial relationship away from traditional banks.

Adding credit products will generate new a revenue stream from interest revenue, which can be added to the deposit revenue, and interchange revenue the company is already earning. The charter also allows the company to run these lending programs with lower capital requirements. Not to be overlooked, Varo will also save monthly on not paying for a bank partnership or BaaS provider to run its neobank.

Overall, Varo will be able to lower operating costs and capital requirements, increase the control and oversight of their platform, offer new products quickly, and gain new paths in revenue. Additional monetization opportunities exist if Varo decides to rent out its bank charter to other fintechs and become a partner bank itself.

new opportunities for varo as a partner bank

A benefit of having their own bank charter is turning around and becoming a partner bank for other fintechs. Varo can rent out their charter, as Bancorp had done over the last five years, and become a complete program manager for all companies interested in offering their own banking products. By offering its own infrastructure and software, Varo can monetize on per account fees, increased deposit and loan interest, program management fees, and interchange revenue that fintech partners would bring in. A white-label Banking-as-a-Service (BaaS) channel from Varo as an all-inclusive “tech-first” bank makes complete financial sense, and would set the firm apart from all other options in the industry — The first BaaS bank.

The BaaS sector in FinTech has offered an alternative to legacy bank infrastructure. A company looking to directly integrate with a bank to offer banking products would need to bring their software platform or tech partner to develop a custom implementation. There’s still the matter of a bank approving the potential partnership, the limitations that would be part of any approval, and how long the whole process would take. Today’s top BaaS providers have directly integrated their API-driven product suite with specific bank partners to reduce the time to launch down to about 3-6 months (instead of over a year).

Varo can reduce this speed to market even further by providing a quicker turnaround on bank approval of fintech clients AND the go-live APIs being available for internal testing within days of contract signing. An efficient overall process can also lead to a less expensive alternative in today’s industry ecosystem.

A potential downside in fintech startups signing up, however, is the risk of direct competition. Varo is an existing neobank with unlimited potential in the financial services it can now offer. New companies considering a partnership may not be approved if it means taking away market share in an already competitive marketplace — similar to clients of Galileo being wary of the acquisition by SoFi. Ultimately, Varo can be strategic in which opportunities have the most upside with revenue potential and least downside in losing existing (or potential) clients.

What’s next for FinTech, Banking, and financial services?

The blurred lines between fintechs and banks have completely vanished with this landmark announcement in the financial services industry. The largest gap for fintech companies in offering banking products is effectively gone. Will we see a flood of bank charter applications from fintechs? Not anytime soon. The process is still seen as lengthy, costly, and lacking certainty — the risk is incredibly high and the reward unknown. Square and SoFi are the only other companies that have filed an application in the past.

We won’t know for at least a year from now if Varo’s move to become a bank is paying off with increased revenue and market leadership. The regulatory landscape is likely to change in the next months as a response to this milestone, making it easier or harder for other companies to follow the same path. The wider implications for financial services will be based on regulators taking a firm stance in enabling innovation.

For Varo, these first months of being an independent bank (transitioning from a fintech) will be crucial. Company strategy and culture will need to adjust — a “break things fast and learn” mentality can lead to regulatory complaints and fines. Customer expectations of support and data protection will be at an all-time high. Established financial institutions are hoping for Varo to slip up and fail, while the fintech community is hoping for smooth sailing. Like everyone else in the industry, we’ll keep a close eye on Varo’s early days and months as a bank.

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