SECTOR SPOTLIGHT: The Rise of FinTech Partner Banks

SECTOR SPOTLIGHT is a monthly series on FinTechtris that explores a specific sector within the expansive FinTech space by defining its history, frameworks, business model, leading companies, and outlook.

In the first half of 2018, FinTechtris had a post about banks and fintechs (“Partnership for Innovation”), which briefly discussed the two sides starting to team up. Banks were looking to upgrade their user experience and back-office activities, while fintechs looked to leverage the trust and compliance experience from institutions. At a general level, most fintechs and banks were still competing directly for market share.

About a year after, we then deeply explored the topic of “FinTech Partnerships with Banks” being the future of financial services. Through partnerships, banks accessed low-cost deposit volume from the end-users of FinTech apps, and fintechs utilized the bank charter and licensing of their new institutional partners. Speed to market was a welcomed benefit that both groups enjoyed. Early partnerships started to expand between multiple banks and fintechs — launching deposit products, card services, and lending programs. Direct competition between both groups had started to dissipate.

Here at the halfway point of 2020, the proven revenue streams in both sides working together have only increased to the point where these partnerships have created a subset of FinTech Partner Banks.

What is a FinTech partner Bank?

Institutions with experience in various integrations across multiple fintech companies over the last 5 years, can be considered FinTech Partner Banks. These integrations can span an assortment of use cases and industry sectors, and serve consumer and/or business customers. Some banks have gone so far as to build out a separate channel exclusively for FinTech partnerships and integrations. Overall, these institutions have made a strategic decision to incorporate partnerships with fintechs as part of their revenue strategy and risk framework — dedicating necessary resources and operations to the growth of this channel.

For early FinTech Partner Banks, a specialized sector focus (instead of a general approach) has been the path forward in building sustainable partnerships. Some banks have chosen to focus on consumer or business banking through neobanks, card programs through prepaid providers, or lending through installment loans from fintechs. Here are some of the institutions actively working with fintechs today:

Consumer or Business Banking (checking, savings, and/or card products)

• Bancorp: Chime, SoFi Money, Venmo, BlueVine, Oxygen, Uber, NetSpend;

• GreenDot: Stash, Uber, Wealthfront, Walmart MoneyCard;

• NBKC Bank: Betterment, Digs, Joust, TrueBill, Empower, Tip Yourself, Long Game;

• BBVA: Simple, Digit, Catch, Azlo (for SMB), Wise (for SMB);

• Lincoln Savings Bank: MoneyLion, Acorns, Qapital, M1;

• Choice Bank: Lively (HSA), Current, Douugh, Lili, Teampay (debit card only);

• Radius Bank: Brex (for high yield account), Treasury Prime (for SMB);

• UMB: Personal Capital, Unifimoney;

Consumer Lending (installment loans, or credit cards)

• Cross River: Affirm, Upstart, Seedfi, Stripe, Upgrade, Best Egg, Coinbase, Finix, Rocket Loans;

• WebBank: LendingClub, Prosper, Avant, Petal, Upgrade, Klarna, PayPal Working Capital;

• Sunrise Banks: Self.inc, TrueConnect;

SMB Lending (installment or revolving loans, credit cards)

• Celtic Bank: Kabbage, Square Capital, BlueVine, OnDeck, Deserve, Stripe Capital, Surge Card, Fundera;

Card Issuance (prepaid, debit, or credit cards)

• Sutton Bank: Cash App, Upgrade, Robinhood, Monzo, Brex, Marqeta, Ramp, TeamPay;

• Metropolitan Commercial Bank: Revolut, MoneyGram, Current — (all 3 programs are debit);

• Sunrise Banks: Passbook by Remitly, True Link;

• Coastal Community Bank: Aspiration, One Finance — (both programs are debit card and high yield interest);

• Wex: Divvy (business credit card), PayChex, HSA Bank (debit card);

Examples of other banks who have started working with fintechs include: Comenity, Axos Bank, MetaBank, Emigrant, Live Oak Bank, Veridian Credit Union, MVB, The Bank of Missouri, Stride Bank, First Century Bank, Middlesex Federal, Blue Ridge Bank, CFSB, TAB Bank, Hatch, CBW Bank.

From the list above, there are a few key takeaways to emphasize:

• Most partnerships today are focused on a single product only; fintechs that offer a secondary product through a bank often form a separate partnership with another institution;

• Banks heavily prioritize fintech platforms with a large, existing base of customers (such as Brex, Stripe, Coinbase, and Uber) in order to quickly capture high deposit volumes and transaction fees;

• The top 5 banks in the US (that include Bank of America, JPMorgan Chase, Wells Fargo, and CitiBank) have yet to make a significant move in opening their doors to fintechs; the list above is mostly composed of regional or community banks that lack a brand name or a national network of branches;

• Fintechs that offer a neobank and/or card program partner with banks with assets under $10B, since they are considered Durbin-exempt when it comes to interchange revenue rates; banks over $10B in assets generate lower rates and therefore pass back less interchange to fintechs.

Despite the high-upside for these smaller banks and credit unions, there are still multiple challenges in considering which FinTech companies to work with. what types of use cases to allow, and long-term partnership effects.

Challenges for FinTech partner Banks

In the past 5 years, the discussion on industry challenges has centered on the experience of emerging and growth-stage startups. The conversation has now shifted towards banks working with fintechs, and what services can be offered by fintechs (through bank partnerships) that won’t compete with existing programs at financial institutions.

An early win for both sides has been with lending. Many banks have stopped (or greatly reduced) offering personal, unsecured loans in the last 15 years due to the higher risk of non-payment — choosing to focus mostly on credit cards (that provide additional interchange revenue).

FinTech companies filled this gap in personal lending and grew balances by 72% between 2005 - 2018 (from $69B - $119B). However, the financial risk in poor loan performance during an economic downturn can wipe out revenue for fintechs, especially in lending to low-credit consumers. In these difficult times of COVID-19, the industry is closely watching all fintech lenders to see who may or may not survive, and which companies cut credit access to clients. For banks that support fintech lenders, its not clear who would own a loan default.

“It’s a game of musical chairs, but if the music stops who is left holding the loan? Whoever is holding these consumer loans has to be prepared to be stuck with loans because the process could eventually stop.”

Alan Lane, CEO of Silvergate Bank (CNBC)

Besides financial risk, there are also concerns with compliance risk. As fintech companies welcome a wide range of users, inevitably a group of customers are ‘bad actors’ — looking for ways to commit fraud, engage in money laundering, or other illegal activities. What mitigating controls do fintechs have in place to onboard users and monitor transaction activity? FinTech partner banks must be knowledgeable about compliance programs at fintech companies, but defer the details to a fintech partner choosing from an approved list of compliance vendors. Poor or lax controls here can quickly lead to losses and regulatory action/penalties.

Finding a FinTech partner bank does help create valuable partnerships in the short-term, but the future holds a growing trend of fintech companies being banks (FinTech Bank). Despite the lack of approval for a national FinTech charter, mature fintechs are purchasing banks (e.g. LendingClub buying Radius Bank) or getting their banking license approved (such as Varo Money). This movement will lead to fewer opportunities for regional banks to grow their fintech channel. For now, banks feel comfortable playing the role of experienced advisor and helping fintech firms navigate the heavily regulated banking space. Similarly, FinTechs are able to save valuable time and cash flow for immediate priorities (such as product and growth) by deferring the heavy lifting to banks.

Looking ahead, the FinTech Partner Bank space can quickly become crowded as more community banks looking to capture deposit volume and transaction fees beyond their local footprint, test the waters with a fintech partnership. The key differentiators for banks gaining fintech business will be:

• Speed to market: banks are seen as slow to move when it comes to product innovation — minimizing the integration timeline for a fintech from 6 months to 6 weeks is a tremendous advantage;

• Cost structure: aligning costs to business models and user growth can help fintech companies (especially early-stage) increase success as they ramp-up their customer base; the early-stage fintech of today can be next year’s Chime or Brex. This also opens up the ability to poach fintech business from other banks;

• Multiple product integrations: Providing multiple offerings to a fintech increases revenue and the length of partnership, as fintech companies are less likely to switch banks they do more with (making them more “sticky”);

• Banking core infrastructure: Most banks still run on legacy core structures in which integrations with fintech partners become complex; having significant updates here can make future integrations faster and less costly;

• End-user support: Customer support in financial services needs to maintain a regulatory standard, especially for managing customer disputes and claims; banks that can provide support and expertise as part of their program will stand out from the competition.

OUTLOOK on PARTNERSHIPS between banks and fintechs

In the span of 2 years, we have seen the industry dynamic between banks and fintechs shift from rival to ally. Far from being considered disruptors, fintech companies have become true partners in the future growth and success of the industry — alongside financial institutions. Overcoming cultural differences, banks and fintechs can coexist for mutual gain.

What does this new decade hold for bank-fintech relations? Anticipate early movement of one side to the other — fintechs becoming banks (through acquisition or charter approval) at a faster pace, AND banks becoming fintech-like (by purchasing fintech companies or products to run on their own). There may be a longer horizon for large banks to make an organizational change towards fintech (as seen in the chart above), but the sustainability and success of established fintechs can change this quickly. Look for big banks putting cash to use with key fintech acquisitions or internal efforts of launching a FinTech division of their own.

The lines between banks and fintechs will no longer exist as both sides evolve to become similar in capability and execution.

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