A swath of banks are gearing up to offer their banking services to fintechs for the first time, or accelerating the efforts they have dabbled in so far.
Providing financial services to fintechs behind the scenes is a relatively cheap way to acquire new customers on the deposit side and generate loan volume on the lending side. During periods of low interest rates, it is an appealing way to generate fee income.
“It was also a way banks could ride and benefit from the fintech wave instead of compete,” said Jonah Crane, a partner at advisory and investment firm Klaros Group, in a recent interview. “Banks saw hey, there is higher fee income, higher return on assets, higher return on equity, it will drive a higher valuation multiple. And every day there are a bunch of new fintechs raising large amounts of money, getting into the space and needing partners.”
But the timing of these new launches is counterintuitive. Interest rates are going up; fintechs are facing their own
During American Banker’s Digital Banking conference, Crane
Conversations with banks entering or heightening their presence in this space reveal what factors are still galvanizing them to take the plunge.
The founder and CEO of Piermont Bank recently won recognition as a Digital Banker of the Year from American Banker. She discusses her approach to working with fintechs.
Lead Bank, which has $778.9 million of assets, hired Huma Usmani, formerly of Radius Bank and LendingClub, in a newly created position, banking as a service director, in October 2021. The digital bank already provides underlying services for Self, a credit builder account, and Dama Financial, which extends bank accounts to
Usmani names several benefits for community institutions such as Lead: lower customer acquisition cost, a national reach and new customers in new markets. She says that President Biden’s executive order last July, which encouraged the Consumer Financial Protection Bureau to consider rulemaking that allowed for the
For
Potential BaaS partnerships are likely a couple of years away, but Marcio deOliveira, chief technology officer of Climate First, says there is a place for Climate First because it will be strategic in targeting environmentally focused fintechs.
“We are not positioning ourselves to be a generic banking-as-a-service provider,” he said.
Climate First, which has $167.3 million of assets, already offers solar loans that borrowers apply for online and a checking account that benefits Project Regeneration, a nonprofit advocating for a plan to end the climate crisis. It could potentially replicate these products for fintechs.
“The beautiful thing about technology is it can scale very easily once you build it,” said deOliveira.
The challenger bank Swell, which launches next month, is Central Pacific’s first client. Central Pacific incubated Swell for more than a year before spinning it off on Jan. 1. It is aimed at what the company calls “strivers,” or people who want to take control of their finances and tackle debt. This includes near-prime customers seeking credit. The initial products will be a checking account and line of credit where users can move money from their checking account to their credit account instantly and vice versa. Otherwise, Central Pacific has several fintechs in the pipeline that are in various stages of production or due diligence.
For the community bank, the major goal was growth.
David Morimoto, chief financial officer of Central Pacific, says that Hawaii occupies less than 1% of the U.S. banking market. “Why limit ourselves to less than 1%?” he said. The institution has $7.3 billion of assets, but “the Hawaii banking market is competitive and we could never get to be $14 or $15 billion of assets in Hawaii because the M&A opportunities are limited,” he said. BaaS opens up that possibility.
Allan Rayson, chief innovation officer and chief technology officer at the $1.8 billion-asset Encore Bank, is weighing the pros and cons of BaaS alongside other options that would accomplish the same goals of sourcing deposits, raising fee revenue and increasing its valuation as a bank.
“There is no shortage of opportunities to lend money in the markets we are in,” he said. “But we want to fund those loans as cost-effectively as we can.”
At the same time, Rayson says there is more regulatory scrutiny on BaaS today than there was even several months ago. The
One way Lead Bank is addressing concerns about risk is by targeting fintechs that “have it all buttoned up,” said Usmani, meaning they are well funded, have access to capital, are able to acquire customers and have founders with good track records.
One of Swell’s first hires was the general counsel and chief compliance officer, who has more than 20 years of experience and a small team underneath her.
“We made a huge investment, largely because [Central Pacific] required it,” said Kevin Dahlstrom, Swell's CEO.
In February, 15 consumer groups
One market force keeping banking-as-a-service relationships alive is challenger banks that need more than one bank partner as they grow, Crane pointed out. For example, Chime lists both The Bancorp Bank and Stride Bank as the underlying institutions behind its products. Or if they experience trouble with their current partners, they could look elsewhere. “Wherever the current market environment will lead, a lot of fintechs haven’t reached the end of their runway,” Crane said.
He still foresees fintechs needing the support of chartered banks because they won’t become banks themselves. “I still think there is enough structural demand out there that you will continue seeing the models grow and expand,” he said. “But I suspect it won’t be quite the buzzword a year from now as it has been the past year.”
Dahlstrom sees a bright future for the service.
“My take is there is still an enormous amount of consumer problems to be solved,” he said.
