As fintechs buy up banks and acquire charters, companies looking into the option of legally becoming a bank face a series of challenges and potential risks along the way.
Challenges a fintech could face as it becomes a bank include regulatory concerns, scaling for multiple product offerings and adjusting core business models, according to investment expert Matthew Alfieri.
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Alfieri, a growth equity partner with Centana Growth Partners, told American Banker that fintechs acquiring banks or applying for charters need to plan for setting aside additional money on the balance sheet for regulatory capital. Regulatory capital, also known as a
"That's one challenge that fintechs have not historically had to do with a bank sponsor," Alfieri said. "Their cost of capital is much higher than a large, established bank, because they're still taking capital in on venture returns as they're transitioning into a new business model."
Alfieri said that since
"One thing that I think fintechs should consider to help mitigate that is ensuring they're of sufficient size and scale, and hopefully even profitability, so they can bear some of those core costs organically as opposed to having to rely on external funding," he said. "If you're a small fintech with limited or even no profitability, your cost of capital is going to be high because you're raising capital from a venture capitalist or growth equity fund that has expectations of making 20% to 30% internal rate of return."
Some fintechs entering the banking space may also need to hire additional personnel with specific knowledge in bank regulation. Currently, fintechs aren't as strictly regulated as banks, and the complexity of bank regulatory approval processes and requirements may require additional expertise beyond a fintech's initial staffing.
"Fintechs have been operating under a different regulatory paradigm," Alfieri said. "Part of the process of becoming an OCC-regulated bank is actually going to present in front of the OCC. They want to know a lot about who your executive team is, who's on your board of directors, what knowledge they have about banking to ensure that they know how to navigate that. Oftentimes, there's a personnel upgrade required in order to better position yourself to not only adhere to the regulatory requirements but navigate some of the complexity there."
Wil Hamory, a risk management expert and fintech lead at the commercial insurance firm Founder Shield, told American Banker that the regulatory side of a fintech becoming a bank comes with costs — whether through doing it right or getting it wrong.
"Fintechs must establish robust internal controls, risk management frameworks and governance structures aligned with traditional banking standards," Hamory said. "This approach undoubtedly increases operational complexity and costs. On the flip side, regulatory violations can result in severe penalties, enforcement actions, reputational damage and even restrictions on business activities."
When a fintech acquires a bank charter and thereby becomes a bank in the official sense, it gains the ability to offer banking services such as checking and savings accounts or direct lending alongside whatever the fintech originally specialized in. For example, with the SmartBiz deal, the lending fintech can now offer national small-business loans and directly accept deposits to fund those loans.
Multiple product offerings could bring fintechs into stiff competition with established banks, according to Alfieri. Fintechs often compete with banks on one specialized product set or technology offering, but when they acquire bank charters they start to compete on the bank's home turf.
"Offering multiple products is a space where larger banks have some competitive advantage, in part because their cost of capital is lower," Alfieri said. "I can perhaps get a mortgage from a fintech, or I can get one from JPMorgan Chase because I'm doing my wealth management and my ordinary banking with JP Morgan. They oftentimes can offer lower rates as well and that is more attractive to the consumer, but it is also costly to the bank because they have lower margin and still the potential risk of loss. The big issue is whether or not fintechs have the right to win in a multi-product line environment."
Much like other tech companies, fintechs are often fast-moving and looking to jump on board whatever the next new innovation in the market is. This business model may be tempered after acquiring a bank charter due to the comparatively slower pace of bank regulation, according to Alfieri.
"One thing that allows fintechs to continue to be agile is the fact they are oftentimes operating on more uniform technology stacks that tend to be cloud native," he said. "That allows them to iterate from a product perspective at higher speeds, but at the end of the day, they're still going to be subject to the same regulations as a bank. Those regulations will require adequate testing of risk management policies and, at times, regulatory approval for new products as they look to roll them out. As a bank, you can only move as fast as the regulators are willing to let you move."
Overall, Hamory believes that the recent trend of fintech companies acquiring bank charters will significantly reshape the banking-as-a-service, or BaaS, industry.
"By obtaining charters, fintechs can offer banking services directly, reducing reliance on traditional sponsor banks and BaaS intermediaries," he said. "This shift may lead to a more integrated ecosystem where fintechs control both the customer interface and the underlying banking infrastructure."
Traditional BaaS providers may face increased competition from fintechs that successfully address the risks of becoming banks, according to Hamory.
"This evolution could also drive consolidation in the industry, as larger fintechs and banks acquire smaller BaaS providers to expand their service offerings," he said. "Overall, fintechs becoming banks may lead to a more streamlined, competitive and innovative BaaS landscape."
