The benefits and drawbacks for banks in buying fintechs

Fintech acquisitions are an alluring if underused path for banks to follow in their quest to boost innovation.

American Banker's Innovation Readiness report, published this month, found that nearly two-thirds of the financial services companies surveyed — which were divided between 110 financial institutions and 69 insurance companies — are using at least one form of strategic corporate transaction to advance innovation. In fact, among institutions involved in mergers and acquisitions, investments in fintechs and joint ventures, 79% see these methods as "very" or "somewhat" important to achieving or accelerating innovation.

Investing in fintechs or startups is the most popular choice, at 31% of respondents. In contrast, 18% dabble in fintech or startup acquisitions. But this marks an increase: In 2022, only 7% of firms surveyed acquired fintechs or startups as part of a corporate innovation program. The number stood at 10% in 2021. 

Nevertheless, banking companies such as Fifth Third Bancorp in Cincinnati and Ally Financial in Detroit have been snapping up firms in recent years. According to American Banker's research, the top two reasons for strategic corporate transactions are to acquire more customers and to diversify customers, markets or product offerings.

Banks sometimes hesitate to buy fintechs because of historically high valuation multiples, said Tim Johnson, U.S. transaction services leader and global deal advisory lead for financial services at KPMG. 

"Deals have been very cash-centric and expensive," he said. However, the past 12 months have seen a slight pickup in activity as fintechs have run out of other options for exit opportunities and private equity has slowed down.

There are other factors to weigh when considering whether to buy a fintech instead of building the capabilities or participating in a joint venture.

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Joint ventures mean sacrificing some control over a company and how it operates, whereas buying means complete control, points out Johnson. At the same time, a partnership "allows you to further evaluate whether it suits the needs you're trying to achieve," Johnson said. "You can see if that scratches that product itch or serves as a better method in attracting or retaining customers."

Custom-building a solution gets a bank exactly what it wants but takes time, and "the expense of investing in building it yourself often doesn't pay off the way you think it would," said Johnson.

Robert Ruark, national financial services strategy leader and U.S. fintech leader at KPMG, finds the most common reasons that banks acquire fintechs are for the product capabilities and to access a new channel or market. But a secondary benefit is "the bank gets development talent they don't have," he said.

To set up the venture for success, it's vital a bank clarifies the reasons it is buying a firm.

Fifth Third has been on a streak of acquisitions over the last few years, including the health care lender Provide, renewable energy lender Dividend Finance, health care payment software maker Big Data Healthcare and embedded payments platform Rize Money.

"It's very important to remember why you made that acquisition," Bridgit Chayt, head of commercial payments and treasury management at the $213 billion-asset Fifth Third, said on a panel at American Banker's Most Powerful Women in Banking conference in October. "They have something you don't, whether that was in mindset, the way they worked or the technology. But there was a formula that you weren't recreating within your own organization."

Cultural differences are bound to come up when melding, say, a buttoned-up environment with an agile employee base that is used to flying by the seat of its pants. Sometimes that can be a positive.

When Fifth Third acquired Rize Money in May, "it was a bit of an epiphany to say, wait a minute, I don't want them to be like us, I want us to be like them," said Chayt on the panel. "It was the way that they approached and solved problems. They could run at a different velocity because they weren't navigating the full organization. We put those two things side by side and said, how do we find that place in the middle?"

Ally has learned from experience as well. The $195 billion-asset company purchased the online brokerage firm TradeKing in 2016, lender Health Credit Services in 2019 and subprime credit card issuer Fair Square Financial in 2021.

Diane Morais, the president of consumer and commercial banking at Ally, said on the same panel that for Ally's first acquisition, "we tried to integrate it almost too quickly and we broke some stuff." 

For another, the bank went "too slow."

For the most recent acquisition, "I don't know that I could completely call it just right, but it's a lot better," Morais said. "We've tried to be really thoughtful about how we nest them into the culture."

A bank must hash out where the fintech will sit within its organization and to which department it reports.

"We've seen some deals fall apart from a value creation standpoint when there isn't clear accountability and ownership, or there is split accountability," Ruark said.

Finally, a bank should continue to let the fintech's employees do what they love. That could involve linking cash bonuses to specific technology development and deployment, according to Johnson. It could also mean saving other responsibilities for bank employees.

"The more successful integrations figure out how to ring-fence the technology people so they continue to focus on the things they like to do, which is product development, and they don't get caught up in making sure they are complying with all bank's standards and policies," Ruark said.