Why adding BaaS partners is no easy task for fintechs

Adobe Stock

It's not a good time to be a fintech looking for a sponsor bank. 

Simply put, there's a supply issue: There are more fintechs that require a sponsor bank than there are sponsor banks to support that need, Bryan Mucahey, managing partner at FS Vector, told American Banker. Not to mention, established fintechs are looking to add second or third banking-as-a-service partners to scale existing products or launch new ones, further cluttering the pipeline.  

"It is very hard for fintechs of any size to partner with the banks that they'd like to partner with, and that's because there just aren't enough partner banks and those that do exist are incredibly busy," Mucahey said. "That's a problem for trying to have an innovative financial services economy where most of the innovation is happening at the venture-backed fintech side of the market." 

The supply shortage is the product of multiple factors, he said, including the regulatory environment under the Biden administration, whose propensity to issue consent orders against BaaS providers kept many banks on the sidelines. 

It's also difficult for banks to get into partner banking, Mucahey said. "It requires new technology, contracts, new staff, sometimes more capital, more planning and all those things mean when a bank wants to get into banking as a service, they're probably not onboarding programs for over a year." 

There's also fewer banks out in the market that solely focus on providing banking services to fintechs, Hillel Olivestone, head of strategy and corporate development at Cross River Bank. Cross River specifically focuses its business on providing banking services to fintechs. 

"There were a large number of banks trying to do things like Cross River does and be specifically 100% focused fintech institutions. I think there's fewer of those," Olivestone said. 

Some community banks that provided BaaS services have gotten out of the market, too. Fairfax, Virginia-based MainStreet Financial shuttered its BaaS subsidiary after it failed to hit revenue and deposit targets, ending the bank's four-year BaaS experiment. 

Not to mention the failures of Evolve Bank & Trust and middleware provider Synapse have left some fintechs to reevaluate their current partnerships and look for new ones. Business banking fintech Mercury parted ways with Evolve in March, opting instead to migrate its customers to its other partner banks, Choice and Column.

"The state of the market post a Synapse and Evolve world, is a more scrutinized world and rigorous environment," Olivestone said. "Regulators want to make sure, as always, that the banks have proper controls in place and oversight on their fintech partners and clients." 

And switching BaaS partners isn't easy, either, for fintechs, Adam Shapiro, a partner at Klaros Group, told American Banker.  

"Let's leave aside the current environment. It's never been easy to change partner banks. There's a huge amount of technical integration work with a new bank," Shapiro said. "One of the pieces of advice that we always give to people that are choosing their first partner bank is to plan for success here. Moving is like getting divorced." 

That environment has led banks that specialize in banking as a service, such as Cross River Bank and Column, to be more deliberate in the fintechs they work with. 

For example, Cross River has "raised its standards a bit" in different areas when they are evaluating whether they want to onboard a potential client. Cross River was one of the banks hit with an FDIC consent order in May 2023 that required it to not only be careful about taking on new clients but seek permission from the bank's board and the regulators first. 

"We're looking at everything about the company," Olivestone said. "Do they have a proper compliance team, risk team and management team that understands the requirements that we're going to need them to follow? Do they have a proper amount of capital to survive and obviously make the investment worthwhile on both sides. … Does the product itself have market fit and scalability?" 

Column, which also specializes in providing banking services to fintechs, has maintained a high bar for onboarding new clients even in the face of some players in the market pulling back, Nick Rasines, head of sales and partnerships at Column, told American Banker. 

"One of the big things that's changed over the last couple years is there were other providers in the space – and some don't exist anymore – they just kind of let people launch and test products and kind of get going pretty quickly," Rasines said. "That's something that's changed a little bit over the last couple years, because [fintechs are] realizing that it's really painful to change banks. At the end of the day, a lot of our clients are thinking about banks for the next decade. They're not thinking about the bank for the next 60 days." 

But the shortage of BaaS providers isn't just an operational roadblock for fintechs, it can be the lynchpin to receive necessary funding from investors, FS Vector's Mucahey said. 

"A lot of fintechs raising Series A, Series B rounds in those pitch decks, or as part of that fundraise, they're often promising to launch a new product, [which requires a BaaS provider]," Mucahey said. "Sometimes what [investors] will do is they'll actually request or require that the fintech has a signed term sheet before they'll either release any of the funds or even sign those fundraising rounds." 

The problem isn't likely to be fixed anytime soon, he said. "We need capacity for hundreds, if not thousands, of new fintechs. And it's not just new fintechs. Each product that each fintech offers needs a partner bank, and sometimes it's not the same partner bank, so you'll often see banks support a fintech credit card within the deposit account hosted somewhere else."