The Big Idea | FinTech’s Big Leap into Banking (Feb. 29, 2020)

Throughout the year, we’ll be offering a deeper look at some of the biggest trends in fintech, which we believe will continue to impact financial services in the coming decade. This leap day, we’re taking a look at how fintech firms are acquiring national bank charters. As always, if you have any ideas for us, or there’s anything you’d like to know more about, drop us a note at fintechupdate@gmail.com.

Since appearing on the scene in a big way in the mid-2000s, U.S. fintech firms have offered a variety of financial services, but they’ve generally relied on workarounds for traditional banking services like deposit-taking and loan origination. But this month, after years of impasse, we saw a breakthrough. Well, two. Fintech pioneers LendingClub and Varo Money both got closer to possessing national banking charters, as LC became the first fintech to acquire a chartered bank and Varo received FDIC approval to hold insured deposits. This week, we’re looking at what these developments mean and what they may portend for the future of fintech. 

So, what’s the big idea with fintechs getting national bank charters?

Well, first, what’s the big deal with national bank charters? All banks operating in the U.S. are chartered and regulated by either their state financial regulator (“state banks”) or the federal bank regulator, the Office of the Comptroller of the Currency (“OCC”) (“national banks”). And while there’s plenty of value in a state licence, OCC approval is basically the vintage Daft Punk of bank charters — harder, better, faster, stronger. (Well, not faster.)

A national bank charter comes with cool features like the ability to transfer money across state lines without needing individual state licenses, offer loans without state interest rate caps, and hold deposits (*FDIC insurance sold separately). In other words, national bank charters offer the highest “flexibility in terms of authorized commercial banking powers,” which are very attractive to fintech firms looking to upset the status quo of traditional financial services.

Here’s the problem: America’s byzantine regulatory regime has proven difficult to navigate for fintech firms seeking those powers. In addition to being the guardians of America’s depository galaxy, the OCC and FDIC are still skittish from the rash of bank failures during the financial crisis (465 from 2008-12, compared to only 10 from 2003-07), and they’ve been extra careful handing out charters since then. Even if the OCC were to charter a bank de novo (lawyer-speak for “new,” but they charge $1k/hr for it), getting the FDIC on board would be its own challenge, and customers aren’t going to be psyched about making deposits without FDIC insurance. As a result, for the past several years, fintechs interested in offering bank services have been making due with workarounds like (i) partnering with existing banks and white-labelling their products, or (ii) pursuing other charters, like an industrial loan company (“ILC”).

That’s why this month was such a watershed for fintech. On the 10th, Varo Money became the first fintech firm to receive preliminary approval from the FDIC after three years, multiple applications, and nearly $100 million-worth of effort. With FDIC approval in hand, Varo only needs to set up a bank holding company and get final approval from the OCC before it ascends to the heavens as a full-fledged bank. Meanwhile, LendingClub’s splashy $185 million acquisition of Radius Bank represented the first time a fintech firm has purchased a chartered bank, which will give the online lender the bank powers it has long sought through other means. Both deals still have regulatory hurdles to leap, but both are expected to close, meaning Varo and LC will be nationally chartered banks sooner rather than later.

Why should I care?

As we wrote last month, fintech is going through a period of convergence and consolidation, as large companies gobble up smaller ones and firms roll out new products that encroach on others’ turf. Lenders are no longer just lenders, and payments firms no longer do just payments; everyone wants to be everything. As Todd Baker recently put it, “the monoline . . . model is a dead end for FinTechs and they know it. [Most now] are engaged in ‘rebundling’ into bank-like product suites.”

A bank charter not only facilitates this broader range of service offerings, it also comes with high barriers to entry, meaning the most mature and sophisticated firms can put some distance between themselves and their competitors in the race for your business (…and data. And loyalty. And first-born…). 

Getting a bank charter isn’t cheap, whether through application or acquisition. In both cases, firms must demonstrate to regulators that they have the technical expertise to manage a bank, appropriate risk infrastructure, an impeccable business model, a resolution plan, and appropriate compliance processes and personnel in place, among other elements; and none of that comes cheap or easy. 

What should I look out for?

There’s plenty to keep an eye on as the fintech space rapidly evolves, but in the short- to medium-term we’ll be looking out for renewed efforts by some of the larger, more mature fintechs to get charters of their own, as well as continued consolidation across the industry.

The motivation here is nothing short of survival. As we wrote above, having a charter is a strategic advantage for firms looking to diversify their product lines and serve more and more varied customers. As firms like Varo and LendingClub expand their brand and product mix — while also reducing their back-end costs by eliminating their reliance on bank partners — they will be able to box out smaller and less mature competitors that rely on single revenue streams and need partners to survive. The result will be a race among the most mature firms to compete on equal (i.e., chartered) footing.

However, that race is grueling, and many firms will either fall short of getting regulatory approval for a de novo charter or fail to find an acquisition target that makes as much sense as Radius did for LendingClub. These firms, feeling the squeeze of increasing competition and the prospect of a slow death in the shadow of their chartered peers, may opt for the M&A route with a complementary financial institution, either fintech or traditional. It’s hard to know how long this will take or just how much consolidation there will be, but it’s unlikely that by this time next year we’ll see a fintech ecosystem as diverse and independent as it is today.

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