Giving the banks a run for their money

An increasing number of fintech companies are applying for US banking licences, potentially turning former partners into competitors

Jelena McWilliams (right) Chairman of the Federal Deposit Insurance Corporation during a conference on fintech
Jelena McWilliams (right) Chairman of the Federal Deposit Insurance Corporation during a conference on fintech 

Will the banks be able to keep up in this rapidly changing landscape? The exploding popularity of fintech applications continues to transform the finance industry, a sector of the economy previously dominated by traditional-minded institutions. One notable development in the increasingly widespread use of fintech apps is the merging of banking and fintech that we are beginning to see. Fintech companies are rushing to apply for banking licences, and quite a few have already been approved. The first to lead this trend was fintech giant Square, which was able to obtain approval to create an industrial bank from the Federal Deposit Insurance Corporation (FDIC).

Since then, other fintech companies such as Varo Money, LendingClub, SoFi, Figure and Oportun either have been approved to create their own banks or have applications pending. These developments are important because it will create competition for existing banks and also affect the partnerships between the two entities in the future.

Certainly it is alarming for banks to realise that their current partner may soon become a competitor, armed with the benefit of a deep understanding of their operations borne from their work together. However, this change in status will also subjugate fintech companies with an increased amount of regulation and oversight. As fintech continues to create easy, convenient, quick and low-cost methods of serving the financial needs of individuals as businesses, banks must move to develop their own mobile banking technology to stay competitive.


Changing fintech landscape
In a select few US states, industrial banking charters are offered to companies who want to offer banking services and loans to small businesses without the burden of oversight by the Federal Reserve. Industrial banking charters are controversial, with many raising issues with a licence that allows non-financial companies to offer banking services. Because of this, an industrial banking charter has not been approved in 10 years – at least not until Square had theirs approved in March of 2020.

Certainly, this is an interesting development for the financial services sector. It could be a very positive change for small businesses, who may find that they have more options in terms of obtaining loans.

Servicing the small business market brings ample opportunities for fintech, as this historically has been ignored by traditional financial institutions

Square’s focus has always been on helping small businesses, which has never been more important, since the coronavirus pandemic has hurt profits for so many of them. In fact, one other interesting trend that has been seen among fintechs in the midst of the pandemic is the opportunity presented to them to serve small businesses under the Paycheck Protection Programme (PPP).

Fears that fintech will completely supplant the existing financial services sectors have been reignited. The birth of fintech originally scared banks for this same reason, and most of the traditional financial institutions reacted by agreeing to partnerships with fintech companies in the hope of riding their wave of success. The ability of fintech companies to offer new solutions, face challenges and adapt to a rapidly changing tech landscape has forced banks to reform their technology and adapt to better suit customers’ needs.

In fact, servicing the small business market brings ample opportunities for fintech, as this historically has been ignored by traditional financial institutions. This is a problem, with only 27.5 percent of small businesses, on average, being approved for business loans by banks. The pandemic has devastated small businesses, yet all signs point to the beginning of a recovery for the economy as a whole. It could be the perfect time for fintech applications to start offering banking services to help revive small businesses around the world.


Bypassing barriers
However, the process of applying for a banking charter can be lengthy. For example, it took Varo Money three years to be approved for theirs. Some fintech companies have found clever ways to bypass this governmental barrier, however, by acquiring digital banks in their portfolio. LendingClub was able to acquire Radius Bank in February, which may have saved them the steep fees involved in a banking charter application.

Both Radius Bank, LendingClub and Varo Money have focused more on individual consumers rather than small businesses, although this could change. The democratisation of stock reading, cryptocurrency investing and online banking has broadened access to financial services typically reserved for the middle or upper classes.

The financial services market has become so rife for innovation, and so potentially lucrative, that many industries are trying to get a piece of the pie. There has been a new term coined for technology companies who have recently begun offering financial services: techfin. However, traditional financial services point out that without the necessary knowledge, the ease with which everyday people can invest money via fintech apps can become dangerous. With fintech apps moving into the banking sector as well, there is a concern that these companies will encourage their users to invest their money rather than keep them in savings accounts.


Banking with fintech apps
So, what is behind this trend of fintech companies moving to get involved in the banking sector, rather than sticking with their partnerships with well-established financial institutions? By expanding their services to include those most commonly found in the banking sector, fintech apps can expand their clientele and gain access to a larger market. The profit is undoubtedly larger, as fintech companies can then cut out the middleman and deal directly with their customers, building relationships in the process.


Will we see more fintechs in banking?
There is a lot for fintechs to gain by applying for a banking charter. However, as we mentioned previously, the application process can be lengthy and expensive. There are also a lot of government regulations and obstacles that need to be overcome before an application is approved. Robinhood learned this lesson when they pulled their national banking charter application.

Previously, there was discussion from the Office of the Comptroller of Currency (OCC) of a special banking charter for fintech companies that would fast track the application. However, this was shut down in October 2019 after a New York federal judge ruled that the OCC, the regulator issuing the charters, did not have the authority to create this special type of charter. However, it is a significant development to have seen three fintech companies get approved with their banking charters (Square, Grasshopper and LendingClub). There have only been nine banking charters granted nationwide since 2008, and none at all in the past 10 years.


The benefits of a banking charter
It’s a fact that the traditional financing institutions have underserved small businesses, especially minority-owned small businesses. It’s also true that many of these same small businesses were hit hard by the pandemic and forced to close their doors because of lack of funding.

There is a huge need for financial services for small and mid-sized businesses as well as individuals who are just getting their financial lives started. There are undoubtedly hurdles to obtaining a national banking charter, but the rewards are astronomical. Fintech businesses with banking charters can work with Automated Clearing House (ACH), a standard payment rail. They can operate in any state in the US without having to deal with different state laws and jurisdictions and offer their customers FDIC insurance.

Fintech companies may be shaking up the financial sector, but that might be a good thing. Despite negative PR about the risks involved with new fintech investing apps and the value of cryptocurrency, clearly these companies are leaning towards accepting more federal regulations in return for access to broader market segments. The approval of so many fintech applications for national banking charters will serve to further legitimise many of these new fintech apps, and possibly become stiff competition for their former banking partners in the process.