What’s the secret sauce of a successful bank/fintech partnership?
- Fintechs initially came in the banking industry as a disruptive force, but now they are increasingly partnering with banks as the market becomes more competitive.
- There are many moving parts in a bank/fintech collaboration, and a successful partnership requires effective communication among both parties.
Fintechs entered the banking industry as a disruptive force – the incumbent system was not working for everyone, leaving ample opportunity for a new generation of financial services providers to change banking forever through creative technologies.
Initially skeptical, traditional lenders would watch on the sidelines. But pressed to compete, banks and credit unions have increasingly been opting to bring some of that innovation in their own products and services.
One way of doing that has been through fintech partnerships – this way, banks don’t have to build anything themselves, so that means speed to market and agility, and it requires a smaller budget than a full-on acquisition route. For fintechs, they get to focus on just doing one thing well while gaining access to a wider customer base and industry expertise.
“Why compete by offering the same core products that have high set-up and maintenance costs, when you can specialize in bringing additional value, at the same time driving down costs of having to maintain,” said Simas Simanauskas, partnerships director at ConnectPay.
In recent years, partnerships have been growing increasingly popular – almost 60% of banks and credit unions entered into at least one fintech partnership over the past three years, according to Cornerstone Advisors. The average number of bank/fintech partnerships per year doubled to 2.5 in 2021 from 1.3 just two years earlier.
Source: Cornerstone Advisors
In many ways, this is the perfect duo. Banks sit on large amounts of data, effectively acting as a goldmine for fintechs hungry to power their algorithms to shape improved and tailored outcomes. But compliance also plays a huge role – the fintechs that understand this aspect and are deeply committed to doing things by the books are more likely to win banks over.
After all, the potential to be unlocked here is to reimagine the size of the pie, rather than compete for the same small slices. Collaborations between banks and fintechs can also produce positive externalities, such as offering financial services to previously underserved corners of the market and expanding access to capital.
There can be multiple types of bank-fintech partnerships. A bank might need help with its operations, and can use third-party technology to improve efficiency. There could be projects around the customer-facing parts of the business, and here the bank could keep the direct interaction with its customers or just focus on the banking products and services while leaving the customer relationship to the fintech.
Source: IMF Global Financial Stability Report
Where to start
It all begins in finding the right prospective partners, either through formal processes or an organic approach driven by relationships. Many banks choose to create an innovation hub in order to facilitate multiple partnerships.
At US Bank, David Ness leads the bank’s dedicated fintech engagement unit, which developed an ecosystem of partners over the past six years with VCs, accelerators, private equity, investment banks. They regularly have conversations with them to build up those relationships, but it’s almost impossible to stay on top of all the new tech solutions that are popping up all the time.
“It's a balancing act right between just finding companies versus then actually delivering the value to our customers by implementing those solutions. So we're constantly going back and forth, tweaking that model. It’s a big challenge to narrow it down and be disciplined when it comes to what to focus on, when there’s so many possibilities out there,” Ness told Tearsheet.
US Bank has worked with the fintech sector in a number of emerging areas, including cryptocurrency, distributed ledger technology, tokenization of assets, digitization of credit applications, fraud detection, blockchain in foreign exchange conversion, personalized financial insights, and API integrations.
The goal is to commercialize these solutions, either directly in a consumer-facing app or into one of the bank’s production environments, by looking at how to layer in the bank’s existing capabilities with the fintech’s solutions, Ness said.
But to get there, bank/fintech partnerships require very close collaboration between the two.
Alignment of goals
The most important aspect of a successful partnership between banks and fintechs is that both parties understand each other's goals, and they share a common commitment to reaching those goals, according to Ryan Harris, EVP and head of payments partnerships at The Bancorp.
The Bancorp doesn’t go directly to the consumer – it’s a bank whose business model embraces disintermediation by enabling fintech products and services. It’s one of the biggest bank partners in the space, working with market leading tech firms like Chime, SoFi, Venmo, Oxygen, BlueVine, Uber, to power their financial services in the background.
“If expectations are not aligned, things can go wrong very early on, so it’s important to have a clear understanding at the onset of the relationship for each other’s capabilities, risk appetites and what their roles are going to be throughout the relationship,” he said.
Depending upon the product type and the risk profile of the customer, The Bancorp ensures that its partners have the funding, bandwidth, and management expertise to be able to accomplish their goals. In partnerships, the bank looks for a demonstrated ability to scale and human resource, as well as compliance and risk management infrastructure that really matches the ideals of the bank. And, of course, their product needs to be good enough to move the needle for the market.
“I’ve seen a ton of great ideas which could be very successful but they didn’t have the right people behind them. In so many cases, you're betting on the strength of the fintech’s team more than you're betting on the product. You need strong entrepreneurs and people who have shown a history of being able to innovate, pivot and do things quickly if something's not working,” Harris told Tearsheet.
Alignment of goals is a top priority for fintechs as well, as they want to make sure that they bring multiplicative value to their customer, according to Charles McKinney, co-founder and CEO of embedded mortgage fintech Vontive.
“We want to see a partner that has a core product or service where bolting on the Vontive mortgage will be accretive to them – not just as a new revenue stream, but also in terms of the sale-through rate of their core product or service,” he said.
If the two parties are not fully on the same page, it can lead to unsuccessful partnerships, especially if the bank’s incentives aren’t aligned up and down the organization, said Kathryn Petralia, co-founder of Kabbage and, more recently, Keep Financial. Prior to the American Express acquisition, Kabbage had a number of partnerships with trillion-dollar banks like Santander, ING and ScotiaBank.
“What we found was that partnerships were not successful because our interests weren't aligned. The CEO would be excited about partnering with a fintech, but the people who had to do the work every day were less excited because they didn't get paid more for doing that work,” she noted.
For a bank, partnering with a fintech can also bring a certain amount of risk. This is the part where things can get tricky – fintechs like to move fast and break things, while banks change slowly and are highly regulated, leading to a tough balancing act.
In more traditional banks, the risk management divisions have an incredible amount of say relative to new products. This is why it’s important to find the right people in risk management functions that are going to protect the bank, but also be innovative thinkers at the same time, according to Bancorp’s Harris.
“Allowing fintechs to move quickly and be on the edge of breaking something while staying within the bank's risk appetite and keeping them compliant is the secret sauce. We've built our entire organization to allow those parties to innovate and surround them with people that can ensure that if they knock a glass of crystal glass off the table, we're there to catch it before it breaks,” Harris said.
It’s important to keep an open mind, he noted – just because the bank’s always done something in a certain way does not necessarily dictate the way it needs to be done in the future.
But to get many programs up and running, banks do have to take on some risks, especially in lending.
“If what you want to do is open up your risk aperture, then the people in that organization have to be comfortable doing that. If they're not, then the partnership doesn't go anywhere, because the bank just keeps doing what it has done every day,” Kabbage’s Petralia added.
Bringing in an external partner takes a certain amount of adaptation for banks, as they need to ensure they stay compliant and meet regulatory obligations every step of the way. But a bank can start small and work with a single processing entity, Harris suggests.
“Invest in data centers to allow for scalability, hire people that have done it before, that know how to manage data and build risk appetites - those things are going to align well with fintechs,” he advised.