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Banking Briefing: The SMB/fintech fairytale & what makes a successful challenger bank

  • The recent news about Brex could be a cautionary tale for other SMB-focused fintechs.
  • Plus, MX's VP of product gives his thoughts on what makes a successful challenger bank

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Banking Briefing: The SMB/fintech fairytale & what makes a successful challenger bank

Stop, drop, and roll away: Is the SMB banking saga coming to a halt?

By now, you’ve probably seen the news about Brex: The Silicon Valley-based fintech, which started out with the goal of funding early-stage startups, has sent a less-than-welcome message to its thousands of SMB customers, telling them to withdraw their funds by mid-August.

It turns out that in light of the funding dry spell, Brex had to make a quick call on who to serve. It opted for its bigger, venture-backed clients, leaving behind SMBs like restaurants and retailers.

“It’s terrible. It’s the worst outcome for us, too,” co-founder and CEO Henrique Dubugras told CNBC. “We invested so much money in acquiring these customers, serving them, building the brand, all these things.”

Not casting any shade on Brex here, but the whole story does put a less flattering angle on all the ‘fintechs banking SMBs’ stories that have been circulating the past couple of years – i.e. the ‘banks won’t help you, but we will!’ plot.

It will be interesting to see how SMBs respond to this story, and whether or not their trust in fintechs will hold up in the wake of this new development. 

In the notice Brex sent to its SMB customers, the lender offers an alternative option in partnership with Bluevine.

"Bluevine any good?" tweets one not-so-happy user.

The future of the challenger bank – thoughts from David Whitcomb, VP of product at MX

With the news about Brex and the slew of challenger banks unable to set solid foot in new markets, figuring out how to build a sustainable, profitable challenger bank is, to say the least, a challenge (yes, I know that pun is getting old, but so are a lot of challenger banks, it seems, so…)

These developments beg the question: what does it take to build a successful neobank?

David Whitcomb, VP of product at MX, a financial data platform, has a lot to say about the topic:

"If you’ve ever worked at a traditional bank or credit union, you’ve watched neobanks and challenger banks create products that are competing with your digital experiences, impacting the conventional approach to NSF and overdraft fees, and entering markets you thought would be too small to create a meaningful balance sheet impact. You’ve probably asked yourself, 'How will they make money?' as you’ve watched them rise to prominence.

If you hop on FinTwit (Fintech Twitter) for any period of time, you’ll see discussions of compression of valuations and reduced multiples. Many fintech companies and neobanks are feeling the pressures of a tightening economy and experience this compression firsthand – especially if they don’t have a clear path to profitability. If we zoom in on niche banking options, we can learn quite a bit by looking at one example of a neobank that obtained its charter, Varo Bank. 

Why can we look at Varo as an example? Because bank financials get published! Sheel Mohnot and Jason Mikula offer their insights on Varo Bank in a Twitter thread that shows the risk that user growth, achieved through costly customer acquisition, and not followed with healthy user engagement, can have on a bank’s financial statements. I highly recommend reading through the thread and looking at Jason Mikula’s call report table. Varo received a valuation of $2.5 billion at their latest fundraising in 2021, and based on the call reports, growth patterns, and bank valuations, revenue could be under $1 billion. This should be a wake-up call to neo/niche banking providers that don’t have strong user engagement or growing revenue streams other than debit card interchange fees.

Simply put, it’s easy to pay people to open a new account and create user growth. Varo has offered $100 perks. SoFi has offered up to $300. Chase offers up to $225. Consumers will sign up for new accounts if you pay them to open an account! If you can’t turn a new account into consistent card transactions, it is going to be very hard to find profitability. This is where chartered banks have a distinct advantage. Banks that own their deposits can lend them and earn interest income. Lending is one of the many ways banks leverage their balance sheets to maintain profitability, and most niche banking providers don’t have that lending option.

Many neobanks have been dependent on a bank for their charter. As a result, the neobank does not formally own the deposits the way a bank does. They don't manage a balance sheet the way banks do – they focus on managing experiences and engagement first. If you survey most neobanks, their lending options may include small loans for items like overdraft and may cap at $500. If they're issuing car loans or personal loans, they may have an industrial loan charter, which is typically a very different type of business.

Challenges aside, how do niche banking providers move forward? There are a few key considerations that can give them a chance to find profitability, or at least a long journey ahead:

  1. Can you find a captive audience from the beginning?
    • Does an affiliation give you access to a high-volume group of people with similar problems?
  2. Know your customer and solve their problems. 
    • You won’t need to pay them if you solve their problems well.
  3. Diversify revenue streams. Interchange isn’t sufficient. 
    • Can you sell something?
    • Can you charge a fee for a premium service like real-time money movement? (See PayPal and Venmo)
    • Can you create an attractive credit card rewards program?
    • Can you create referral networks? (Look at BNPL shopping programs)
  4. What network effect can you create?
    • Cash App’s P2P service and wallet were just the start of their success.
    • Focusing on geographic or social groups can accelerate the growth of a network
  5. Do you have a benevolent parent company that benefits as well?
    • Venmo has PayPal
    • Cash App has Block

It’s clear that in the current venture funding environment, niche banks are not without their challenges, but neither are many early-stage startups. Once a niche bank has found product-market fit, finding the path to revenue is about creating additional value that creates new revenue streams. It’s not simple, but neither is banking, the industry in which they compete, so maybe we shouldn’t be surprised."

What we’re reading

On Starling’s success – efficiency or carelessness?

Over the course of the pandemic, Starling has added around 15,000 new consumers a month. That’s despite circulating critiques surrounding the banking app’s fraud controls. (The Guardian)

N26: How (not) so C-suite it is

N26 has been experiencing some pretty noticeable hiccups on its race to the top, with its expansion into US and UK markets being put on hold. But when it comes to all those higher-profile employees leaving the digital bank, CEO Valentin Stalf takes on an attitude that’s more akin to a shrug. He does admit there aren’t enough women at the C-suite level, so…yay? (Sifted)

Because kids, it’s always more fun to spend money on a planet that’s inhabitable 

The Basel Committee on Banking Supervision is recommending banks to revise their payment and bonus structure to make sure they don’t interfere with goals concerning climate change. (FT)

Banks may not be your besties, but crypto firms aren’t exactly your chums, either

Alex Mashinsky, CEO of crypto lending platform Celsius, has been quoted as saying that banks are not your friends. That’s sort of the vibe a lot of crypto platforms emanate – 'We're the good guys, they're the bad guys.' Only, these crypto companies aren’t exactly saviors, as demonstrated by many of their own sneaky lending policies. (FT)

The Ant goes marching

Ant Group is launching a new challenger bank in Singapore, targeting SMB users. (Coin Republic)

The meatier the jargon, the deeper the waters

The FRA-OIS spread and other stress indicators are, well, indicating that the US banking sector is in deep waters. (Reuters)

What we're writing

What’s Happening in Payments Ep. 8: Klarna and the future of BNPL, PayZen’s ‘Care Now, Pay Later’, and Mastercard’s ‘Smile to Pay’ system

Data Snack: DAOs are gaining traction with consumers as well as regulators

For retailers, embedded finance solutions are still confusing

‘The deeper the liquidity pools, the more quickly we can get to value in crypto’: Ripple’s Brooks Entwistle

After integrating Afterpay with Square Cash App and Seller ecosystems, in-store sales are up 384%

The Acquire Podcast Ep. 11: Movement as marketing and transformation with StrawberryFrog’s Scott Goodson

The Green Finance Podcast Ep. 2: The S in ESG and the role of inclusive product design

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