Rebundling banking services: Are fintechs trying to be more like banks?

The emerging trend of fintech companies acquiring banking licenses is gaining momentum, blurring the line between fintech and banking. 

More fintechs are racing to become banks by putting in bank charter applications and are being given the green light for banking licenses. From Varo to Klarna, to Square, and earlier this year, SoFi – many fintechs have gone this route.

Source: S&P Global

Fintechs have risen in popularity by changing the world of banking as they target the pain points that customers experience with traditional banks. Acquiring a license may seem contradictory for fintechs looking to take the same course of action as legacy banks.

So why are fintechs that have grown to a certain size continuing to pursue a banking license?

Some of the main reasons revolve around securing a larger value chain of banking services for better profitability rather than focusing on a specific category, expanding market reach, and getting access to cheap capital when it comes to lending. Other additional benefits include strengthening the trust of shareholders and consumers alike, working in tandem with regulations, and gaining a competitive edge among peers.

Traditionally, in a typical bank-fintech relationship, both sides act as competitors and collaborators at the same time – however, there are as many differences as similarities between the two. 

Acquiring a license eliminates the need for partner banks, which means fintech companies can access lower-cost deposit funding and become direct providers of financial services.

But stepping into the banking industry subjects a fintech company to strict regulation and constant oversight. In order to level the playing field, recent regulatory measures and the report released by the US Treasury show that new regulations and rules are approaching to monitor fintechs on the same level of scrutiny and regulations as banks.

I spoke with Luis Trujillo, Chief Compliance Officer at Alviere – an embedded finance platform provider, on why fintechs would go down the same path as traditional banks to get a license, whether acquiring a license guarantees a successful banking business model and if it poses a threat to banks.

1) Classified as a TradFi disruptor, isn’t it counterintuitive for fintechs to go down the same road as traditional banks and get a license to become one?

Luis Trujillo: If we look at fintech in a vacuum, from the perspective of “being licensed makes you one of them,” it does seem counterintuitive. However, it’s important to note that to be truly viable, fintechs must operate within the regulatory and legal framework that applies to our industry. Otherwise, the fintech operation is illegal or highly dependent on a third party, leaving the entire ecosystem - banks, brands, and their customers - at risk. 

As fintech becomes more widely adopted and used, scrutiny and concerns around its risks escalate. It’s a logical progression from disruptive tech, but as risks are identified, there’s a need to move towards a more regulated category.

Additionally, although fintechs are disruptors by nature, they need to coexist with legacy banks as their offerings are becoming increasingly intertwined. We view banks as partners for growth and new business, not as threats. Our investor portfolio includes some of the biggest banks in the world. And we believe the best solutions come from close collaboration between a legacy bank and a fintech.

As a platform, we are inherently more nimble than a traditional bank, but it is also critical to provide the regulatory and licensing framework needed to ensure we are responsibly opening new business and revenue opportunities for our clients, while not putting their brand and product at risk.

2) Is acquiring a banking license the confirmation of a successful business model, or is it required to gain trust?

Luis Trujillo: It’s a combination of both. Fintechs absolutely gain trust via the soundness of their effort to become regulated financial institutions. And you don’t have to look hard to see the difference in company profiles when you compare the “licensed” vs. “non-licensed” fintechs. Even for fintechs, licensed companies are always more widely known and successful, while non-licensed names become unrecognizable. 

3) How can traditional banks ensure the fintech sector stays in compliance with existing regulations?

Luis Trujillo: The fintech sector is highly reliant on traditional banks. Banks can ensure the fintechs remain compliant with existing regulations by having a strong third-party risk management program. 

I’ve seen some banks do a certain level of due diligence on fintechs prior to partnering with them, but the process is either not as comprehensive as it should be, or isn’t ongoing after the partnership is established. 

This brings exposure to the industry overall — some fintechs don’t have the capacity or an understanding of how to maintain a proper compliance and risk management process. And those that are unlicensed operate with little to no supervision — posing a heightened level of risk to their partners and customers.

4) Getting a banking license essentially means that fintech companies no longer need to partner with incumbent banks – how would incumbents react to that?

Luis Trujillo: If we’re talking about an actual bank charter, then, yes, incumbents do not want that because it removes them from the picture. But the reality is, most fintechs do not want, nor should they aspire to, obtain a bank charter. There are a number of reasons why. 

As opposed to banks whose financial products and services are far and wide, fintechs have a focused business model and don’t necessarily need a bank charter to offer services as a regulated financial institution. They should opt for licensing based on the needs of their business.

For example, fintechs that operate in the payments, cards, prepaid, and crypto space can get all the cover they need with money transmission licenses. However, fintechs extending credit must further obtain a combination of sales finance and consumer lending licenses. 

Fintechs can and should be, fully regulated while still having the opportunity to work closely with the incumbents.

5) Why does a banking license matter all the more now for the fintech sector? 

Luis Trujillo: Regulatory pressure and reputational risk is beginning to mount on the legacy banks that partner with unlicensed fintechs. Some banks have already been put on notice or have received cease and desist orders. It’ll only take a few major cases of compliance failures or consumer harm for these banks to begin offloading all or part of their fintech partner portfolio. When this happens — and at some point, it will — those fintechs without their own licenses will be at risk.

6) Where is the bank-fintech relationship/partnership heading given potential oncoming regulations?

Luis Trujillo: We’ve been witnessing a trend where the market is beginning to consolidate. Fintechs that are doing things right are being acquired by large banks (e.g. BNP’s recent acquisition of Kantox), large card networks (Visa's recent acquisition of Earthport and Currencycloud), or by other large established players in the fintech space (e.g. PayPal and SoFi acquisition of other formidable fintechs). This trend will continue because fintechs provide acquiring firms the opportunity to expand their offerings.

Overall, banks and fintechs will continue to collaborate at a larger scale, and market consolidation between newer, robust fintechs and legacy players will continue.