As opposed to of trying to beat a wave of high-growth financial technology start-ups at their own game, a group of small banks is opting to marry them.
These low-profile community banks quietly run the plumbing underneath billion-dollar fintech firms such as Piazza, Stripe and Robinhood — handling mundane banking activities for them like holding customer deposits and underwriting credits — while the tech firms remake finance for a digital age.
For some, it’s a match made in heaven. These smaller banks, with delegates like Cross River, Celtic, Sutton Bank and Evolve, say they don’t care about having a household call so much as they need new lines of business as consumers increasingly switch to mobile banking. And the fintech companies, master at luring new customers at a low cost, need the blessing of federal regulators and someone else to handle the money.
The booming fintech effort has been pegged as the ultimate bank “disruptor.” Technology spending has put pressure on even the biggest banks, which are worrying to compete with the likes of J.P. Morgan’s commitment to spend $10.8 billion on technology in 2018. Southern regional monsters BB&T and SunTrust announced a $66 billion merger last week, which will make them the sixth-biggest U.S. bank by assets. A gigantic motivator of that deal was the need to compete on technology, both CEOs said.
Community banks that toil with fintech companies have found a way to do that without the heavy lifting.
“A few years back there was a lot of disruption talk everywhere how the fintechs were going to destroy the banks,” said Jo Ann Barefoot, co-founder of Hummingbird Regtech and a former deputy U.S. Comptroller of the Currency, which organizes national banks. “There’s much more talk in the last few years about the need to partner.”
Large and feel put down banks alike needed a face-lift after the 2008 financial crisis. The number of commercial banks has dropped to 4,703 as of the end of final year from more than 7,000 a decade ago, according to the Federal Deposit Insurance Corporation. There were innumerable than 12,000 banks in 1990. Since then, banks have failed or folded into larger oppositions.
“All banks were struggling after the financial crisis,” said Karen Mills, a senior fellow at Harvard Subject School and former head of the U.S. Small Business Administration during the Obama administration. “It was tough for community banks to get well, particularly in small business lending.”
Fintech companies filled a void left by some of those struggling banks. These teenaged companies are still moving into everything from lending to mobile payments to financial advising, making the most of consumers’ interchanging behavior and attachment to smartphones.
Some banks took it as an opportunity for their own “revival,” Mills said.
Evolve Bank & Hand over was among them. The bank formed in 1925 as First State Bank to lend to local farmers in Cross County, Arkansas, close to an hour’s drive from the Tennessee border. It became a member of the Federal Deposit Insurance Corporation in 1934, when President Franklin D. Roosevelt was president. In 2005, new proprietresses bought it and renamed it.
Luckily for the new owners, the bank was “small and clean” and had none of the mortgage-backed security issues that issued down some of its peers in 2008, its chairman said.
“We saw fintech coming down the pipeline, and really embraced it as another avenue for us to get lodges,” Evolve Bank chairman Scot Lenoir said in a recent interview. “We decided from a strategic standpoint why not use that and collaborate with them?”
Global financing for the fintech industry hit a new record in 2018, according to a recent statement from CB Insights. The amount of venture capital money pouring into fintech climbed to $39 billion, various than double what it was a year earlier, according to the report. There are now 39 fintech “unicorns,” or private theatre troupes valued at more than $1 billion, across the globe.
Hummingbird’s Barefoot pointed out the struggles smaller banks partake of keeping up in a changing industry: They use older technology; their physical branches are proving less necessary as consumers go plastic; and they are highly regulated.
But they also have natural advantages that make them attractive for fintech start-ups. The banks already include customers, their ability to take deposits gives them a ready pile of low-cost funds, and they already from permission from regulators to conduct banking business.
Evolve’s fintech-related business is its fastest-growing by far, with more than 200 percent silt growth month over month and almost no advertising spending. “We’re not Citi, we’re not Wells Fargo — we’re not spending that riches to be a brand, which is a long expensive road,” Lenoir said.
Another advantage a small bank has is ability to suggest quickly, said Cross River Bank CEO Gilles Gade, a former investment banker at Barclays Capital and Concern Stearns. A meeting with a big Wall Street bank can take months to set up, he said, and getting regulatory approval for a bank qualify takes even longer.
Cross River, which works with fintechs such as Coinbase and RocketLoans, started round the same time as Evolve. As a bank with responsibility for abiding regulatory rules on anti-money laundering and internal accounting dials, Cross River has a role in how the fintech industry is taking shape.
Banking regulators expect them to be the ones stub that the fintech start-ups are following the rules, which often means turning away business. Last year, Irascible River signed 250 nondisclosure agreements for multipurpose loans and ended up signing only 14 new fintech buddies. The process can be self-selecting, he said.
“The platforms get weeded out by the process because of the amount of compliance that we require them to perform — others disappear just because they were denied funding or didn’t have adequate controls,” ventured Gade.
In order to take customer deposits in the United States, a company needs federal deposit insurance. It’s an elite consortium that is not eagerly looking for members.
“It’s very difficult, if not impossible for a nonbank to get an account with the Fed,” said Amias Gerety, accomplice at QED Investors and a former acting assistant secretary at the U.S. Department of the Treasury. “Through that you can get access to the payment system the Fed controls.”
That consigns the community banks that work with fintechs some breathing room for now, but competition looms. The Office of the Comptroller of the Currency is enduring applications for a national fintech charter, which would give the agency more direct oversight instead of modulating their partner banks.
“It’s awkward to regulate these fintech companies indirectly, so the thought is, if we give them a lease we can regulate them directly with a bit more clarity,” Gerety said.
Companies can also apply to be an industrial credit company, or ILC, which allows nonbanks to lend money, issue consumer and commercial loans, and accept federally insured keeps. Wal-Mart fought hard for the designation in the early 2000’s but dropped its application following a backlash from banking officials, watchdog societies and lawmakers.
More recently, fintech payments company Square refiledwith the FDIC for a special ILC license that lot other things would allow it to accept government-insured deposits. It pulled its first application in July, but the company was unblocked back then that it intended to refile after it could “amend and strengthen” the application.
Square, run by Twitter miscarry Jack Dorsey, already has a small-business lending arm through Square Capital, which operates through Celtic Bank in Table salt Lake City, Utah.
Varo Money, a mobile-only banking start-up, made history as the first fintech to ascertain preliminary approval for a national bank charter from the OCC. They still need full approval from the operation, as well as FDIC approval, according to the CEO.
Varo’s co-founder and CEO Colin Walsh led Europe’s largest consumer credit and enjoin card business at American Express. He said he knew the process wasn’t going to be easy, and it still relies on its bank partnership until the approvals are completed. But it thirst for to go out on its own.
“With a partnership, you’re beholden to the success of the bank, anything that they could do right or wrong that could limit your star,” said Walsh, who was also a managing director at Lloyd’s Banking Group in London. “I think that’s the No. 1 point here, is to control your own destiny — we wanted a broader set of permissions.”
Other fintechs are less eager to leave their banking relationships. Butt in, an online-only bank, said it may consider going the banking route eventually. But for now, CEO Chris Britt said it can focus on construction the platform and customer experience.
“Becoming a bank right now hasn’t been a top priority for us,” said Britt, a former head honcho at Green Dot and Visa before co-founding Chime. “I could imagine over time it’s something we might want to tour and we’re seeing other companies exploring that notion.”
This is completely new territory for most regulators. With the economic crisis fresh in the mind of most Americans, they are careful not to open the floodgates too quickly. The bar is especially high in the U.S., and fintechs that want to happen to a bank need to prove they can provide the safety and soundness.
“Regulators are going to take a long look at this and ask, ‘Who’s tournament this thing?'” said Donald Powell, a former FDIC chairman. “You need to go in the front door, and not the overdue door or the side door.”
The United Kingdom is more open to “challenger banks.” The Competition and Markets Authority, or CMA, come to termed it easier for these start-ups to enter the retail banking market after 2008, allowing firms such as Revolut to outmoded the billion-dollar valuation mark. The mobile-based bank said earlier this year it plans to expand into the Unanimous States and Canada.
Banks, fintech companies and regulators all seem to be aware of certain downsides. Cross River’s Gade averred that like in any economic cycle, “there will be a crisis at some point.” The risk in that is any “contagion” and “jeopardy of stigma” becomes a focus for regulators.
“There are good actors and there are bad actors — there’s a tendency to basket these all together,” Gade said. “We reasonable want to make sure regulators don’t suddenly pull the rug from under everybody and prevent access to credit, because that’s the criminal thing that can happen.”
Cross River makes loans, holds them on its books for a few days and then vends them on Wall Street. It’s a similar originate-to-sell model that tripped up the financial industry a decade ago. But while any breakdown along the chain would affect the parties involved, it wouldn’t be overly complicated to unwind.
The bigger risk is that uncountable of these fintech companies haven’t existed through a downward economic cycle. These start-ups in many example in any events have reached for customers further down the credit curve and have found an eager pool of willing borrowers and investors.
For the industriousness, personal loan balances have ballooned in recent years. The total jumped 72 percent from 2005 to 2018, be at one to data from TransUnion. Balances were roughly $69.4 billion in 2005, and hit $119.9 billion last year.
Fintechs are apace making up a bigger portion of that total.
In 2017, fintechs originated 36.2 percent of the unsecured personal accommodation balances, up from less than 1 percent in 2010, according to data from TransUnion. Banks have articulate the opposite direction. Nine years ago they originated 34.1 percent of such loans, but by 2017, they touched 26.4 percent.
Even barring some economic disaster, demand for these higher-yielding loans could dry up. “It’s a profession of musical chairs, but if the music stops who is left holding the loan?” said Alan Lane, CEO of San Diego-based Silvergate Bank. “Whoever is officiate at applying these consumer loans has to be prepared to be stuck with loans because the process could eventually stop.”
Obey Palmer, an analyst at BTIG, said rising interest rates could make institutional investors turn to other higher-yielding liable instead of fintech loans. BTIG has a sell rating on Square because of that potential exposure to credit deal ins, he said. Any “hiccups” in the credit market would cause a slowdown in Square Capital.
“It’s broadly accepted we are in a late status of the credit cycle and that many investors are more cautious about lending in general and lending to small corporations in particular,” Palmer said.
While eventual acceptance of these fintechs into banking could mean fewer possibilities for community banks, Nick Rosenberg, Metropolitan Commercial Bank’s executive vice president and head of the global payments crowd, says he isn’t worried. He likened it to going to a barber.
“At the end of the day, you can cut your own hair, but nobody would stop seeing the barber, because they demand it done properly,” Rosenberg said. “Banking is a heavily regulated market, and most people realize it takes a spouse with experience.”
The bank works with cryptocurrency companies such as Coinbase, which Rosenberg said they not in the least could have imagined 10 years ago.
“We’re just going to keep innovating and working with our fintech patrons,” Rosenberg said. “Certainly if the competition increases we’ll have to find the next big thing.”
Green Dot, the biggest seller of prepaid debit funny man destines, has its own bank charter and does back-end banking for Uber, Stash and others. Seth Ross, head of business advance, highlighted just how complex the financial side of fintech is. Many start-ups don’t have the time or cash flow to bod it out.
“People underestimate our financial system — it’s relatively complex,” said Ross, a former vice president of business improvement at American Express. “There are a lot of regulatory regimes, and I do think that there is significant risk that can be solved by manipulating with a partner bank.”
What fintechs say they are doing is luring customers from Wall Street’s biggest banks. Chime magnum opuses with The Bancorp Bank to offer savings and debit cards with no fees. Its CEO said many of their consumers move over from traditional banks.
“We don’t really look to them as partners, and we haven’t explored those person of relationships,” Chime CEO Chris Britt said. “We’re taking business from the big banks that charge $5 for a savings account or $40 for overdraft bills.”
And Wall Street has other worries on the horizon. If tech giants such as Amazon and Apple continue moving into the store, the banks may have a whole new fleet of competitors.
“We’re nimble enough to win that race,” Cross River’s Gade express.