A Tale of Symbiosis
How fintechs and banks rely on each other to thrive
As the banking world adapts to the acceptance of Open Banking, we sought to understand how Durbin amendment exempt banks (those with assets under $10B) are positioning themselves as the vendors for many consumer-facing fintech offerings. Of the 5,000 community banks in the US, only 4–5 dozen of those partner with fintech companies.
The purpose of this report is to shed some light on how fintechs can and should work with banks and what these fintechs can expect as part of the onboarding process. In this review, we crystalize conversations with several banks, BaaS platforms, and DTC fintechs about their respective experiences working in the emerging ecosystem. Along the way, we touch upon additional points that provide insight into the role banks are playing to invigorate financial innovation.
The proliferation of fintechs came on the heels of the financial crisis. According to Finextra
[In 2019], the number of people who said they had high confidence in banks had climbed to 32% (from 22% in 2009), which is still less than one-third of consumers.
Fintechs, according to Finextra, have been able to earn customer trust by being technology forward, providing a clean user interface, and quickly innovating on functionality given their agile tech stacks. Today, we are seeing markets develop in every part of the fintech stack, including payments, cards issuances, ledgering, KYC/AML, and treasury/wealth management.
A Quick Overview on Banks
In compiling this report, we have divided banks into two categories — ones that have inhouse technical capabilities to work with fintechs and ones that do not. The main reason for this bifurcation is internal modernization initiatives. Banks that are working with fintechs and aggressively modernizing their infrastructures will be best positioned to thrive in the “new normal.” We define the new normal as banks renting out their OCC Charter to collect deposits, i.e., the marketing is done by a fintech, and the resulting customer deposit is held by the bank. While the relationship is meant to be symbiotic, there is friction around who owns the end customers — each party wants control and to stay top of mind for the end user.
As fintechs accrete deposits to their banking partners, these innovative banks will have significant advantages around learnings from their fintech partners, more visionary and concrete roadmaps for future products, and more creative ways of scaling their balance sheets on a national level. The community banks that are not currently focused on infrastructure modernization will likely miss out on this paradigm.
According to research by Marqeta,
an overwhelming majority (94%) of banks surveyed agreed that more advanced technology would enable greater competitive advantages, as well as a broadened range of choices and better flexibility for customers.
Furthermore, 84% of executives said legacy banking infrastructure was restricting them, making it almost impossible for them to innovate. Potential initiatives that banks can work on to overcome this rigid framework include improving user experience surrounding account opening, fortifying KYC/AML safeguards, and integrating with BaaS platforms. These endeavors can enable 1) enhanced speed to market for new products and 2) focus on digital customer experience. Companies that are helping banks with innovation in many of the aforementioned key areas are MANTL, Alloy, Hummingbird, Moov, Modern Treasury, Treasury Prime, Unit, and Modernbanc.
How does a fintech choose which bank to work with?
The best way to answer the question is by taking the approach any well trained economist would take and say, “it depends.”
Banks differ in their core competencies. For example, banks like Lincoln Savings Bank are focused on debit and savings products, WebBank and Cross River Bank are focused on credit products, and Evolve Bank is focused on a bit of everything. Importantly, all of these banks power the next generation of fintechs. As a fintech founder, it is crucial to start the search among the subset of banks that cater to your product roadmap. This is an underappreciated nuance — if the go-to market is debit, but credit is also part of the equation, the partner bank should ideally support both products. Otherwise, there may be a speed bump at which point a new relationship will need to be established, thereby delaying product rollout.
The readiness of a bank to partner with the appropriate fintech startup depends on a few factors. The diligence a bank does on its fintech partner is similar across the board. Banks evaluate who is on the cap table/how much has been raised (many do not engage until the startup has raised at least $3M), growth plans, strategic initiatives, compliance programs (crucially, the hiring of a chief compliance officer), and most pertinently, the specific plans for how the fintech will scale. Given the number of directions the banks get pulled into by fintech innovation, it is clear that to differentiate between signal and noise, these banks need to believe that their fintech partners will ultimately achieve scale. This scale is the payoff the banks expect to receive from investing engineering resources, upfront capex, and human capital to support innovation.
Unit recently published a great tool for founders to think about whether it makes sense for them to launch various financial products and what the economics look like.
The BaaS platform determines the capabilities that can be offered. Banks think about buying versus building just like a startup — it is a trade off between speed and control. When banks choose to onboard a BaaS partner, they are inherently exposing themselves to vendor lock-in. This vendor determines the capabilities that fintechs can build. For example, to build products that utilize the Radius Bank Charter, developers are onboarded through the Treasury Prime sandbox, the BaaS platform that the bank chose to work with. Other banks do not have a BaaS partnership and instead build out their own suite of APIs that fintechs can read and write to directly. It is a good use of time to tinker with the available APIs to understand whether a bank supports your product blueprint. BaaS providers include SynapseFi, Unit, Moov, Bond, Productfy, and many more. The commonality is that these providers have various bank partners.
Compliance is central to any successful partnership. Since most fintech startups move fast and break things, they are abruptly met with resistance when it comes to partnering with banks. Historically, banks have shied away from breaking things, and if something does break, they need to ensure that it does not violate any regulatory compliance frameworks. As such, which party owns the compliance flow becomes a point of negotiation — fintechs should spend time communicating with and educating their respective bank partners on their compliance initiatives and alignment with the bank’s concerns. It is imperative for fintech partners to support and protect the banks from the possibility of being exposed to unexpected losses or regulatory risk while balancing a great user experience.
The sales cycle. The amount of time a typical partnership takes is 6–9 months and is largely dependent on a few key factors. The primary factor is whether or not the bank has in-house technical resources. If it does not, the sales cycle is naturally longer and more prone to internal educational frictions. Companies like Synctera are trying to solve for this lack of technical expertise by building a marketplace that connects banks with fintechs.
The negotiation process — a game of give and take. First is cost. A bank could charge up to $150K in fees to onboard fintechs. However, this cost could be paid out at various contract-signing milestones — i.e., at term sheet signing, contract signing, and go live. Second is “minimums” that banks require — this can come in the form of interchange revenue from transaction volume. We have heard revenue targets starting as little as $15K per month and scaling up to $100K per month as the product offering matures. Fintechs should not be so quick to sign contracts with banks without understanding the repercussions of not meeting the minimums.
The onboarding process — different for each bank, but ultimately boils down to a few key points. Part of onboarding is integrating into the bank’s processor (generally Galileo, i2c, First Data, FIS, Q2, etc.). It is worth identifying the processor that is best suited for the fintech’s short and long term goals before identifying a banking partner with which to integrate.
Additionally, as part of the integration process, the fintech will send over NACHA and transaction files for the bank to verify, after which the bank will do diligence on the robustness of the compliance program. Once technical and compliance diligence is complete, generally the bank will issue an LOI to the startup.
Regarding processors: The core function that they serve is processing payments and keeping the ledger up to date. Fintechs differ by their approach here — some build their own ledgering infrastructure, some rely on the BaaS platform’s ledger infrastructure, and others rely on their partner bank’s processor to maintain the ledger. This difference becomes material when the fintech wants to transition to either a new partner bank or a new processor. Therefore, it may pay dividends for fintechs to front the cost of building out the ledgering infrastructure in-house so that scaling becomes easier in the future. [Note: Fintechs should make sure that their card printer works with their processor and issuing bank of choice — it is a small detail that if done carelessly can set back a company a few months.]
A few of predictions for the future of BaaS and banks:
Without the upfront investment, the balance of power will shift to BaaS platforms. In order to prevent themselves from being commoditized, banks will start investing into building out their own platforms. If not, as non-finance companies continue to embed financial products, BaaS platforms will further concentrate market power away from banks that cannot offer best in class products.
More funding and more exits in the BaaS space. In the last few years, a dozen or so BaaS providers have received venture funding. In the near future, there will be specialized BaaS platforms that are focused on specific subsectors such as AgTech. We will see more of these solutions come to market and more money will flow into the sector. Additionally, we may start seeing core providers acquire legacy BaaS platforms as a way for them to verticalize and innovate on current offerings.
Sub-Durbin Amendment bank competition will go much wider than the community. As more banks see their competitors roll out successful programs with fintechs, late movers will start their digitization initiatives. This should lead to further innovation from both the fintechs as well as the banks. Integration will naturally become more seamless, and banks will put a greater emphasis on best practices for infrastructure building, such as more robust IT departments.
Banks will modernize their core ledgering technology. According to research by Credit Suisse, less than 2% of banks have gone through core replacement per year since 2013. With new core rollouts, there is more robust infrastructure to introduce products that are catered towards important arenas, such as a more personalized customer experience. As partnerships between banks and fintechs become more ubiquitous, it will fuel the rate at which cores are modernized.
Conclusion
The road to partnership between fintechs and banks can be long and winding, but there are certain arrows in the quiver that can make the process more direct and less stressful.
Thank you very much to all those who have contributed to helping me understand the infinite moving parts of bank partnerships, onboarding, diligence, and go-to-market. A special shout out to Productfy, Albert, Cross River Bank, Privacy, Moov, Lincoln Savings Bank, Grasshopper Bank, Railsbank, Forty Grand, and PayGility Advisors for putting up with my endless questions.
I’m an investor with Rosecliff Ventures Management, a NYC based fund manager that invests from Seed through Series B. At Rosecliff I focus on Fintech. Feel free to reach out to me at dan@rosecliff.com. The opinions in this post are my own and not those of Rosecliff Venture Management, or any Rosecliff affiliate.