Banking on Fintech

The financial crisis of a decade ago catalyzed many secular changes in the U.S. banking system, but few are starker than the collapse in new bank charters. According to data from the Federal Deposit Insurance Corporation (FDIC), between 2000 and 2008, well over 100 new bank charters were granted each year on average. A drought followed the financial crisis, however; between 2011 and 2016, just two charters were awarded in aggregate. Since 2017, the average number of charters granted has ticked up slightly but remains an order of magnitude shy of pre-crisis norms. Yet despite the broad disinterest in bank charters, we are seeing a surge of interest from an interesting source: fintech.

Fintechs Increasingly Seek Bank Charters

Historically, technology companies operating in banking or bank-adjacent markets have avoided the acquisition of bank charters for several reasons. The chief ones include the fact that operating outside of the formal banking system presents regulatory arbitrage opportunities, the difference in valuations between banks and fintech companies has typically been stark, and operationally, the cultural differences have also been great.

These factors are clearly not the disincentive that they once were. Consider these recent developments:

• In February 2020, Lending Club announced the acquisition of Radius Bancorp; the transaction closed in February 2021, giving the company a bank charter. Lending Club projects that access to deposits will lead to a 90% decline in funding costs, equal to $60 million in savings in year one. Like SoFi, Lending Club noted that the bank charter, among other virtues, “enables a more predictable, stable income stream.”
• In July 2020, the Office of the Comptroller of the Currency (OCC) granted a national bank charter to mobile-only neobank Varo Money. For the previous four years, Varo had partnered with The Bancorp.
• In November 2020, online personal lender Opportun applied to the OCC for a national bank charter, as did Figure Technologies
• In February 2021, both Thrivent and Brex applied for industrial loan company charters
• In March 2021, Square began operating a Utah-chartered industrial bank, a year after receiving conditional approval from the Federal Deposit Insurance Corporation (FDIC). Also that month, European fintech Revolut filed a draft application with the FDIC for a U.S. bank charter.

SoFi began exploring the possibility of an industrial bank several years ago, and the OCC granted conditional approval for a national bank charter in October 2020, but the move into formal banking was accelerated with the March 2021 announcement of SoFi’s acquisition of Golden Pacific Bancorp. Interestingly (and quite bullishly, should you find yourself in possession of a bank charter) in a recent investor presentation, SoFi estimated that a bank charter would contribute roughly $200 million in EBITDA in its first full year of operation, rising to $300 million in year four. It bears noting, however, that SoFi cites such benefits of a bank charter as “increased net interest margin (NIM) from holding loans longer” and “enables increased growth in lending.” Both claims are accurate, but neither tends to lend great support to the valuation premium fintech companies fetch relative to balance sheet lenders.

What is Driving the Surge in Fintech Bank Charters?

One element driving this surge is likely a recognition that in order to fully participate in the banking sector, fintechs will need to adhere to regulatory standards. For example, one of the most fundamental regulator-driven differences between the banking industry and the tech world is that banks are forced to operate their business more conservatively than is true for fintechs.

Amazon was nearly a decade old before it started printing annual profits; for several years prior, management regularly noted on investor calls that more established business lines, such as selling books, were at or approaching profitability, but that this was offset by the losses incurred by new business lines. While the persistent overall losses engendered some skepticism at the time, it seems safe to say that history has vindicated founder and CEO Jeff Bezos’ strategy. However, this is not a strategy that regulators would accept in a depository institution. The embrace of bank charters may be a sign that this cohort of companies has forsaken such a strategy.

A related factor could be that the bankifying fintechs are maturing to a stage where the culture clash between tech and commercial banking is less pronounced. On the other hand, this influx of non-traditional competitors could disrupt not only the business model of commercial banking, but the culture as well. This is very much a double-edged sword. New perspectives can be beneficial, leading to potentially useful innovations and serving as a stress test of sorts to established structures. Vernon Hill founded Commerce Bancorp after a career in fast food, and his experience fueled a renewed branch expansion that swept through the industry, as did consumer-friendly innovations like evening and weekend branch hours, and free coin counting machines in branch lobbies.

However, Vernon Hill’s popularity with customers and investors was not shared as fully by regulators or competitors. Everyone tends to be on their best behavior when applying for bank charter approval; it will be interesting to see to what extent entrepreneurial ferment seeps into fintech banking operations as they get more established.

In pursuing bank charters, fintechs also now seem more willing to bet that the constraints that accompany charters won’t compromise their valuations. Early evidence suggests that they aren’t wrong. Bank of New York Mellon (BNY Mellon) was founded in 1784 by Alexander Hamilton, one of the founding fathers of the U.S. and the country’s first secretary of the treasury. BNY Mellon’s businesses keep global capital markets running smoothly; it is one of eight U.S. banks designated as globally systemically important by the Financial Stability Board and has a market capitalization of $45 billion. On the other hand, Square was founded in 2009 by tech entrepreneur Jack Dorsey,  who also happens to be the co-founder and CEO of Twitter. The company currently enjoys a market capitalization of over $100 billion.

The Market Cap of Fintech Square Is Now Twice That of BNY Mellon

While culture and valuation remain open questions for fintechs, one certain benefit of fintechs’ acquisition of bank charters is dramatically improved transparency. The gulf between bank and fintech valuations is wide, yet it is dwarfed by the gulf between bank and fintech disclosure requirements. The FDIC demands vast troves of data from banks each quarter and makes nearly all of it publicly available to American bank investors, for free and in a timely fashion. This spills over into public company disclosures; bank earnings reports often include voluminous statistical supplements while fintech earnings releases tend to provide much less detail.

Be they public or private, however, fintechs with bank charters will file voluminous call reports each quarter, and those with a bank holding company structure will also file (equally voluminous) Forms Y-9 each quarter, offering a far more detailed look at their balance sheets, income statements, and risk profiles than before. The experience of Green Dot is illustrative. When Green Dot Bank opened in 2011, the new subsidiary accounted for just 16% of total corporate assets; today, the bank accounts for 79% of total assets.

The Share of Green Dot Assets Domiciled in the Bank Subsidiary Has Crept Higher Over Time

An interesting secondary effect to watch for is the extent to which this trend of fintechs with bank charters eats into the profits for banks that specialize in “charter rentals,” serving as the bank partner for fintechs that lack bank charters. Banks such as The Bancorp and privately held Cross River Bank have built thriving businesses out of providing third-party depository and payment services to non-banks. If more and larger partners continue acquiring bank charters of their own, the effect on this cohort of banks could become noticeable.

Conclusion

The large-scale move of fintech firms into formal banking structures is still in the early stages. By watching regulatory relationships, cultural evolutions within the firms, and valuations, aided by improved transparency, observers may be able to get a handle on whether this is a short-lived trend or something that changes the face of the banking industry.