Mercury, Yotta, Fold, Juno, Brex, Copper, YieldStreet, and a host of additional firms all provide banking-like services, but none are chartered banks. These firms all require partner banks to provide access to the banking system, and banks are exiting the business of partner banking. Without banking relationships these firms may not be able to continue.
Non-bank providers of banking services have grown considerably over the past decade, and venture capital firms have invested substantial sums. Financial technology firms directly interact with customers, and in some instances, it is difficult for customers to understand that they are not directly dealing with an FDIC-insured banks. The fintech firms provide the marketing through to the technical platforms so that customers may not even realize that the fintech firms are really inserting themselves between customers and the actual partner banks.
Proponents of the fintech industry call the arrangement Banking-as-a-Service (BaaS), while the detractors, primarily those concerned with the safety and soundness of the overall financial system, have used the derisive name rent-a-charter.
Fintech companies appeal to customers because they provide a customer experience, or perhaps a product, that is not generally available directly from a chartered bank. The fintech firms typically dedicate substantial resources to the customer interface, and they rely upon the partner banks for the core deposit and payments functionality.
Some chartered banks entered the BaaS business because it seemed to be an attractive method to obtain low-cost customer deposits. The reality, however, has been a little more complicated.
Partner banks typically provided fintech firms with a single account at the bank where all of the fintech customer funds were comingled. Called a “For Benefit of” the fintech customer account (FBO), the partner banks generally never knew individual customer balances within the FBO account and relied upon the fintech firms to maintain the accounting ledger. For the bank this meant that they only had a single customer, the fintech, and the fintech interacted with all the customers to which the money actually belonged.
This arrangement had some regulatory complexity. Banks are expected to know their customers, and if the banks never knew the identities, balances, or transactions of the actual beneficial owners of the money, they may not have been in full compliance with their regulatory requirements.
Things became even more complex with the introduction of middleware companies that operated between the financial technology firm and the bank. The middleware purported to make it easier for the fintech companies to interact with the banks. In at least one instance, they added another point of failure to an already complicated system.
In April 2024, the middleware provider Synapse Financial Technologies filed for bankruptcy and materially impacted fintech firms and customers. Almost six months after the bankruptcy filing there are still customers who do not have access to their money, and there appears to be missing funds. Jelena McWilliams, former FDIC Chair, was appointed as the bankruptcy trustee. Details of the event have been well covered by Jason Mikula in FinTech Business Weekly.
The environment for partner banks is about to get even more difficult.
In a unanimous vote, in September 2024 the Board of the FDIC approved a proposed rulemaking on Requirements for Custodial Deposit Accounts with Transactional Features and Prompt Payment of Deposit Insurance to Depositors, better known as the “Synapse Rule.” A good summary was written in FinTech Business Weekly. Should the rule be adopted partner banks would be required to know the beneficial owners and balances in FBO accounts, and hence for the banks the complexity and costs of partner banking will increase.
Banks are already withdrawing from relationships with fintech firms. The complexity of BaaS has resulted in banks running afoul of the rules, and numerous partner banks have received regulatory enforcement actions including Choice, Cross River, Evolve, Green Dot, Lineage, MCB, Piermont, Sutton, Thread, and others.
There are a number of fintech firms seeking partner banks, and such relationships are proving hard to find.
Fintech companies may also need to adjust their playbooks as two members of the Senate Banking Committee, Senators Elizabeth Warren (D-MA) and Chris Van Hollen (D-MD), have asked banking regulators to restrict use of the FDIC name and logo by non-bank entities, and to begin supervision of fintech companies.
The financial technology industry arose for a number of reasons, but perhaps one element is that bank industry leadership is really good at managing the risk and business of lending and courting large corporate accounts, and relatively little focus has been given by the banking industry on the consumer and consumer experience. Fintech companies have been filling a need, and banks need to step up their consumer game.
The changes in the regulatory environment are not likely to eliminate fintech companies, but it will force a change. Expect to see joint-ventures between banks and technology companies, and for the banks to take the lead in these ventures for management, compliance, and ensuring safety and soundness. The financial returns for fintech companies will change, and banks will need to receive a share of the upside to better reflect both the costs and risks to the bank.
The time of standalone fintech companies seeking to change the banking industry may be coming to an end. That does not mean the end of innovation, but rather the banking industry will need to step up their game so that they can meet the fintech companies halfway. The current companies may not exist in the same way tomorrow, but the good ideas will.
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