My work with fintechs and banks sometimes reminds me of “Men Are From Mars, Women Are From Venus.” John Gray’s 1992 blockbuster posited that men and women are so fundamentally distinct that they might as well come from different planets. I wouldn’t say that fintech leaders and bankers come from different planets. But it’s fair to say fintechs are from Silicon Valley and banks are from South Dakota.
Fintechs commonly prove more decisive and react more nimbly to environmental changes than banks. Fintechs often succeed by taking risks. Banks, on the other hand, are expected to manage their businesses to achieve extraordinarily low probabilities of failure.
Similarly, each type of company attracts people who fit their cultures.
Fintech executives often find bankers ponderous, while bankers often see fintech executives as reckless.
These differences can lead to a wide range of miscommunications and mismatched expectations. Let’s examine some of the typical situations where banks and fintechs get out of synch and look at common ground. Then we’ll look at ways to move forward.
Bank-Fintech Partnership Mismatches
The problem begins from the very start, when a bank and a fintech are “courting.”
Bank says: “We can help you build, launch and scale your fintech product.”
Fintech thinks: “They have the on/off switch for our business.”
A typical fintech story begins with the development of a better financial mousetrap — a faster, cheaper, more user-friendly banking product or service. To get that mousetrap to market, the fintech needs a bank partner.
Most often, the fintech isn’t looking for help with building or marketing the mousetrap. It just wants access to the banking system. It may even be dismissive of the bank’s expertise and capabilities.
Fintech says: “We can accelerate your business.”
Bank thinks: “Can we handle that?”
Because banks with less than $10 billion in assets are exempt from the Durbin Amendment’s interchange limits, payments-oriented fintechs often partner with small banks. This type of banking-as-a service (BaaS) partnership can turbocharge a bank’s growth.
However, regulators expect the bank’s risk management capabilities to grow accordingly. So a fintech may find its promises of growth elicits more anxiety than excitement in a potential bank partner.
Bank says: “We have a strong relationship with our regulators.”
Fintech thinks: “Are you sure?”
Banks can’t share confidential supervisory information with their fintech partners. So it’s hard for a fintech to feel confident that it understands its bank partner’s regulatory risks.
Nearly 25% of banks partnered with one or more fintechs have received formal enforcement actions from their primary federal regulators since the beginning of 2020. Many more have received informal (non-public) enforcement actions.
Regulators have required several partner banks to offboard fintech partners. No matter what its bank partner says, every fintech has reason to question whether it has the full picture — and reason to worry about its exposure to unseen regulatory risks.
Read more: Is ‘Headless Banking’ the Next Evolution of BaaS?
Fintech says: “We effectively deploy our capital.”
Bank thinks: “Uh-huh, what about the next raise?”
Even in these days of relative austerity, venture capital firms often push startups to spend money quickly to accelerate growth.
A bank may wonder if a fintech’s burn rate is sustainable and whether the VCs will be there in the next fundraising round.
Onboarding a new fintech partner is resource-intensive. No bank wants to work with a fintech that’s at material risk of going under.
Bank says: “Our strong compliance culture empowers our partners.”
Fintech thinks: “It’s going to take way too long to get onboarded.”
Well-established BaaS banks have spent years refining their risk management practices in response to regulatory pressures. These banks view their compliance capabilities as market differentiators because institutions with less mature compliance programs may face regulatory restrictions on onboarding new fintech partners or growing existing fintech relationships.
Those regulatory directives have left a growing number of fintechs in need of new or redundant bank partners, pronto.
But an established partner bank’s onboarding process may take a year or more. Fintechs that lack that kind of runway are forced to look for a partner bank with less extensive requirements — often a new entrant to BaaS without a clear understanding of regulatory expectations.
Fintech says: “We offer best-in-class risk and compliance products.”
Bank thinks: “I hear my regulators calling.”
Until recently, fintechs and BaaS intermediaries commonly pitched that they could handle compliance. For a small partner bank with few compliance resources, this was a compelling proposition.
However, the interagency third-party risk management guidance and recent BaaS-related enforcement actions have made clear that regulators expect banks to own their partner risks. Banks may long to offload compliance responsibilities to their fintech partners, but they can’t — not without taking a lot of regulatory risk.
Read more: Maybe BaaS Is Absolutely the Last Strategy Your Bank Should Be Looking At
Mismatches When Fintech-Bank Acquisitions Loom
The possibility of fintechs acquiring banks to gain access to the financial system seems to be coming up more and more. This leads to a different set of potential misunderstandings.
Fintech says: “We are successful and growing rapidly.”
Bank thinks: “These guys aren’t profitable.”
Until recently, fintechs enjoyed easy access to capital that allowed them to focus on topline revenue rather than profitability.
Unprofitable fintechs looking to acquire banks emphasize their impressive topline numbers. But regulators expect new or acquired banks to be profitable within three years of regulatory approval of a de novo license or change of control.
Bankers often doubt that an unprofitable fintech can meet this expectation.
Bank says: “Fintech and bank valuations aren’t apples-to-apples.”
Fintech thinks: “Their trading multiple is WHAT?”
Fintechs are typically quoted in multiples of earnings, whereas banks are valued differently at different points in the economic cycle.
During most of the cycle, banks trade on multiples of earnings. Those multiples are correlated with loan growth, as reflected by future earnings expectations.
However, when loan growth slows, as it has recently, investors focus on bank book value because they have less visibility into future earnings.
A fintech may be disappointed by the typical 1 to 1.5 multiple when a bank is valued based on its book.
Read more: How FinWise Bank Plans to Survive the Storm in Banking as a Service
Fintech says: “Our leadership welcomes regulation and is committed to meeting bank regulatory expectations.”
Bank thinks: “They have no idea . . . ”
Fintech executives typically have a good grasp of the regulatory requirements applicable to their products and services.
But there’s more to it. Bank senior executives commonly devote large portions of their time to staying abreast of a wide array of regulatory concerns, preparing for regular examinations and other interactions, responding to regulatory requests, and managing personnel engaged in those tasks.
Bankers often doubt that fintech executives who have not worked in the industry truly understand the regulatory burdens associated with operating as a bank.
Bank says: “We are well-capitalized.”
Fintech thinks: “It costs HOW much?!”
Banks must hold enough capital to satisfy tiered regulatory capital requirements, which are specified as ratios of capital to total assets (leverage) and risk-weighted assets (risk-based).
To be considered “well-capitalized,” a bank must maintain ratios of 5% leverage, 6.5% common equity Tier 1, 8% Tier 1 risk-based, and 10% total risk-based capital. A bank can point to its ability to meet these rigorous requirements as an indicator of its financial soundness and value proposition as an acquisition target.
A fintech can’t be blamed for thinking that’s a pretty expensive proposition. That’s especially so given that new and recently acquired banks must typically meet substantially higher minimum capital requirements for at least three years following regulatory approval.
Read more:
- Before You Boldly Go into Partner Banking, Focus on Data and Compliance
- Bankers Say BaaS Turmoil Primes Future Growth
- What Banks & Fintechs Must Know About Washington’s Guidance on Partnerships
The Critical Importance of Bridging the Bank-Fintech Divide
Like Martians and Venusians, the differences between fintechs and banks can seem unbridgeable. And fintechs and banks could be forgiven for thinking, in the face of regulatory hostility, that efforts to bridge the gap are doomed.
But there are three reasons for banks and fintechs to focus on communicating more effectively:
1. A shared understanding of the regulatory expectations for compliance and risk management will reduce the likelihood of regulatory friction that can derail bank/fintech partnerships.
2. Aligning on financial expectations and wherewithal will ensure neither party to a potential BaaS relationship or bank acquisition wastes its time.
3. There are industry and political pressures that may result in additional opportunities for both BaaS and bank acquisitions.
Bank/fintech partnerships are here to stay. BaaS provides community banks with a badly needed strategic option. Millions of consumers now get their banking services through a fintech intermediary. Regulatory actions that hurt the banking industry’s competitiveness would also diminish the regulators’ relevance.
Thus, as much as regulators might like to, they cannot put the BaaS genie back in the bottle.
But it is also clear that the partnership model exposes fintechs to the regulatory and solvency risks of their bank partners. For that reason, many fintechs have concluded that they have no viable alternative to acquiring a bank.
These would-be bank acquirers may find a more receptive regulatory climate in 2025, either because a Trump administration will bring with it new regulators or because the regulators in a second-term Biden Administration may feel freer to open the entry gates.
In the meantime, my advice to banks and fintechs is simple: Learn each other’s language.
Understand what your partner is trying to achieve and what concerns them. Respect each other’s capabilities. You are better together than apart.
Also, it’s okay to wear a hoodie with a suit jacket.
About the Author
Michele Alt is co-founder and managing director at Klaros Group She served for more than two decades in the law department of the Office of the Comptroller of the Currency.