Banking as a service and embedded banking are evolving quickly, as tougher federal guidance on third-party relationships and higher interest rates change the dynamics of the business.
So says Rodrigo Suarez, chief banking and innovation officer at Piermont Bank.
Unlike other banks that started developing relationships with fintechs only after adopting BaaS, Piermont was familiar with this segment from the start. The New York bank was founded in 2019 to focus on serving innovators, so BaaS seemed like a natural fit.
BaaS is a business model in which a nonbank that wants to offer its customers banking products partners with a traditional financial institution to facilitate that. Often these are fintechs targeting consumers with a basic offering like a savings account and debit card. What sets Piermont apart is that it prefers to have businesses as the end users of its BaaS partners.
“We are a commercial-focused bank,” says Suarez. Even in cases where a consumer might be the end user, “the relationship that we have on a day-to-day operational perspective is with the business itself.”
BaaS Guidance Will Discourage Some Banks and Fintechs
The new guidance for managing third-party relationships took effect June 6. It is a joint effort by three agencies, the Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp.
Suarez says while the guidance isn’t very specific, the general message is unmistakable.
“It’s clear that there are now higher expectations on banks that are launching businesses with any third parties, whether it’s BaaS or any other initiative.”
— Rodrigo Suarez, Piermont Bank
Suarez believes that regulators will be giving more scrutiny to whether banks have the knowledge and infrastructure to work with partners, making it harder for those that all of a sudden decide, “This fintech thing is cool. Let’s go ahead and do this.” He also believes some institutions that have merely dabbled in BaaS and embedded banking will bow out after concluding that the cost to comply isn’t worth the potential gain.
But part of that calculus is the client base. Often with banking as a service or embedded banking, institutions are facilitating products for consumers. But Piermont Bank sees more opportunity on the business side. Suarez says he would rather not devote time and effort to BaaS partners who are trying to build “a bunch of me-too Chime competitors.”
The time of the narrow neobank, with a simple banking account, perhaps a debit card, and an affinity tie-in, is coming to an end, he argues. Money’s no longer cheap and without other sources of profit, interchange income isn’t enough for long-term survival.
“There was really no additional value around the offering,” says Suarez. “Those models are going to be really hard to scale and to sustain.”
While fintechs aren’t directly subject to the federal guidance, Suarez thinks they will be affected by the change in atmosphere. The investment, planning and controls that they’ll need to have in place to be seen as viable in light of the guidance will discourage all but the most serious.
Overall, “the bar is higher now,” says Suarez, who joined Piermont in 2020 specifically to build up its BaaS operation.
“The expectation will be that fintechs and startups need to be more established and have much more robust operations, and that’s going to weed out a lot of tech companies that in the past might have considered launching a banking product through a BaaS model,” he says.
Read more: Where Are Bank-Fintech Relationships Headed?
Piermont Bank Works Commercial Side of Fintech Street
The earliest use of the “embedded banking” term goes back to predictions that banking would become so woven into the fabric of other companies — like the “invisible” payment that happens when people use Lyft — that financial institutions would lose their public visibility and become the equivalent of utilities. Suarez doesn’t buy into that, but instead sees the best banking-as-a-service partnerships as those where the activity is more than simply a nonbank sticking its name on what’s essentially a bank’s product.
“It’s a little bit counterintuitive,” he says, “but the business models where the banking product is not the main thing are the ones where the partnership will be more successful in the long term.”
In such arrangements, the banking product will not become a commodity with somebody’s label on it, but a suite of features complementing the main activity that will make the combined package “stickier, richer and more sustainable,” says Suarez.
He gives several examples of current partnerships that the $557 million-asset Piermont Bank has to illustrate how this can work: Buildertrend and Found.
Buildertrend is a software provider for construction companies. Its subscription-based software helps builders manage their projects and their businesses.
“The product is already working successfully and reaching profitability,” Suarez says. “Now they’re adding banking features to enable client companies to bring financial services functions into their operations on the platform.”
Piermont provides the behind-the-scenes muscle necessary for Buildertrend to offer the additional services. “Those services are not going to drive Buildertrend’s success, but it does make its product richer,” Suarez says.
He sees the Buildertrend type of business model as more sustainable than that of yet another neobank.
Another example is Found, which offers a package of banking, invoicing, tax and bookkeeping services for independent contractors. Piermont provides the banking services, including deposits, payments and financial tools.
Finding such opportunities means getting word of them before other institutions. “We’re very well connected to the fintech ecosystem. We know a number of venture capital firms and work with multiple fintech accelerator programs,” Suarez says.
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Fintech Connections Offer Useful Insight on BaaS Sector
Besides gaining leads through fintech industry contacts, Piermont Bank is able to gain perspective on how it is doing versus other BaaS and embedded banking providers. This is a sector where there are few sources of centralized data — there isn’t even agreement on how many banks offer banking as a service. (One player active in the space estimates there are roughly 100 BaaS providers in all — some say three times as much, some half as much.)
Working the connections also helps keep Suarez in touch with what innovative companies want from a bank. A big plus for Piermont from the outset was being a startup itself and being able to choose its technology without the hindrance of any legacy systems, according to Suarez.
“Many of the banks doing this are a little bit clunky,” because they have to adapt their legacy systems to be able to work the fintechs’ more modern technology, he says.
The connections to the tech ecosystem can also pay off directly. Piermont has a client called AngelList that maintains a venture fundraising platform. In addition to other services already being provided, Piermont will be offering capital call lines through AngelList. (These specialized lines of credit are issued to limited partners in investment deals. They are tapped when an investment firm requests a portion of committed capital from a limited partner in order to make investments or to pay fees and expenses.)
Piermont is also growing in other ways. Though Suarez continues to oversee its BaaS and embedded banking activities, his duties recently expanded. He’ll be digging deeper into product design and working to boost volume in Piermont’s more traditional lines of business, such as commercial lending, where the bank focuses on the lower middle market.
Piermont Views Big Banks as Unlikely BaaS Competition
Major banks, including giants headquartered in New York, have not shown much interest in competing in BaaS, but Suarez says Goldman Sachs bears watching. Its activities with Apple — Goldman is the bank behind the Apple Card and the high-yield savings account tied to the card — “are clearly like the flavor of what we’re doing.”
But, in spite of its size, Goldman is a newcomer to consumer banking, Suarez points out. (It has taken some nasty lumps in the process of learning about the business and is now scaling down.)
Will other big banks horn into the business?
“I don’t think it’s necessarily that they don’t want to get into the business, but that they have such large existing retail networks and very significant consumer customer bases,” says Suarez. “They don’t necessarily have the incentive to develop new delivery channels to acquire more customers.”
He cites a meme of the tech business called “The Innovator’s Dilemma,” based on a theory set out in a book of that name by Harvard Business School Professor Clayton Christensen.
“The concept is basically when you’re an entrenched player with an established business, even if you see a threat, sometimes it’s hard to jump on that business quickly because you are so focused on your current operation. It’s so profitable and healthy that it’s hard to justify why you would invest and incur costs on something that’s going to have more of a longer-term payoff for you.”
He feels confident community bank-sized players like Piermont will continue to have a long runway. To that end, the bank is actively recruiting both banking and fintech talent. The blend is important. Suarez says those that attempt to compete with just legacy bankers on their team would benefit from having “a few more fintech-forward-thinking folks as well.”