How Square is Building a Small Business Banking Powerhouse

Only part of what's going on 'bankwise' in Square is under the umbrella of the fintech's industrial bank. You need a wider-angle lens to see how its affiliate service, Cash App, and its parent Block's pending acquisition of buy now, pay later player Afterpay are part of an emerging banking empire.
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One of the hazards of being an incumbent competitor is legacy eyesight. It is easy to fall into the habit of seeing everything in the context of previous experience.

So when the Utah industrial bank doing business as Square Financial Services opened its doors, it was easy for banking industry observers to see the institution as simply another fintech paying its way into the banking system. It introduced three products, one of them really the adoption of a credit product previously offered as Square Capital.

However indications are that the industrial bank charter means much more when viewed in the context of the “Seller” ecosystem that will still be called Square in the wake of the parent company’s adoption of the name Block in December 2021.

In fact something interesting about the new industrial bank is how infrequently it receives specific mention in the parent company’s presentations. While the traditional banking industry has watched different players enter the business one way or another, what they are finding is that the newcomers don’t want to just be another bank — but they do want to use the charter for the powers and access it brings.

Beyond the Plastic Dongle:

It is becoming clear in both actions and the statements of company officials that the ambitions of Block, Square’s parent, are growing quickly beyond the small business part of the economy where the company began.

In third quarter 2021 earnings comments, CFO Amrita Ahuja noted that mid-market sellers, those with over $0.5 million in annualized gross payment volume, have surpassed the original micro seller base to become the largest portion of the company’s payment volume. Hundreds of larger firms now work with customized versions of Square’s payment services.

Here’s a look at how things appear to be shaping up as Block and its Square seller ecosystem continue to evolve. This begins with the comments of Lewis Goodwin, CEO at Square Financial Services, made during an appearance on Jim Marous’ “Banking Transformed” podcast.

Square’s Friendly Ecosystem Bank

Square Financial Services, the industrial bank, began as a de novo in March 2021, but because it took over Square Lending, it had $163 million in total assets as of the third quarter 2021 call report.

That doesn’t reflect all lending activity because the bank continues to sell many of the loans it makes to Square sellers to investors. As of the call report date, the bank had $79.5 million in loans on its books. However, overall, counting sold loans, the bank made approximately 83,000 business loans in the third quarter alone, coming to $594 million. This marks a return to nearly the levels seen prior to the pandemic, which had caused a falloff when many small businesses faced shutdowns and more.

On the deposit side, Square Financial offers Square Savings and Square Checking, the latter of which is at present provided by Sutton Bank. Square Financial handles the savings product. As of the call report date, the bank had total deposits of $70.9 million.

Goodwin told Marous that while checking and savings accounts may seem mundane, many traditional banks don’t offer these specifically for small businesses in the low fee or low minimum forms that they would prefer. As a result many small business owners use their personal accounts. One of the plusses for Square sellers is that a pre-arranged percentage of sales processed by Square can be moved automatically into savings.

“We focus on our ability to serve our sellers and to provide a great experience for them while doing so, because if we don’t somebody else will. That’s been our opportunity,” says Goodwin.

Goodwin says that many traditional banks don’t focus on the needs of smaller businesses.

“Traditional financial institutions do a good job of serving the masses, but they miss the edges — and the edges are very big.”

— Lewis Goodwin, Square Financial Services

He adds that “there are millions of people who need financial services and we make sure we’re looking at trends to discover the things our sellers need.” Goodwin explains that Square’s ability to keep its fingers directly on each seller’s pulse by processing sales helps it understand each customer.

Square itself has been enhancing Square Invoices, a service offered to sellers to simplify billing. This includes adding a version designed for mid-level and larger sellers. The company has been offering a growing range of software-based services to help growing firms to meet the management challenges of that growth, to enable them to concentrate on their core business.

Square’s loans came from recognition, based on data, that many sellers needed more working capital. The company’s sales records enable it to use artificial intelligence to offer credit, rather than relying on traditional business credit underwriting. “Our data is virtually real time, and we understand a business’ strengths and trends,” says Goodwin. This strength parallels that of Amazon’s third-party seller lending programs, where the ecommerce giant knows to the minute how well merchants are doing in its marketplace.

Marous asked Goodwin if the bank’s charter would permit it to offer consumer services or if it was limited to business products.

“The industrial bank charter is very much like a traditional bank charter, with very few limitations,” said Goodwin, “so it certainly allows entrance into the consumer space as well as the small business space. We’ve chosen to focus on the small business space during our de novo period.”

Goodwin added that he feels it’s important regulators get comfortable with how Square does business as a bank — it is the first fintech to obtain an industrial bank charter, though others have tried or are trying. He says it’s important for regulators to see how the parent company supports the bank and that it demonstrates compliance.

“We certainly have a full plate now, with what we’ve got,” says Goodwin. “But I think there are lots of opportunities as we look forward.” This suggests potential work with consumers, beyond what parent Block is already doing.

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Broadening Square’s Appeal to Consumers by Expanding Cash App

During 2021 Block has been expanding its Cash App product. This affiliate of Square began as a P2P vehicle, like PayPal, Venmo and Zelle. However, its forms have multiplied to the point where calling it a P2P product only is like calling Mastercard or Visa a charge card. Cash App is used as a way to make small investments in stocks and in Bitcoin, for example. (Block is to Square and Cash App as Alphabet is to Google — parent companies with more recognizable subsidiary names.)

Cash App overall has more than 40 million consumers who are active every month — two thirds of them weekly — and over 70 million who are active in the course of a year.

In the third quarter of 2021 Square launched “Cash App Pay,” available for both online and in-person transactions. The service is available for mobile devices. Cash App itself makes a physical card available. So far, the company says, Cash App Pay has proven most popular for online checkout. (In time, the company hopes to take Cash App Pay beyond its seller ecosystem.)

“With Cash App Pay, individuals can seamlessly pay with their Cash App account at Square sellers using a QR code or tapping a button on their mobile device at checkout,” said Jack Dorsey, Chairman and CEO, during an earnings presentation. Dorsey, who resigned as head of Twitter in favor of his Block role, noted Cash App Pay’s debut came on the heels of the company’s expansion of Cash App service to 20 million U.S. teens, representing major growth in potential seller customers. (Cash App Pay’s concentration on Bitcoin for its crypto choice is because Dorsey personally wants to see Bitcoin become the currency of the internet.)

“Our strength lies in our ecosystem model, especially as our ecosystems connect together. Having these multiple ecosystems is our ultimate superpower and differentiator. Any connection we make between these ecosystems strengthens the overall value of our broader ecosystem to customers.”

— Jack Dorsey, Founder, Block

Block has been working on ways to make it easier to move money into the Cash App channel. Direct deposit of paychecks and tax refunds are two major sources of inflows. There’s also a way to deposit checks and cash to these accounts. This is via over 30,000 retailer locations, including Walgreens and Family Dollar.

Block reports that much of the increased inflow seen in 2021 has come among Square’s Cash Card holders. (The company indicates that more than 7 million people using the card on a weekly basis.)

These efforts are part of Block’s efforts to build a commerce platform around Cash App. In 2022 the company will be investing substantially in marketing for Cash App. This will include paid marketing as well as beefing up the Cash App referral program, according to CFO Amrita Ahuja.

Read More: How Klarna’s Attack on the Payment System Could Impact Banking

Joining Two Ecosystems in a Major Way with One Deal

A wrinkle that may potentially inject even more octane into the synergy between Block’s ecosystems — the Square seller system and Cash App — is the acquisition of Afterpay, which is expected to be completed in early 2022.

This acquisition represents a two-way connection between Block “worlds.” On one hand, once it joins other options in Cash App, it will bring those consumers a new payment choice and one that is currently very hot. On the other, it will bring sellers a new option for expanding sales. In addition, Afterpay will be bringing approximately 16 million consumers in the U.S. into the Cash App population. Among U.S. Afterpay customers, an average of 15 BNPL purchases are made monthly.

“Afterpay probably represents the largest potential for connecting the ecosystems,” says Dorsey.

Ahuja noted during an analyst presentation that Afterpay already has a sales team that is going after business from larger merchants, which plays into Square’s ambitions for more large customers.

In November 2021, months after the acquisition deal was announced, Afterpay unveiled a new “money and lifestyle app” for Gen Z and Millennials that is called Money by Afterpay. As announced it is being offered to current Afterpay customers in Australia only. It will be interesting to see if the fledgling app survives the merger and if aspects of it are incorporated into Cash App.

Read More: The Real Risks and Hidden Costs in the BNPL Game

Financial Institutions Must Be Alert to Square’s Coming Marketing Push

Something that traditional institutions will want to watch out for in 2022 is a general bulking up of Square’s sales force that onboards new sellers, especially larger ones in the mid-market segment and continued focus on certain verticals such as restaurants.

“It’s not just about growing the size of the sales team, but it’s empowering our sales team with the tools and automation to be able to know the right seller to call on at the right time with the right message,” says Ahuja. “And that persists through the funnel, not just at the top of the funnel when we’re bringing a new seller on, but later with our account management teams as they continue that relationship with sellers and onboard them with new products.”

With the addition of Afterpay, as a two-way connection between ecosystems, and with a bank under Block’s roof, the threat of Square looms larger for banks and credit unions than ever.

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