Fintech Banking Suddenly Advances on Multiple Fronts
Several recent developments, including changes by Trump regulators, suggest that banking charters for fintechs are back on the table. For most traditional bankers, this means more unwelcome competition – although a small group may land a one-time windfall.
By Steve Cocheo, Senior Executive Editor at The Financial Brand
Fintechs are gaining direct entry into banking via charter again . For most traditional banks, this will represent new challenges for some, new opportunities for others, and further evolution of the industry just as it faces unprecedented economic turmoil.
The recent acquisition of a community bank by small business fintech SmartBiz, creating SmartBiz Bank, is widely seen as a harbinger of more to come, just as the new administration is considered to be more favorably inclined to deal making and mergers and acquisitions.
Three new fronts in this revolution include: a specialized type of charter in Georgia; growing indications that fintechs could become state-chartered industrial banks; and a wave of fintech acquisitions of traditional banks specifically to acquire their charters.
Specialized Georgia Payments Charter Begins to Thaw
The most recent wrinkle is the news that Stripe has an application pending for a specialized charter in Georgia. This follows on Fiserv obtaining the same type of rarely granted charter in 2024.
Why Georgia? Atlanta has come to be known as "Transaction Alley." According to one source, two-thirds of U.S. card transactions flow through payment companies based in or near the city. More than half of the country’s largest payment processing firms are based there, as are roughly 275 fintechs, including payment specialists. Thousands of jobs there come from the payments business.
Jobs were part of the impetus behind state legislation over a decade ago to create a new, limited state banking charter, the "merchant acquirer limited purpose bank charter," or MALPB. Some use the shorthand "malpbee" to refer to the charter. Merchant acquiring is the process of accepting credit or debit card payments for merchants, historically done by a chartered bank.
As written, "it’s a very limited charter," explains James Stevens, partner and co-leader of the financial services group of Troutman Pepper Locke LLP. "All it really does is enable somebody in the merchant acquiring business to become a bank under Georgia law, so they can become a member of the card networks and eliminate the need to have a sponsor bank."
In fact, at present a holder of a MALPB charter cannot use the word "bank" in its name. As envisioned, MALPBs are not depositories and can’t engage in general deposit taking. They aren’t required to have federal deposit insurance, although they are allowed to apply for it. In addition, under federal rules the charter doesn’t make the MALPB a "bank," so owners of one don’t have to submit to Federal Reserve bank holding company oversight and regulation.
Since its passage, the MALPB charter lay fallow. One player, Credorax, received approval from the Georgia Department of Banking and Finance in 2014, but surrendered the charter without ever using it, according to a department spokesman. Industry experts explain that at the time Credorax couldn’t obtain direct access to the Visa and Mastercard systems. Without that the limited charter was just a piece of paper.
In the interim, of course, the payments business has rapidly evolved, dominated by commercial banks.
However, "distribution has shifted," says Richard Crone, payments consultant. "Merchant acquiring has consolidated over the decades, moving from being bank-owned to ‘PayFac’- driven models." PayFacs are merchant services businesses that set up electronic payment and processing services for business owners. Among the largest of these are Stripe, PayPal, Square and Adyen.
Crone explains that the digitization of acceptance removed much of the geographic component from acquiring — you no longer needed an acquiring bank in the merchant’s backyard — and the movement towards larger, national-level banks accelerated the trend. Many banks walked away from the merchant acquiring business and as PayFacs’ influence grew, major banks that remained in the business became conduits connecting the PayFacs to Mastercard and Visa.
"All they are now is the plumbing," says Crone. Still, without the plumbing, there is no flow.
Read more: Federal ‘Payments Charter’ Threatens Turf Battle Between D.C. and the States
That’s the way it’s worked because Mastercard and Visa rules require a traditional bank to be part of the process.
No official word has come out that they’ve changed their policies. However, people like Stevens and Crone read the willingness to press forward of Fiserv, Stripe and a rumored third major player to that has filed preliminarily for a MALPB charter as indications that Mastercard and Visa may be about to change their position. Both the attorney and the consultant point out that companies like Fiserv and Stripe have deep relationships with the card companies. They argue that neither would have proceeded with charter plans without something firm to go on.
"Visa and Mastercard have to adapt," says Crone. "Blocking access weakens their relevance. Supporting MALPBs aligns with where the volume is."
PayFacs obtaining the specialized charters could streamline backend processing and remove some friction. Fiserv hasn’t revealed much about its plans for the charter yet, and Stripe even less, although both have stated that they won’t upset existing banking arrangements.
Stevens, whose firm was involved in lobbying that brought about the Georgia law creating MALPBs, says his team is already handling multiple applications in development for the charters. These companies are encouraged by the movement by Fiserv and Stripe.
"I think most of the early applications like Fiserv and Stripe will be filed by very large, very established firms that would have a high likelihood of getting through both the [banking] department’s process and the process at the card networks," says Stevens. If those go through smoothly, he says, smaller payment firms could follow.
A key question is, who is that third applicant? The Georgia regulatory process requires that an application be officially accepted before it is evaluated and until that happens the matter is considered confidential.
Crone speculates that it could be PayPal, or another large PayFac. He adds that more could come of these charters than meets the eye, depending on what other doors are opened by chartered status.
"New rails, new power," says Crone. "I don’t think this is just about cards. If the charter opens access to FedNow and Real-Time Payments, it sets up PayFacs to bypass Visa and Mastercard with real-time pay-by-bank alternatives — fully integrated, end-to-end." He sees this tying into social commerce trends as well.
Read more: PayPal Sets Its Sights Beyond Payments to Be a Shopping Platform
Seeking a Charter Can ‘Future-Proof’ a Fintech’s Business
Michele Alt, who helped get the SmartBiz Bank deal through the regulatory process, has worked with numerous fintechs that have wanted to obtain a bank charter of their own. (Alt is a partner at Klaros Group.)
"Many fintechs and blockchain companies especially did not really have a hope or a prayer of obtaining a bank charter during the Biden administration. But they are thinking strategically now and trying to go for the window of opportunity now that it’s open," says Alt.
The appeal is to "future proof" the business. Funding for fintech investments has been an up and down affair in recent years after the huge influx of funds when the cost of money was near zero.
"You get access to low-cost funding in the form of insured deposits. That’s pretty cool," says Alt. For a lending fintech, that provides some insulation from volatile markets.
In an April speech, FDIC Chairman Travis Hill talked about charters for fintechs in the context of encouraging formation of new banks overall. He recognized that, for example, "a fintech with a large number of deposit accounts may present less risk to the Deposit Insurance fund if it becomes a regulated bank, rather than placing deposits at multiple banks through complex partnership arrangements."
There will be no regulation-lite for fintechs, but Hill said that FDIC will, "in collaboration with the chartering authorities, approach these types of applications with an open mind."
Significantly, Hill said that now that he is chairman, a proposal he made as an FDIC board member on industrial banks is moving ahead. The proposal is a request for information on questions dealing with applications for formation of industrial banks, also known as industrial loan companies. The Biden FDIC had frozen consideration of deposit insurance for new industrial banks. The traditional banking industry has generally opposed formation of more than the roughly two dozen that already exist.
Right now outstanding charter applications are in place for three major auto companies — Stellantis, Ford and General Motors — Alt notes.
These are auto companies with massive lending portfolios. Alt explains that industrial loan companies, a charter only available in a small group of states, were specifically formed so nonbank industrial firms could provide financial services to customers and employees. Under current law, ownership of such a firm permits acceptance of insured deposits, but takes the parent company out from under bank holding company regulation and oversight.
"This makes the industrial bank the Holy Grail of bank charters, certainly for industrial companies and for many fintechs with a broader range of activities than just banking," Alt says.
Alt says the boogeyman for banking groups is the thought that Big Tech could get into banking by creating industrial banks.
She recalls how banking lobbyists worked to kill Walmart’s past attempt to get into banking via an industrial bank charter.
"If they worked hard to kill Walmart back in the day," says Alt, "imagine what their reaction to Google or some other Big Tech applying for this charter would be. They’d be apoplectic, because that would be a very serious competitive threat."
Read more: Can New ‘Credential’ Concepts from Mastercard and Visa Recapture Consumers’ Eroding Loyalty?
Buy a Bank and Snag Its Charter
Acquiring a bank and becoming a bank in the process is a quicker way in than going through the entire chartering process. Multiple fintech players, including SoFi and LendingClub, have taken this path.
The typical strategy is to buy a small bank — they cost less — and install the fintech’s body on the bank’s chassis, according to John Adams, head of investment banking at Sheshunoff Investment Banking. One caveat however is that the regulators expect the acquiring fintech to maintain the local service that the target community bank provides to its locale.
Adams says that in 2023 to early 2024, his firm was fielding many queries from fintechs looking for a bank to buy, seeing a charter application from scratch as too heavy a lift to accomplish. Then interest flagged.
More recently, apparently on the change in administration, interest has picked up again. "There’s a perception that the new administration will be friendlier," says Adams.
Adams says that depending on who the fintechs’ advisers are, some are interested in state-chartered banks, while others prefer to acquire a national bank.
In the past, he says, smaller banks had to go on the offensive, trying to find a buyer if ownership and management wanted to get out of the business. Now, they are getting inbound calls from fintech buyers.
"They realize they’ve got leverage," says Adams of the banks.
For the seller, selling to a fintech could have an edge over a sale to another bank. Adams says that fintech buyers appear willing to pay a "strategic premium" on the bank-to-bank price, in order to obtain access to the banking business.
He adds that the "sweet spot" for buyers appears to be in the range of $200 million in assets. That’s a pretty small bank by today’s standards, but it’s big enough to get a fintech’s nose in the banking tent.
