Non-bank fintech companies face tough challenges

As the digital asset market booms, many fintech companies that provide banking-like services are facing unprecedented challenges. According to (Forbis) magazine, many companies, including Mercury, Yotta, Fold, Juno, Brex, Copper, YieldStreet, etc., although they provide bank-like services, are not actually formal banks holding banking licenses. . These companies rely on cooperative banks to provide access to the banking system. However, as banks gradually withdraw from cooperative banking assets, these fintech companies may find it difficult to continue to operate.

Non-bank financial services providers have grown rapidly over the past decade, with venture capital firms investing significant capital. These fintech companies interact directly with customers, and in some cases it’s difficult for customers to even notice that they’re not dealing directly with an FDIC-insured bank. These companies provide a full range of services from marketing to technology platforms, so customers may not realize that fintech companies are actually intermediaries between customers and the actual partner banks.

Banks withdraw from cooperation and regulatory pressure increases

Supporters of the fintech industry call this arrangement "Banking-as-a-Service" (BaaS), while opponents, mainly those concerned about the safety and soundness of the overall financial system, use The derogatory term "rent-a-charter".

Fintech companies attract customers primarily because they offer customer experiences or products that traditional licensed banks generally cannot provide directly. These companies typically invest significant resources in customer interfaces and rely on partner banks to provide core deposit and payment functions. However, some licensed banks have entered the BaaS business because of the seemingly low-cost access to customer deposits, but the reality is much more complicated.

Co-operative banks usually provide fintech companies with a single account at the bank, where all fintech customer funds are commingled together, called a "For Benefit Of" (FBO) account. Partner banks typically do not know the specific balance of each customer in an FBO account, relying instead on fintech companies to maintain accounting books. For banks, this means they only have one customer, the fintech company, and the fintech company interacts with the customer who actually has the money.

This arrangement brings with it certain regulatory complexities. Banks are expected to know their customers (KYC), and if banks never learn the identity of the actual beneficiary of funds, balances or transactions, they may fail to fully comply with regulatory requirements. In addition, the situation becomes more complicated with the emergence of intermediary software companies between fintech companies and banks. These intermediary software companies claim to make it easier for fintech companies to interact with banks, but may actually increase the system's failure points.

The regulatory environment tightens, and financial technology companies face a test of survival

In April 2024, intermediation software provider Synapse Financial Technologies filed for bankruptcy, with major consequences for fintech companies and customers. Nearly six months after the bankruptcy filing, there are still customers who are unable to access their funds and appear to be missing funds. Former FDIC Chair Jelena McWilliams was appointed bankruptcy trustee.

The environment for cooperative banks is about to get tougher. In September 2024, the FDIC Board of Directors voted unanimously to approve a proposed rulemaking titled “Requirements for Managed Deposit Accounts with Trading Functions and Prompt Payment of Deposit Insurance by Depositors,” referred to as the “Synapse Rule.” If the rule is adopted, cooperative banks will be required to know the beneficiaries and their balances in FBO accounts, which will increase complexity and cost for banks in cooperative banking properties.

Banks have begun to withdraw from partnerships with fintech companies. The complexity of BaaS has led banks to breach the rules and a number of partner banks have received regulatory enforcement actions, including Choice, Cross River, Evolve, Green Dot, Lineage, MCB, Piermont, Sutton, Thread and others. Many fintech companies are looking for banks to partner with, but these relationships are becoming difficult to establish.

Future Outlook: Fintech needs to adjust its strategies, and the banking industry should improve services

Fintech companies may need to adjust their strategies as two members of the Senate Banking Committee, Elizabeth Warren (D-Mass.) and Chris Van Hollen (D-Mass.) , Maryland), has asked bank regulators to restrict the use of the FDIC’s name and logo by non-bank entities and has begun regulating financial technology companies.

There are many reasons for the rise of the fintech industry, one of which may be that banking industry leadership is very good at managing risk and business accounts, but pays relatively little attention to consumers and consumer experience. Fintech companies have been filling this need, and banks need to improve their services to consumers.

Changes in the regulatory environment are unlikely to wipe out fintech companies, but will force them to change. Joint ventures are expected to emerge between banks and technology companies, where banks will lead governance, compliance, and ensure safety and soundness. Financial returns for fintech companies will change, and banks will need to gain greater revenue market share to better reflect the bank's costs and risks.

The days of independent fintech companies trying to transform the banking industry may be coming to an end. This does not mean the end of innovation, but the banking industry needs to improve its capabilities to be able to compete equally with fintech companies. The current companies may not exist in the same way in the future, but the good ideas will continue to exist.