Fintech faces challenges as banks withdraw from partnerships

Twenty years ago, consumers were limited to chartered banks or credit unions when it came to choosing a checking account. However, with the rise of financial technology (Fintech), modern consumers have many choices for transaction accounts. Traditional banks and credit unions remain the main options, but an entire industry of non-bank fintech providers has also emerged.

However, the golden age of Fintech appears to be over. Fintech companies need cooperative banks to enter the banking system, and banks are gradually exiting cooperative banking assets. Without bank support, these companies may not be able to continue operating. Well-known Fintech companies such as Mercury, Yotta, Fold, Juno, Brex, Copper and YieldStreet may have funky names, but they are not banks. In order to provide products and services to customers, the companies themselves must become customers of the chartered bank. In effect, Fintech companies simply put themselves between the end customer and the actual bank.

This arrangement in which banks provide banking products to Fintech companies is often called Banking-as-a-Service (BaaS). However, this model is at risk of unraveling. Banks are beginning to realize that they are not just providers of technology infrastructure, but also realize that they have a more important role in the financial ecosystem. Many banks are opting out of working with Fintech companies due to regulatory pressure and potential legal risks.

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Source: eMarketer “Banking-as-a-Service” (BaaS) operation diagram

The rise of Fintech and regulatory dilemmas

Fintech companies have been able to rise rapidly in part because of regulatory arbitrage. Banks and Fintech companies do not operate on the same playing field. Banks are heavily regulated by governments and must adhere to strict rules such as capital requirements, lending standards and consumer protections. In addition, banks also bear major responsibilities such as preventing money laundering and combating terrorist financing, and need to have a deep understanding of the activities of all customers.

In contrast, Fintech companies avoid many of these regulatory requirements and focus on providing consumers with a superior user experience. They view other aspects of the bank as “infrastructure” and invest significant resources in improving the customer experience. This makes them more innovative in some ways than banks that have to think about full operations.

However, this model also brings risks. In April this year, Synapse Financial Technologies, which provides services to the Fintech industry, declared bankruptcy, causing a significant impact on Fintech companies and end customers. Even six months after the bankruptcy filing, there are still customers who are unable to get their money back and are experiencing missing funds. This highlights the risks fintech companies face in the absence of adequate regulation and bank support. If you want to know the complete story of Synapse, you can read Jason Mikula’s report in (Fintech Business Weekly).

Future outlook: Fintech needs to transform

The banking industry is re-examining its relationship with Fintech companies and is no longer willing to act solely as an infrastructure provider. Banks recognize their leadership in financial innovation and have begun to refuse to allow Fintech companies to escape the full cost of providing services through FBO (For Benefit Of) accounts and other methods. This means Fintech companies need to rethink their business models.

In the future, Fintech companies should look to form deeper partnerships with banks, such as joint ventures. Banks can identify the ideas, technologies and teams they want to work with and engage in strategic discussions. However, the economic benefits need to be fair and banks should gain significantly from these collaborations. Banks should take a leading role in governance, compliance and ensuring safety and soundness.

Overall, fintech companies that fail to establish strong bank relationships quickly may find that no matter how advanced their technology or unique customer experience is, their value may be zero without the support of their bank. The financial technology industry is facing a major transformation. Only by working closely with banks can we survive and prosper in the future financial ecosystem.

Further reading
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