Simpler is better for fintechs breaking into banking

This article first appeared in the American Banker on February 20, 2020.

For years it seemed that no fintech — however well run — would find a way to become a “real” bank.

The reasons were depressingly familiar: risk-averse regulators, approval timelines too lengthy for young companies, control rules that ignored changes in the investment world, to name a few. It got so bad that the Columbia University’s Richman Center dedicated a public program in November to the problem.

Now, just three months later, the world has changed. In recent weeks, two pioneering fintechs — LendingClub and Varo Money — have proven that direct participation in the banking system is possible for digital financial providers.

It’s looking like 2020 will be the tipping point for fintech movement into the regulated banking space.

Just this week, LendingClub said it is acquiring Boston-based Radius Bancorp, marking the first time a major fintech lender is purchasing a bank. The deal is a strategic and financial home run for LendingClub, combining the online consumer lender with a modern, flexible national deposit platform.

It sets the company on a path for long-term success by stabilizing its core funding, adding needed flexibility to its business model and stripping away costly intermediaries. This is something other fintech lenders should emulate.

Assuming the deal is approved by regulators, LendingClub would be able to fund its own loan warehouse with deposits, a big savings as compared to borrowing from bank lenders.

Because it would have a bank balance sheet to work with, LendingClub could be far pickier in deciding when, and at what price, it sells its loans. And the deal completely eliminates the need to pay its current bank partner, WebBank, for its services in originating loans.

Buying Radius will also help LendingClub turn its loyal customer base into a source of new growth. Today, LendingClub is great at generating new online loan customers, but it has little to offer them beyond its core installment loan products. With the Radius deal, LendingClub will be able to offer its customers a complete suite of financial tools and in time, more automated ways to help customers manage their financial lives seamlessly.

LendingClub’s deal follows closely behind a recent (but long-delayed) decision by the Federal Deposit Insurance Corp. to approve Varo Money’s application for deposit insurance to start a bank. This was a groundbreaking decision which many hope will provide the roadmap for future de novo fintech applicants to take the same path, but in less time.

Varo’s dual-track online banking strategy looks pretty good in retrospect. Varo built a large “synthetic banking” customer base with a number of revenue streams while it was pursuing a bank license.

Varo’s customer base and brand presence — plus its cloud-based modern IT core — will give it a big head start over other startup banks.

Of course, there are still obstacles ahead for both LendingClub and Varo.

LendingClub will need to keep regulators happy with its growth plans, integration roadmap and market strategy for Radius. And Varo Money will have to meet the challenge of moving 1 million synthetic fintech bank customers from its existing partner bank to its new deposit platform — all while building out its lending and fee businesses. Both these things seem achievable.

There are a couple of points that other fintechs interested in banking should keep in mind when considering the implications of LendingClub and Varo Money.

The first is that simpler is better: both LendingClub and Varo followed traditional paths to bank ownership by either acquiring an existing insured bank or starting a new bank through the de novo process.

Neither tried for the more exotic industrial loan company charter or the Comptroller of the Currency’s new fintech charter, which is tied up in litigation. That turned out to be a smart move.

Although it is rumored that the FDIC will soon approve a couple of new ILC charters, even successful ILC applicants are likely to run into opposition from Congress and small bankers, who worry that big tech companies can potentially use the ILC “loophole” to gain a banking license.

There is nothing in the law to prevent Amazon, Google, Microsoft or Facebook from acquiring one of these new ILCs since the Bank Holding Company Act doesn’t apply to that charter. The political stakes and risks for ILC applicants have become higher than ever.

The second thing to keep in mind is that while the fintech banking door is open, not everyone can enter.

Both Varo and LendingClub presented themselves to regulators, particularly the FDIC, as “fintech” rather than “tech-fin.”

Varo Money is led by a strong team of experienced bankers, and LendingClub’s executive ranks are full of the same, soon to be supplemented by Radius Bank’s management team. These are people with long histories in regulated banking, and the credibility that goes along with that.

This contrasts with the more tech-first companies like Robinhood that followed the “move fast, break things” ethos of Silicon Valley into a dead end when they sought a bank charter.

The FDIC is focused on risk control. And while FDIC Chairman Jelena McWilliams is innovation friendly, a technology-first approach only goes so far. There’s a big lesson here for the next fintech that seeks to make the leap into banking.

Todd H. Baker is a Senior Fellow at the Richman Center for Business, Law & Public Policy at Columbia and the Managing Principal of Broadmoor Consulting LLC

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