Banks seeing thinner margins in consumer fintech pivot to B2B partnerships

Operational challenges in consumer fintech partnerships are prompting some sponsor banks to explore growth opportunities in less risky areas in the business-to-business space.

Consumer fintech has long been a pillar of banking as a service (BaaS), in which banks provide deposit accounts, loans and payment products to users of neobanks, trading platforms or digital wallets. However, the amount of compliance work required to deal with thousands of consumers could cause distractions at a bank and make the margins of BaaS thin. Some banks are shifting to work with business-to-business (B2B) fintechs, whose customers are more sophisticated commercial organizations that make larger but fewer transactions.

"Managing a smaller number of larger relationships is easier from a compliance perspective," said Brian Montgomery, a senior counsel at Pillsbury Winthrop Shaw Pittman LLP. "It's easier for banks to figure out how to think about that and be prepared to deal with them."

Lincoln Savings Bank's previous partnership with fintech giant Block Inc. is one example of how a large consumer fintech partner can exhaust a small financial institution, said Sean Willett, who took the helm as CEO of the $1.8 billion-asset bank on Dec. 29, 2023.

The Reinbeck, Iowa-based community bank entered BaaS in 2014. In the partnership with Block, then known as Square, the bank provided consumer checking accounts in Block's Cash App, which caters to the underbanked population. But the partnership wound down about four to five years ago.

"Those are spaces I just don't think that small banks are really set up to be in for a long time," Willett said. "I think it just requires continuous investment and then it becomes exhausting, and I then start to wonder what is the real profitability."

Time-consuming responsibilities

The Lincoln Bancorp and Lincoln Savings Bank board appointed Sean Willett as the new CEO, effective Dec. 29, 2023. Source: Lincoln Savings Bank.

The large number of users and high transaction frequency are among the challenges of working with consumer payment companies, especially when a brand spends millions of dollars in marketing to grow its user base. The responsibility to ensure compliance with know-your-customer and anti-money laundering rules and conduct ongoing monitoring of transactions ultimately falls to banks.

Lincoln Savings Bank will continue its BaaS business through its fintech unit LSBX but will focus on fintechs serving commercial needs, wealth management and affinity groups, Willett said. Its current partners include Qapital Inc., a wealth management application, and the consumer trading app Acorns Grow Inc.

Lincoln Savings Bank is not the only BaaS bank reevaluating the value of consumer fintech partnerships. In January, Metropolitan Commercial Bank, a subsidiary of Metropolitan Bank Holding Corp., announced that the bank has decided to focus on B2B fintechs and exit consumer fintech partnerships during 2024, which will result in deposit outflows of about $250 million.

"The reason for it is the economics," Metropolitan President and CEO Mark DeFazio said during the company's Jan. 19 earnings call. "At this point, the regulatory expectations for that oversight [are] extraordinary and it's costly. ... So it has served the bank well. It just no longer has the risk-reward or the economics to support staying in the business."

The growing number of enforcement actions regarding compliance with the Bank Secrecy Act and third-party risk management has brought heightened regulatory pressure onto BaaS practices, and more banks will likely draw similar conclusions and shy away from consumer fintech partnerships, said Jonah Crane, a partner at advisory firm Klaros Group.

Compliance more manageable in B2B partnerships

Banks carry more compliance responsibilities when consumer protection laws come into play, said Frank Schiraldi, a research analyst at Piper Sandler. Although banks under the $10 billion asset threshold are not subject to the supervision of the Consumer Financial Protection Bureau, the CFPB has proposed a larger participant rule to examine leading consumer payment companies.

Meanwhile, becoming profitable has been a bigger uphill battle for consumer fintechs, driving banks to turn to commercial programs that generate more steady cash flows, said Robert Keil, chief fintech officer at BaaS provider FinWise Bank.

At Lincoln Savings Bank, the technology and procedures that the bank established to comply with know-your-customer rules for consumer platforms are still applicable to partnerships with commercial fintechs, where the bank needs to comply with know-your-business rules, Willett noted.

"Our responsibilities and expectations don't change from a regulatory perspective," Willett said. "It just becomes somewhat easier because you're typically dealing with more sophisticated organizations that are accustomed to that process and can provide information."

Not the end of consumer fintech

Despite shifts in business models and regulatory challenges, the model of banks supporting consumer fintechs still has room to thrive, industry experts said.

For BaaS banks, the main lesson is that they need to pace themselves, make necessary investments and find the right fintech partner with reasonable growth goals that match the bank's operational capacities.

"I don't think it's like a mission against consumer fintechs," said Michael Perito, managing director of equity research at Keefe Bruyette & Woods. "I just think it happens to be, a lot of the consumer fintechs are smaller, privately held, venture-funded enterprises, where they have less risk dollars to allocate in their compliance."

Among the long-standing partnerships in consumer fintech, The Bancorp Inc. bolsters neobank Chime Financial Inc. and PayPal Holdings Inc.; Pathward Financial Inc. works with neobank MoneyLion Inc. and payment firm Ouro; and Coastal Community Bank partners with Walmart Inc.'s consumer fintech venture ONE.

"I think it really comes down to one word in terms of why some can do it better than others," Piper Sandler's Schiraldi said. "I think it's scale."