While banks typically reserve the option to exit a partnership with financial technology companies, most fintechs do not have the same bargaining power over their bank partners.
The friction in customer experience, termination fees and risk-control protocols at banks makes it unlikely that a fintech company will quickly change a bank partner in a clear-cut manner, industry experts said. It could leave the fintech company in limbo if its sole bank partner encounters operational issues.
"We rarely recommend that you just pull the switch and move everything from bank A to bank B. It's a lot to do all at once," said Chris Dean, CEO of Treasury Prime Inc., a technology vendor enabling bank partnerships with fintechs. "What we recommend is that you add a second bank, and then if you want a transition, you can, but you could do that incrementally."
Dean added that fintechs now have greater awareness of the risk associated with having concentrated bank relationships after the fallout from the March failure of Silicon Valley Bank, which saw a rapid outflow of deposits. Along with having more flexibility for customers in times of stress, diversifying bank relationships can also help fintechs meet growth goals.
Buy-now, pay-later company Affirm Holdings Inc. is seeking new bank partners to work alongside its main bank partner, Celtic Bank Corp. "We do have most of our volume with Celtic. But the ability to diversify across banking partners is really important. It builds resilience," Brooke Major-Reid, Affirm's chief capital officer, said Sept. 12 at an investor conference. Prepaid card company NetSpend Corp., a long-term partner of Pathward Financial Inc., is another fintech looking to add new bank partners to pursue growth as it looks to add insurance and credit products.
Joint ownership of customers
Adding in new bank partners is less challenging than completely severing ties with an existing one. Ending a bank partnership is difficult because the joint ownership of customers — divided between the fintechs and the banks — creates a layer of complexity.
In a banking-as-a-service (BaaS) arrangement, the fintech often establishes a customer relationship from the commercial standpoint, and the partner bank builds its own customer relationship from a legal and regulatory standpoint, said David Beam, a partner at Mayer Brown.
Even if a fintech transfers a BaaS client to a new bank, the old bank partner may still have ongoing obligations, such as making arrangements to have disputes on previous transactions resolved or to make the transaction history available to the account holder, Beam said.
This means the fintech, working together with its old and new bank partners, will have to figure out how to aggregate and present information stored at two different banks in one account, which can be challenging and time consuming if they use different technology systems.
More than technology, fintechs also have to solve the operational nuances. For instance, if the fintech changes the bank that issues cards for the end customers, it will have to reissue every card number and change the routing number of those accounts, Dean said. The 16-digit card number contains identifiers of the card network and the issuing institution.
Adding a backup bank can help the fintech prepare its technology stack and operational capability for a smooth customer transfer when needed, Dean said. It also gives fintechs the flexibility to test such transfers on a smaller number of customers so that they can identify issues in this process and avoid them on a large scale, Dean added.
What banks are seeking
Banks are looking for fintech partners that provide some stability and could view deposits brought in by their fintech partners as valuable resources to help ease the funding cost burden. The viability of these partnerships was tested during the recent market turmoil that led to the demise of Silicon Valley Bank, Signature Bank and First Republic Bank, and the performance of community banks offering BaaS to fintechs suggests they were able to navigate the environment.
In the second quarter, the BaaS community banks outperformed peers in return on assets and net interest margin, according to S&P Global Market Intelligence data. While regional banks struggled with deposit outflows, community banks' total deposits were steady in the second quarter with a 0.8% decline quarter over quarter, and select banking-as-a-service providers grew deposits 2.2%.
"Our core deposits are staying pretty solid," Pathward CEO Brett Pharr said in an interview. "Most of our end consumers are the lower end of the economy. What we rely on is that stability of those consumers."
Still, banks need visibility on the stability of
Bank partners want to protect themselves against the liquidity risk that could be elevated by fintech partners pulling their customers' deposits, said Bao Nguyen, a partner at Skadden Arps Slate Meagher & Flom LLP and Affiliates. For banks, those deposits sourced from fintech partnerships tend to be yield-driven and riskier than core deposits based on relationships in local communities, Nguyen said.
In deposit-oriented fintech partnerships, the bank provides deposit accounts for a fintech's end customers and earns interchange fees for processing payments going in and out of those accounts. Such banks typically have less than $10 billion in total assets so that they are exempted from the Durbin amendment and are able to charge higher interchange fees.
To smooth the adverse impact of deposit transitions, banks often extend the process, such as asking for a 90-day notice for a large deposit transfer. Banks can also limit the amount of deposits that a party can withdraw in a 30-day period.
"The idea is to prevent a liquidity strain, not to prevent the drawdown of liquidity — you can't prevent that," Nguyen said.
Only 1 part of the equation
For fintechs, they could ask for more flexibility to move deposits by agreeing to terms more favorable to banks on other deciding factors.
Banks that take more fluid deposits tend to hold more liquid assets, which means less yield from investing those assets. The fintech partner can add economic value to the bank on other matters, such as giving the bank a better share of the interchange revenue if applicable, Beam said.
"At the end of the day, it's a commercial negotiation question," Beam said.
If a fintech wants to be released from a contract before it ends, the bank partner sometimes calculates how much revenue it will lose from breaking the contract and asks the fintech to compensate for it, Dean said. But breaking the contract is not a common route that fintechs would choose.
"For most fintechs and banks, it is a pretty sticky relationship because they're actually partners and moving is just culturally difficult," Dean said.
