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Fintechs: How to Choose a Bank Partner – From a Founder’s Perspective

The interest in running a debit card, robust payments program, or being a full-fledged neobank has exploded. For example note the growth, fundraising, and headlines for neobanks or fintechs like Chime, Varo Money, Good Money, Dave, and Aspiration. The opportunity is huge and many big banks are not doing themselves any favors with the slow pace of innovation and brand missteps. Founders are creating better products and improved digital experience, or superior distribution approaches.

In addition to the subscription or other fees charged to customers, an important revenue stream for fintech businesses can be interchange revenue (a small percentage of the transaction charged each time a MasterCard/Visa card is used).

I know these models can be powerful. I co-founded and grew Higher One, a fintech that created debit card/checking account product used by millions of college students without any branches. In addition, we delivered financial aid, payroll, and tuition payments on behalf of schools moving billions of dollars. There is a lot of opportunity and upside!

Starting a banking partnership is easier than ever.  More banks are interested in a partnership with a fintech. Plus, there are more program managers or aggregators that help fintechs get started. 

So, how do you go about finding and partnering with a bank? I’ve spoken to a number of founders about their experience with selecting a bank partner. I’ve incorporated their advice with my own below.

As an aside, if you want to borrow, do lending, accept credit cards (merchant processing) or originate electronic checks (ACH) payments for your own business, you want to work with a different set of partners.  Depending on the details, those needs may be a straight-forward commercial banking relationship.

 

Do I Need a Bank?

You will likely want a bank partner if you plan to hold other people’s money or move a lot of money for other people. Only banks and certain trust companies have access to the Federal Reserve payment system.  Also, FDIC insured banks are the only ones that can accept “deposits”. 

For example, if you want to issue a debit card or checking account to your customers or partners, you will need some sort of financial institution behind it.  For a consumer application that account likely needs to be an FDIC-insured bank. Even if you were able to find a legal way to have a consumer debit card product without FDIC-insurance, it is a strong benefit as consumers have been trained to expect it.

Another example is if you want to process payments for businesses to or from consumers and you end up holding the funds for a while in between. The holding of funds may be part of the business plan to earn interested revenue or it may be incidental.  Either way, you will likely need a bank to hold that For Benefit Of (FBO) account.

 

Using an Aggregator

An easy way to get started with an FDIC-insured debit card or banking program is to work with a program manager. Examples of program managers include Galileo, Synapse, Marqeta, or Sila Money. 

The advantage of working with an aggregator like this is speed, ease of technology integration, and less responsibility internally. The trade-off is often worse economics and perhaps less long-term stability.  If the banking program is core to your business model and your product offering, you may want to have more control and a direct relationship with a bank.

 

Alternatives to a Bank Partner

What are the alternatives to having a bank at all?  Well, you are in luck! Depending on the nature of your business, you may be able to take advantage of one of the alternatives. One big downside to some of the alternatives is often no FDIC insurance. The FDIC guarantee that money will not be lost can be important to many customers and therefore can be a lot to give up.  The other downside to some of the alternatives is complexity and cost.

Alternatives

  1. Getting Your Own Charter – an expensive, time-consuming process which is not for the faint of heart. For years the FDIC approved only a handful of new bank charters.  For a while, it seemed like a middle path might be the so-called OCC fintech charter although that is in legal limbo right now.
  2. Trust Company – a state-chartered trust company may be able to hold assets and make payments depending on your use case. While they may not be FDIC regulated, they will act like a bank in many ways.
  3. Money Market Mutual Fund and/or Cash Management Account – a money market fund offers most of the liquidity of a bank account yet it is primarily under a different regulatory scheme (SEC vs. FDIC). Depending on the nature of your use case, a cash management account may offer benefits of connecting to investment products or opening up the ability to work with non-bank financial institutions. I’m not familiar with too many fintechs that have gone this path. One thing to remember is that once you want to provide a Visa/MasterCard debit card or using the payment system you are pretty much involving a bank even if the high-level brand appears to be a non-bank.
  4. Money Transmitter License State by State: PayPal famously took this route and others have followed. If your use case is focusing on moving money then it can be a more natural fit. It can be expensive and time-consuming to register with so many states, so consider if the right deal with one bank could pre-empt the need for a state by state registration.
  5. Full Crypto – But what about cryptocurrency? While there may be an interesting future in cryptocurrency enabled financial services, they have not yet reached mainstream adoption and are at best in a regulatory gray area for large scale adoption for many consumer applications.

 

How to Pick a Bank Partner

Compared to an aggregator or program manager, if you want better economics, more control, but may have longer onboarding, you may want to consider working with a bank partner directly. The Bancorp Bank, MetaBank, and Greendot are all known for these types of deals although there are many others.

In the early days of Higher One, we worked with any bank partner that would take us.  If you have a choice, I would recommend considering things like appetite, commitment, capability, and division of responsibilities.

  1. Appetite:
    1. Deposit Appetite – you can get a sense of the bank’s appetite for deposits by checking their financials including the call reports filed with the FDIC. A bank making a lot of loans compared to the amount of core deposits likely would be interested in additional deposits.
    2. Types of Bank – understand what works best for among the different types of banks depending on your business plan.  There are state banks, federal banks, state ILC or state trust companies. There are differing opinions about which federal regulator better understands this space so do your research.
    3. Other Partnerships – Check who is sponsoring other products and understand potential bank partners existing fintech relationships.
  2. Commitment
    1. Strategic Reason – For stability and understand their commitment to bank partnership and the strategic reasons they are getting into it.  Will they support the product you want? How will they do oversight? What has been their explanation to regulators about what they are doing in the partnership space?
    2. Who – Take note of who is in the room. If these kinds of partnerships are not an already established business line, you likely want to make sure the CEO is in the conversation.  And even if it is an established business line, if truly important to the bank, you will likely be working with the CEO at some point.
    3. The Board – Ask if the bank board has approved the strategy of partnering with fintech companies. Regulators have the expectation that any product line or initiative will be approved by the board. If the bank’s board is not already involved, they likely will need to be involved later.
    4. Crypto – if there is any crypto or blockchain flavor to what you are doing, it is likely a different set of banks that will be willing to work with you.
  3. Capability
    1. Features/Technology – how do you integrate? One founder told me that a big differentiator is to ask about APIs and get the documentation about what is live. If they have not implemented technology to support a partnership, are they really serious about it?
    2. Bank Size – Under the so-called “Durbin Amendment” banks with less than $10B in assets earn much more in interchange revenue from debit card programs. Therefore, I would focus your search on smaller banks that will not go over the threshold in the short-term. Understanding the strategic plan of the bank is important here. Do they plan to grow through acquisition or otherwise? How important is it to them to stay under the $10B threshold for other business lines?  What is the likelihood that they will be bought by a larger bank?
  4. Division of Responsibilities
    1. Consider carefully which items you want to do operationally and which you want the bank to do. For example, think about the following.  Some banks will have a view that they inherently cannot delegate some of these functions. How will they conduct them and will it allow you to move quickly enough for startup time?
      1. Customer front-end experience (mobile, web, etc.)
      2. Core processing
      3. Card processing
      4. ATMs
      5. Physical plastic card manufacturer and personalization
      6. AML Monitoring
      7. KYC/CIP
      8. Marketing and product design/copy review
      9. Compliance management
      10. Compliant monitoring
      11. Cyber-security implementation
      12. Customer service and operations processes
      13. Third-party risk management/oversight of vendors

 

The Deal and Working with a Bank Partner

Before you approach a potential bank partner, I recommend creating a good package of written materials and doing your research on economics.

Potential bank partners will likely be thinking about some of these items.  As you put together your written materials, think about how to answer these questions.

  1. Strategic Fit – do you help them meet their objective for increasing deposits, fee revenue, or something else? Clearly communicating the value proposition to the bank can help.
  2. Cultural Alignment – what is your risk appetite and are you prudent in risk-taking? Having written materials evaluating key risks and listing controls can be helpful. Being clear about who on the team has responsibility for risk management can also be helpful.
  3. Strong Business – do you have signs of traction, customers, and funding?  Is the team credible to build the business?
  4. Compliance Buy In – do you have the commitment to support the bank in its compliance responsibilities?  You can demonstrate this by having draft written policies for AML, KYC/CIP, compliant management, etc. Also, being clear about who on the team has compliance responsibility and/or experience can also be helpful. Another important step can be learning about the key regulations yourself.

On pricing, ask other fintech executives and review filings by Higher One or other public fintech. There is definitely a range of deals that fintechs are able to negotiate so make sure you understand what is possible.  Generally, if you want more revenue, you should be prepared to take on more costs, operational responsibility, and risk.

As you are working with a potential or current bank partner, it is good to keep in mind the expectations of bank regulators.  Here are some of the things I wish I knew better at the beginning:

  1. It only exists or is truly happening if it is in writing. Or maybe it happens sometimes, but you can’t really be serious about it unless it is written down in policy and likely with a matching procedure.
  2. The board of directors of a bank is involved in a lot of oversight and operational details.  It is more than is common in startup companies. Don’t be surprised by this.
  3. Compliance and audit almost always have separate lines of reporting and communication to the board of directors. 
  4. To ensure compliance, regulators often expect multiple layers of checking. For important things there is often the pattern of (a) procedure by the person doing it (after written training), (b) review by supervisors/peer, (c) then internal audit, and finally (d) external audit.  All of these steps should be documented in writing.

If you have any more questions or suggestions on the topic, please let me know. 

 

You know I’m not a lawyer so this is in no way legal advice!  Appreciation to Eugene, Ethan, Casey, and others for sharing their thoughts. Mistake mine. Brilliant insights are theirs.

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