Protocol | Fintech

Banking-as-a-service made fintech explode. But as a bigger market awaits, so do new problems.

A race is on to supply non-fintechs with backend financial technology to help improve their customer experience. Plenty of obstacles lie in the way.

Banking-as-a-service made fintech explode. But as a bigger market awaits, so do new problems.

Many people in the fintech sector now see a new chance for banking-as-a-service to grow in embedded finance.

Image: unDraw

As the fintech market boomed, so too did business for the banking-as-a-service companies that helped startups interact with banks. But now a new and potentially much larger opportunity to work with non-fintech companies looms for those service providers — along with a litany of new challenges.

So far, banking-as-a-service companies have provided the infrastructure that's key to fintech growth, such as new account creation, white-labelled credit or debit cards, transaction processing, bill payments, ACH and wire transfers. Increasingly interested in obtaining those functions, though, are non-fintech companies looking to add financial services — from debit cards to loans — to their products.

There is certainly a choice for those new customers. Galileo and Marqeta are two long-standing players in the banking-as-a-service sector, but a slew of startups are hot on their heels. Startups say their platforms are built on a newer technology than the incumbents' and can offer more targeted, unique services. Still, unseating these incumbents isn't easy: One venture investor who recently researched the sector told Protocol he decided not to invest after realizing that Galileo and Marqeta still dominate the market.

And behind all of that lurk other challenges for each business involved: the threat from banks going direct to startups, new competition from the fintech juggernaut that is Stripe, and a middleman problem of customers squeezing partners as they grow larger.

Banks in a box

For any company looking to buy banking-as-a-service, the choice is fairly overwhelming.

The main long-standing provider is Galileo, which was founded in 2000 and now owned by SoFi. Its customers include digital bank Chime — which was valued at $14.5 billion — as well as Dave and TransferWise (which rebranded as Wise on Tuesday). Galileo started in prepaid cards, expanded to debit cards and now has a platform with a range of financial services.

Then came Marqeta, founded in 2010, which focuses more on card issuing. It has raised over $527 million and reportedly has plans for an IPO. Its customers include Instacart, DoorDash, Uber, Klarna and Square. Marqeta originally offered consumer prepaid cards, and in 2014 pivoted to an enterprise business offering prepaid cards and debit cards for companies.

Beyond those two big names, a plethora of startups focus on a narrower vertical offering, while others have a broader platform approach with flexibility for developers to build products.

Startups like Synapse, Unit and Treasury Prime offer so-called bank-in-a-box-software — with main features that include core banking, cards and payments, banking partnerships and compliance — that helps fintech companies to quickly launch products. Companies can connect an API and then do things such as issue cards, set up interest accrual or arrange bill payments.

Treasury Prime CEO Chris Dean, who previously sold his startup Standard Treasury to Silicon Valley Bank, said his company has built its technology to be able to easily plug into multiple banks. "It works the same basically across all banks because we know how banking works in U.S.," Dean said. "We use fundamental principles. We don't do things specific to a bank."

Meanwhile, other startups, such as Unit, can handle those relationships and compliance, said co-founder and CEO Itai Damti. Unit has relationships with two banks, and Damti said its differentiation from competitors is that it has its own core banking system and ledger. "We own all the heavy lifting," he said. "You face one company in this process."

(Galileo, by the way, offers two options for clients: They can act as program manager, where they have flexibility to choose partners such as banks and compliance provider, or they can use Galileo Instant, which offers card issuer and card network in one package.)

And for startups that need more customized offerings, rather than a simple debit or credit card, companies such as Synapse, Unit and Treasury Prime say they have more options. For example, Treasury Prime's client Zibo has a landlord app that creates an LLC company and bank account for each building a landlord owns, then manages money, security deposits and repairs for each building.

A big shot at growth

Many people in the fintech sector now see a new chance for banking-as-a-service to grow in embedded finance — where non-fintech companies add credit or debit cards, loans or other financial services to their products.

A good example of that trend is Shopify, which now generates more than 60% of its revenue from merchant solutions, most of which entails financial services such as payments processing and merchant cash advances. Its success story is now attracting other companies to do the same, said Damti, who sees 90% of the long-term banking-as-a-service opportunity with non-fintech companies.

"Marketplaces like DoorDash and other non-fintechs want to roll out financial services products. Offering Dashers credit or insurance will not only create a stickier experience, but will grow revenue for DoorDash," said Jayni Shah, an angel and fintech investor. "DoorDash and other companies will have to partner with banking-as-a-service providers to deliver products efficiently."

Unit is already optimizing for this type of customer, Damti said, with new onboarding experiences, educational materials and customer service approaches. "We have a pretty strong view that more and more non-fintech companies will expand into fintech in the future," he said. "We are gearing toward a low fintech DNA [customer] rather than a high fintech DNA. The market size is just so much bigger."

Companies can use these tools to experiment. "Fintech has been an incredibly expensive area to experiment in, but it no longer is expensive," Damti said. "You can treat this as yet another software project. Many experiments will fail. Our job … is to make sure nothing goes wrong and that everything is done responsibly in a compliant way."

For companies whose customers have a directly related need for a financial service, this makes sense — such as a home repair company offering loans for repairs, says Nikil Konduru, an early-stage fintech investor.

And this could all happen fast: Strong consumer brands without fintech expertise can move quickly, said Monica Desai Weiss, principal at Kleiner Perkins.

But there's a limit to the number of financial relationships that any consumer or company wants, Konduru said. "Sometimes if you have a financial relationship with a J.P. Morgan and you're well-serviced, you don't want something else," he said. "It's a little funny that every single small business needs your debit card or help with payments. That's not a great idea."

The problem with being small

Therein lies the rub: banking-as-a-service companies are partnering with and also competing against banks.

Many offer to connect with multiple banks depending on features that a client needs. "You don't want to have a single point of failure, so you don't want to have a single partner bank," said Sankaet Pathak, CEO of Synapse, which works with multiple banks. "Long term, we want to make this more bank-portable. But it's such a hard thing to accomplish from a compliance and payment protocol and technical perspective."

But some banks want to work more directly with fintechs or end customers to build their own direct relationships. Green Dot has a banking-as-a-service offering with its own bank integrated, and has worked with Uber and TurboTax. Startups Narmi and Mantl are helping regional and community banks and credit unions connect directly to consumers; Blend is helping banks do something similar for mortgages and other loans.

Traditional banks understand that "their core competency is balance sheet management, and they're effectively renting out their balance sheet" to reach more clients, said Mark Batsiyan, partner at Inspired Capital. "Historically, they've had to have either physical branches or other mechanisms in which to reach clients," he said. "They're now identifying a more efficient way to get their balance sheet out to the world just through these technology partners. They're now looking at software solutions and big tech platforms as the more efficient, effective way to reach distribution into their ultimate either depositors or borrowers."

From the community and regional bank perspective, partnering with startups provides another line of business and keeps them up to speed on evolving technology. "It's definitely become more active," said Chris Tremont of Radius Bank, which is now part of LendingClub Bank and works with Treasury Prime. "Branches are staying closed and more people are becoming accustomed to digital. There's also a more favorable regulatory view of relationship and treatment of deposit banks and fintechs."

Banks want to partner with banking-as-a-service providers when they work with clients, said Wendy Cai-Lee, founder and CEO at Piermont Bank, which is working with Treasury Prime. "I want to go to market together," she said. "I want to assess the fintech. I want to be able to talk to them directly. You're going to show me how you're going to run their business. In return, I'll do more for you. We're gonna put you on a path so that you can eventually access financing."

There are other issues around scale for banking-as-a-service companies. One big challenge is that they have to deal with many of the compliance and regulatory issues that banks often have to handle — both for their own compliance reasons and because this is a selling point to customers. Yet these companies don't always enjoy all of the benefits that banks do.

"They end up with the problem of picking up some of the costs banks have," Ryan Falvey, co-founder and managing partner at Financial Venture Studio, said. "With deposits checking, banks have thousands in accounts you can use for lending. For others, you can make money off payments but that's only part of what you can make as a bank."

Another is the maturation of the fintech market itself. Banking-as-a-service providers could face threats as their customers grow to scale and seek to push down costs or build some of this specialized technology themselves, Falvey said.

"A lot of banking-as-a-service providers might end up having the traditional problem middlemen have in highly-fragmented markets," Falvey said. "The structure limits the ability for these providers to increase their margins over time."

Still, some fintech companies such as Stripe and Plaid have grown big enough to overcome this problem by responding to customer needs and growing into adjacent markets, Damti said.

And that's before you get to quite literally the biggest of the scale problems: large banks and Stripe. Goldman Sachs has recently made moves into banking-as-a-service and is already working with Apple. Fintech companies could work with Goldman directly, which could theoretically undercut banking-as-a-service companies on price, Konduru said.

Meanwhile, Stripe is the real looming threat. In December, it launched Stripe Treasury with partners including Goldman Sachs and Evolve Bank & Trust as U.S. partners, and Citibank and Barclays globally, through which customers can create bank accounts, cards, ACH, wire transfer and bill pay. It already had a card-issuing service, and many fintech executives and investors believe Stripe will continue moving aggressively into banking-as-a-service.

"The 600-pound gorilla is Stripe," Konduru said. "Everyone is waiting to see how their Treasury product develops."

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