The collapse of Banking-as-a-Service (BaaS) platform Synapse caused thousands of customers to be frozen out of their accounts, and eight months later tens of millions of dollars in customers funds appear to be missing. This confirmed regulators’ worst fears about BaaS, and brought a political spotlight to partner banking.
You could be forgiven for asking why any bank would volunteer for that scrutiny. Indeed, some have decided the candle is not worth the flame–both Metropolitan Commercial Bank and Five Star Bank have announced their complete exit from the business.
And yet, banks are still seeking to enter the space or expand their banking- or lending-as-a-service activities. Why? They see an opportunity to serve a fintech sector that is back in growth mode following the hangover from the bursting of the Covid bubble, and to fill the gaps left by banks exiting the space altogether or pulling back from certain kinds of partnerships. With a large number of partner banks focused on remediating their enforcement actions, and many prohibited from growing their programs, there is opportunity for new entrants or those looking to expand to quickly add scale.
How can banks avoid the mistakes made by many who entered the space over the past five years? Above all, they must have a clear strategy–understand why they want to enter the business, and how they plan to compete. Many banks in the 2019-2021 period entered casually, believing they could juice fee revenue more or less for free. But as many have learned painfully over the past few years, there is no free lunch in partner banking.
There are a number of ways to develop a niche in partner banking. Here are just a few:
Banks that adopt a clear strategy will reap a number of rewards. Competitively, they will differentiate themselves and be more likely to attract strong partners in their focus areas. They will benefit from scale economies in people, processes, systems, and vendors. Less obvious, but also important, they will develop specialized risk and compliance expertise in the products and verticals they support.
While we’re at it, let’s address one red herring about partner banking: It is easy to look at regulators’ rhetoric and the Synapse events and conclude that banks should only engage in “direct” partnerships and avoid using “middleware” platforms. But that is overly simplistic. Many small banks will need a modern technology platform to support fintech programs, and platforms can facilitate redundancy in bank relationships. The risk management imperative is to ensure roles and responsibilities are clear and banks have access to the data they need to carry out their oversight responsibilities. And both banks and fintechs must rigorously mind the details of ledgering and reconciliation, and have in place detailed contingency and winddown plans that fully protect customer funds.
Partner banking is not for the faint of heart–especially in this environment. But for those willing to commit to a differentiated strategy and grow patiently, the rewards can be significant. Scaled partner banks outperform their peers by a significant margin (see chart below), and regulatory run-ins can be expensive.. One partner bank spent roughly USD 30 million to remediate regulatory findings related to its fintech programs. Enforcement actions can also derail banks from their strategic objectives in areas outside of partner banking. Bankers are jubilant about the incoming Trump Administration, expectation less regulation and a permissive environment to unleash a pend up wave of bank mergers. But banks with outstanding enforcement actions are generally prohibited from acquiring other banks, and would be force to sit on the sidelines.
Community bank stocks have rallied as interest rates have started to come back down and in anticipation of a more lax regulatory environment under the Trump Administration. But their strategic challenges remain, and unless they intend to participate in the expected merger wave, they will still need a strategy for growth and modernisation when the frenzy subsides.
Partner banking offers a path to differentiated economic returns and, for those who get risk and compliance right, a competitive moat that will protect them when cycles inevitably turn.
About Jonah Crane
Jonah Crane is a Partner at Klaros Group. He focuses on fintech, BaaS, Embedded Finance, digital assets, strategy and M&A, and policy and regulation. Jonah previously served as Deputy Assistant Secretary in the U.S. Treasury Department, policy advisor to Senator Chuck Schumer, and M&A lawyer at Milbank LLP. Jonah received a BA in Politics from NYU and a JD from NYU School of Law.
About Klaros
Klaros is a boutique advisory firm focused on the future of financial services. Klaros operates at the nexus of partner banking, working closely with sponsor banks, fintechs, and BaaS platforms to solve their key strategic, risk management, and regulatory compliance-related challenges.
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