When one child misbehaves, even innocent siblings can expect extra scrutiny when their parents come home.
“It doesn’t matter if you’re the problem child,” said Jason Henrichs, founder and CEO of community bank consortium Alloy Labs Alliance. “You’re all in trouble.”
The same could be said of players in the banking-as-a-service space. Financial institutions including Blue Ridge Bankshares, Cross River Bank and First Northwest Bancorp have been forced by regulators including the Office of the Comptroller of Currency and the Federal Deposit Insurance Corp. to heighten oversight of their fintech partners, strengthen compliance and more in recent years; in fact, on January 26, the OCC hit Blue Ridge with a second consent order, while the FDIC published consent orders related to fintech partnerships formed by First & Peoples Bank and Trust Company and Choice Financial Group. A recent analysis by S&P Global Market Intelligence found that banks that provide BaaS to fintech partners accounted for 13.5% of severe enforcement actions issued by federal bank regulators in 2023, a disproportionately large number considering how few banks in the U.S. engage in BaaS, the analysis said.
A fintech or other company tied to a bank experiencing regulatory crackdown may be limited in the products it can launch or modify, or face increased scrutiny from new banking partners if they wish to jump ship.
Even entities that have not run into trouble — whether they are brands seeking chartered banks to support their programs, the sponsor banks amassing these companies as clients or the middleware providers that connect the two — may experience ripple effects in the banking-as-a-service space.
The explosion of banking-as-service programs happened at a time “when the CFPB was relatively silent and there was a period of regulatory uncertainty and a relatively hands-off approach,” said Henrichs. “A number of things were done that today would have been cut off quickly,” including claims regarding FDIC insurance and latitude for programs to conduct their own oversight.
This is causing a shift in how fintechs view their banking-as-a-service relationships and how they should position themselves moving forward.
“As recently as two years ago, it was common practice to figure out the path of least resistance for a fintech-bank sponsor relationship,” said Clayton Mitchell, principal at consulting firm Crowe. “That mindset has changed over the last 18 to 24 months. Fintechs are looking for business partners who are in banking-as-a-service genuinely and strategically. That means the due diligence is likely harder.”
One option that may be more appealing to fintechs is redundancy, or taking on more than one sponsor bank.
“We’re working with a couple of very large fintechs that are explicit in thinking about whether they have the right relationships or need to diversify more,” said Adam Shapiro, a partner at Klaros Group.
He said this urge is driven less by fear that the main partner bank will shut down and more by the desire to preserve flexibility in case new initiatives come under review. He has also observed a growing recognition that different partner banks may specialize in different areas, such as deposits, credit, lending or international payments.
“It’s common for enforcement actions to have either prohibitions on new activity for a period or a requirement for regulatory permission to be granted,” said Shapiro. “If you’re a fintech you want a backup plan.”
Stash, a banking and investing app, relies on Stride Bank in Enid, Oklahoma, as its single BaaS partner.
“Stash Core was built to support multiple banking partners,” said Liza Landsman, CEO of Stash, via email. “Right now, we are only utilizing one partner, but the capability exists for the future as we continue to grow and serve our customers in new ways.”
Moving to another bank is not easy.
“Diversification in terms of sponsors is a logical pathway that a lot [of fintechs] will go to,” said Curt Queyrouze, president of Coastal Community Bank in Everett, Washington. Yet fintechs typically sign three- to five-year contracts with their sponsor banks and it takes time to launch or wind down a relationship. Issuing new routing and account numbers and new cards also causes friction for customers.
“With all the pressures, it’s hard to move,” said Queyrouze.
Coastal Community, which has $3.7 billion of assets, saw a spike in inbound requests in the middle of 2023, as some banks pulled back from this business model.
However, “we’ve slowed the new partners both purposefully and also in response to environmental factors,” including because of regulatory scrutiny, said Queyrouze.
If a company with an existing bank relationship approaches the Warsaw, New York-based Five Star Bank, “we need a pretty convincing story on why they want to leave that bank,” said Abraham Rojo, its head of digital banking and BaaS.
Companies seeking new sponsor banks can take other actions to put themselves in a better position.
“You’re seeing a race to prove out your unit economics in that this is a good and fundable business,” with less emphasis on the number of customers and more on the number of customers that make money for the company, said Henrichs.
Moreover, “There is a shift in the boardroom,” he said. “Previously investors who were [seeking] growth at all costs are now realizing that risk and compliance is not an expense center, but the lifeblood of a company to have freedom to operate.”
Queyrouze echoes these sentiments.
“Be serious about approaches to compliance, particularly about transparency and promises made and promises kept,” he said. “Think about that as a priority. Let us know things about your financial standing, run rates, objectives. The days of having a fintech with a capital focus toward customer acquisition have passed for the time being, and it’s more about unit costing and operating controls and cash flow.”
Rojo, of the $6 billion-asset Five Star, also analyzes leadership.
“We look for their ability to sustain the business,” said Rojo. “I look at their leadership and what they are trying to do, especially how they are differentiating themselves in the market. Who are their backers? Are they well funded? Do they have the background to execute something like this?”
Shapiro advises fintechs and other brands using sponsor banks to watch the regulatory environment carefully and read enforcement actions to see where their bank’s vulnerabilities lie.
“If there is something you see that your bank is not asking you for that regulators are concerned about, do it yourself,” he said, such as providing fair lending data. “Put a report on your file about what they should be asking for.”
Fintechs may also want to revisit their relationships with middleware providers. Synapse, for instance, laid off nearly half its staff in October after one of its partner banks, Evolve Bank & Trust, and a large fintech client both broke ties with Synapse and decided to work together directly.
“The value is as enablers. When they start acting as gatekeepers, that provides negative value,” said Shapiro.
He suggests that fintechs evaluate the benefits of these providers’ technology and operational support but pursue a direct contract with a bank around its banking services.
Fintechs or other companies that embed financial services can view a sponsor bank’s troubles in two lights.
“Either the fintech company should be considering another bank, who may face similar challenges, or more likely, [recognize] that any enforcement action will provide the needed guidance and strengthen the bank’s compliance system and programs overall,” said Phil Goldfeder, CEO of the American Fintech Council, which counts BaaS-oriented banks among its members.
Even one that came under scrutiny itself can spin the experience into something positive.
“If a fintech was examined by regulators and successfully responded to that, we consider that a good thing because they did the homework, showed their commitment and invested in that business rather than winding down,” said Rojo.
“I haven’t seen fintechs that have their act together on risk and compliance, and have business that appears desirable, have difficulty getting new relationships,” said Shapiro.
He even sees new banks quietly enter the market in search of fintech relationships.
“They’re not out at conferences directly marketing [their services] but they’re lurking in the background and looking for people that meet a risk-reward profile,” said Shapiro.
