By Ryan Weeks on 24th May 2018
A little over a year ago, Funding Circle boss Samir Desai kicked off an industry conference with a presentation entitled: To be or not to be a bank. That no longer seems to be the question.
It wasn’t so long ago that fintech firms saw the word ‘bank’ as a dirty word. But today, for fintechs of a certain size, a tipping point has emerged.
Zopa, the world’s original peer-to-peer lender, threw its hat into the ring in late 2016. Revolut joined the fray late last year. Prior to these bids, both were prime examples of how to disrupt financial services without needing to be a bank. Now, such examples are dwindling in number.
Starling Bank had a banking licence in place before it launched. Its founder and chief executive Anne Boden agrees that there are ‘huge regulatory demands’ associated with being a bank, and adds that ‘being a bank such as us that actually provides day-to-day retail banking services is not easy’.
So why bother? Why are these game-changing firms so desperate to burden themselves with banking licences?
“Depending on what customer you want to serve and what model you want to develop, there are different models that make sense. Becoming a bank depends on what customer you want to serve,” said Janardana.
Zopa saw gaps in the market in 2016. It identified ‘adjacent needs’, such as credit cards and auto-finance, within its customer base that were not being catered to – except by products that Janardana sees as ‘adversarial’. By that, he means products that are not built with a customer’s best interests in mind.
Zopa also saw an opportunity in the savings market. Janardana explained that, at big banks, new customers often get a better deal than existing customers. “The banks, if you stay with them, will punish you,” he said.
He also cited the high level of trust that customers have in Zopa as another reason why the firm had a chance to become those customers’ ‘primary financial relationship’.
But why did Zopa have to become a bank to take advantage of that?
“For savers: they want to save money, they want the FSCS guarantee,” said Janardana. The FSCS (Financial Services Compensation Scheme) is a state-sponsored guarantee that covers savers for up to £85,000, protecting them against their bank going bust. Generally speaking, only banks enjoy the coverage of this scheme.
To offer credit cards, a bank needs a high level of liquidity. “I’m effectively making a very explicit promise to you that I’ll have that money available all the time,” said Janardana.
He believes the best way to make that happen is through the FSCS guarantee, because that attracts money that is very ‘sticky’.
Starling Bank boss Anne Boden agreed that the decision to become a bank is about giving customers what they want. She spoke of the advantages of being able to offer an ‘end-to-end proposition’, which simply isn’t possible as a non-bank.
“Starling’s a bank because it’s the way that we can provide the service that we need to provide and be profitable,” she said. We’ll get to profitability later (yes, that was a fintech joke).
As Boden says, there is also the little matter of making money.
Jonathan Segal, a partner at law firm Fox Williams, says that the temptation to launch new products is a key driver of the banking licence goldrush.
“I think the driving force is in one sense simplicity. Most of these platforms started off with one product, whether that be P2P or e-money. Started off, got traction just doing that one product and doing it very well. As soon as you start adding more products, you tend to need more regulatory licences… And that just complicates things,” he said.
Cross-selling strategies are nothing new in banking, and digital banking apps are no strangers to the strategy. Many operate marketplaces, often powered by partnerships, through which they offer a range of add-on products to their current account customers.
However, speaking to AltFi last year, one behavioural economist, Brendan Meehan, stated his belief that reliance on third-parties is merely ‘a temporary state’. His theory is that neo-banks will ultimately build these products internally as they push to boost profitability. A banking licence would allow them to do that.
“One driver for becoming a bank is that you just need the one licence to be a bank. Once you’re a bank you can suddenly do all the things that all the fintechs in their wildest dreams would like to do,” said Segal.
Boden said that when she started Starling, she felt that she could ‘only do it profitably by being a bank’.
“When you’re a bank you can take deposits and you can lend and therefore you have a revenue stream. A lot of the pre-paid card propositions are relying on somebody else’s banking licence,” she said.
Boden very much echoed the thoughts of Ricky Knox, chief executive of Tandem Bank, as put forward in a speech at March’s AltFi London Summit entitled: How does a good bank make money? In a nutshell, Knox’s argument was that a bank must make its money the old fashioned way: by taking and lending deposits. All the bells and whistles – the marketplaces, the spending analytics, and so on – exist to drive what he called ‘customer lifetime value’.
This is the first of a two-part piece on banking licences. Part two will be published tomorrow.