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What more regulatory scrutiny means for banks and BaaS startups

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May 28, 2024
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Photo illustration: Shoshana Gordon/Axios. Photo: Unit

Amidst increased regulatory scrutiny, banks are being more selective about which fintechs they choose to work with, and that's changing the economics of those relationships, Unit CEO Itai Damti tells Axios.

Why it matters: It's harder for pure-play fintech startups to get up and running, as the time it takes to find a banking partner and the costs involved have increased substantially.

The big picture: Our conversation with Damti took place while early Banking as a Service (BaaS) competitor Synapse was in the midst of bankruptcy proceedings that have frozen customer funds.

  • That, in turn, has led some banks to pull back from partnering with fintechs or quitting the sponsor business altogether.

(This interview has been edited for brevity.)

What's your view of the BaaS market right now? How do you see the ecosystem dealing with the Synapse fallout?

  • I think what's happening more broadly is that ... unrelated to the Synapse incident, changes in this ecosystem are coming from more regulatory attention to the space in the last 18 months.
  • The main mode of signaling from regulators has been enforcement actions. It's been consent orders and other types of enforcement, because in the U.S. you have more regulation by enforcement than regulation by legislation or any kind of specific guidance.
  • The banks are going through longer and more burdensome exam cycles, and that affects how they want to work with fintech companies.
  • But I believe ... after this moment in time, there is going to be a much higher level of clarity on how people are expected to behave and what banks should do to operate safely and sustainably in the space.

How has that changed how banks approach partnering with fintech companies and BaaS providers?

  • One, they are reexamining the structure. ... "How do we make sure that we are in close contact and have a direct operational relationship with partners?"
  • The second is a selection question. "Who do I choose to keep? And who do I choose to accept into my ecosystem?" are much more burning questions than they used to be.
  • The third is a financial question: "How do I make sure that I price programs, the right amount, and to the right point ... when the cost structure that I incur as a bank is increasing?"
  • All banks that choose to stay in the space, I think, have grappled with those three questions.

When it comes to the structure question, how does that affect the Units of the world, if these banks are looking for a more direct relationship with their fintech partners?

  • What has changed is that, in the day-to-day of those relationships, we've noticed that it's more advantageous for the bank and for the clients to be in direct communication.
  • We now are shifting more of the communication ... to the surface area between the bank and the client. In that way, we're doubling down on these direct relationships.
  • We also give banks today control over the economics in ways that they can just price per deal.

What does that mean for new, unproven fintech companies that want to work with a BaaS provider or partner bank to get up and running?

  • I would separate the young companies into two groups. One is old-school fintech, like neobanks or credit card programs. What we've seen in this camp is that there are very few new companies that are just trying to compete based on a pure-play fintech offering.
  • The economics of CAC and LTV across the fintech ecosystem and the thin margins in financial services all point to these being a very difficult game for startups. So people are not choosing to start these companies.
  • The second group is young companies that might be more vertical in nature. ... These types of businesses tend to be more favored by the banks, because the business models are usually software plus financial services.
  • A lot of these companies actually do end up getting served, even in the early days; they just pay higher prices these days. They have to accept higher price points, but the ecosystem remains somewhat accessible for them.
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