As Challenger Banks grow, lenders should be nervous

There are challenger banks, and now there may be everyone.

Over the past few years, there has been an increase in digital-only businesses with little more than a simple, user-friendly interface in front of a prepaid card.

The target were those for whom a traditional banking relationship was undesirable, necessary and/or too costly to sustain.

All of this would rely on relationships with traditional financial institutions (FIs), on a “leased” basis, where the outsourced, brick-and-mortar bank would hold deposits.

The end result was a hodgepodge of fragmented services that basically put a few basic banking functions into a single app.

But now, the rise of FinTech banks has adopted a new strategy: where digital-only businesses become FIs, nationwide – offering a wide range of services and products – consuming (and absorbing) a bank and being granted a banking charter by the Office of the Comptroller of the Currency (OCC).

This allows them to avoid the need to build a bank from scratch while still offering the same services as more traditional players.

Buying a bank is a relatively quick way for FinTechs to get the national banking charter that allows them to take deposits and make loans. The elimination of the third party – this “rented” bank – also allows FinTech to control costs.

In the latest example, as reported last week, SoFi Technologies completed its acquisition of Golden Pacific Bank. The bank has $150 million in assets. After the acquisition, SoFi intends to offer automated savings and what it said would be “differentiated checking and savings accounts for easy budgeting.” SoFi had received prior approval from the OCC and the Federal Reserve to become a national bank.

Read also: SoFi completes $750 million purchase of Golden Pacific Bank

SoFi thus joins LendingClub, Block (formerly Square) and Varo as examples of digital startups that have applied for bank charters and, in many cases, have integrated banks into their operations.

Varo was the first of the consumer FinTechs to receive a national banking charter from the U.S. government, and in the past year and a half or so since receiving that charter, it has come to market with several offerings that allow incumbents accounts to quickly access their paychecks, take out installment loans and open free checking and savings accounts.

LendingClub, of course, early last year completed its acquisition of Radius Bancorp for $185 million, giving the company the runway to launch a full suite of branchless banking services. We argue here that the overall goal is to have a platform in place with new offerings in a way that cements cross-pollination, where building up savings on one side of the consumer equation (and even from the professional client) can be used to repay the debt elsewhere.

Anuj Nayar, vice president and head of financial health in the United States at LendingClub, told Karen Webster of PYMNTS following the acquisition of Radius that LendingClub considers its most direct competition to be the world’s SoFis, where personal finances are the focus. “But now,” with Radius in the operating mix, “we can add savings to the puzzle,” he told Webster.

Square, for its part, launched Square Financial Services last year — and here, with a nod to its small business customer base, is allowing the company to launch checking and savings accounts for those businesses. Square’s goal is to become a primary funding point for these businesses.

Read here: Square Circles Traditional Banking

The real challenger banks

Perhaps it’s time to recognize Square, LendingClub, SoFi and Varo as the companies that can truly wear the “challenge bank” mantle because they have operated and will operate the banking infrastructure (purchased and, in some cases, built) to do much more than launch basic debit cards and accounts.

Platforms help, of course. National ambitions are much more easily achieved when there is standardization in the mix, when apps can help build brands without having the costs of physical branches thrown into the mix.

But in the battle against traditional banks, the main front is trust. As we noted last year in a report on digital banking, we found that only 7 out of 100 consumers join digital-only banks. As many as 11% still interact with FIs primarily through physical locations.

It’s no surprise that younger consumers are interested in making the leap to digital channels: more than half of Gen X and Gen Y consumers would be interested in switching to these models. But interest, it should be noted, does not translate into quick action, and a wait-and-see approach may set in. Up to 47% of those not inclined to make the switch cited data security as a top concern.

In the meantime, digital banks will continue to fund fundraising operations from institutional and exchange lenders until a critical mass sets in and they earn enough on lending activities to help to complement innovation. Traditional financial institutions have an inherent advantage in terms of scale and trust, but it remains to be seen how long these advantages might last.

Focus on niche audiences

None of this is to say that challenger banks are fully on the path to disintermediating traditional FIs. But by focusing on different segments – different niche audiences, in other words – these challengers go beyond the realm of simple digital banking.

The key differentiator may be this: many challenger banks can make a name for themselves with results-based services and products.

In a world where more than 50% of consumers live paycheck to paycheck and 40% of people who earn at least $100,000 a year live paycheck to paycheck, consumers are looking companies that can help them move towards a state of financial well-being. Real-time data and analytics – here LendingClub is another example.

In a separate interview with Webster, CEO Scott Sanborn noted that consumers are more adroitly matching their cash flow (via paycheck receipts) and spending. He said the cloud and platform model allows LendingClub to unlock deep analytical capabilities and create engaging experiences. Sanborn pointed to billions of data points gleaned over 15 years to make the most effective lending decisions.

Thus, the challenger banks – which offer banking services, yes, but to well-defined audiences and which sell new products according to need – are leaving the era of prepaid cards stuffed with user interfaces far behind them.

Read also : Imminent rate hikes pose new challenges – and new opportunities – for lenders