Limitations In Fintech's Partnership Model

Partnership dominate fintech, but they're not always a win-win.

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Vaibhav’s going to be doing “Inside Fintech,” where I’ll be hosting “Fintech Tonight,” a fintech talk show.

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One of the biggest trends in fintech over the past year or two has been the ecosystem’s newfound openness to partnerships versus disruption. If you’re looking for an overview, Andreessen Horowitz partners Rex Salisbury & Anish Acharya wrote a great primer on them recently.

I don’t feel like getting into *why this happened*—that’s been well covered. Long story short—completely upending a regulated industry is harder than it looks. Yes, the technology is archaic, but changing such an entrenched ecosystem takes more than better tech.

While observing this trend, I’ve noticed some potential short and long term issues around partnerships in fintech, whether its between a partner bank and a banking-as-a-service provider, a bank and its neobank partners, or something else. I want to focus on the most common model/version: enabling a consumer financial product through partnerships. In many cases, its a debit card but in some it’s installment loans (Shopify Pay Installments), a credit card (Apple Card), a debit card and app (Samsung’s new deal with SoFi), or something else.

It’s important to note that there are three main stakeholders in this relationship:

  • The Actual Bank. This is a chartered institutions that holds the deposits and manages all the financial operations.

  • The API Provider. This can be a bank, like GreenDot, or a tech company, like Galileo, Synapse, and newer players like Unit Finance, Bond, and Moov.io. These folks are focused on making the simplest, most reliable, API’s for customers and bank partners to enable a stable relationship (or…they should be.)

  • The Client. This is usually the neobank or whoever’s using the API. This group is mainly responsible for the consumer facing product experience.

While many focus on concerns around the relationship between the Client and API Provider, the relationship between the Bank and API Provider is fraught with issues too.

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Here are some issues around the whole model that I’ve been thinking about.

  • Interchange Revenue Rate Split Between Partners: All the aforementioned stakeholders split interchange revenue that the bank makes when you swipe a card they issued. They share it cause they all do some of the work. For Clients like neobanks, its a significant source of revenue. For API Providers and Banks, its icing on the cake: they’re already charging monthly and annual fees. At a high level, API Providers charge the clients a SaaS fee, and Banks charge API Providers.

    But this revenue sharing agreement changes over time as the Client’s leverage increases. When you’re an early stage neobank with just funding and a few customers, your partners will offer you awful rates. As your distribution scale and engagement levels increase, a single client starts to account for more and more interchange revenue (especially as weaker Clients start falling off/pivoting.) In the long run, if you’re a neobank at scale, your leverage during renegotiations increases. If you want lower rates, what’s a BaaS platform to do—say no, and risk you taking your interchange revenue with you? Even others, who charge on other metrics like a monthly fee per card issued, will run into this issue—with unit economic and margins so small in consumer banking, Clients will inevitably look for ways to decrease their variable costs, which rise as they grow.

    Single client risk, or when your business model is dependent on 1 or a few big customers, is an issue for the API providers than the Banks in this situation (more on that later.) Switching costs are still a real pain for Clients looking to switch API Providers and especially partner banks, but most of us in the ecosystem have seen it happen countless times over the past 2 years or so. If there’s a strong enough business case for the Client to make around moving off a provider, they’ll bite the bullet and do it.

  • Pricing Model: Everyone says its so easy to make a neobank nowadays. And that’s definitely true in part—API Providers have made the technology barrier significantly lower. But it’s still a costly process—API Providers have fees just to play around with a sandbox, not even to use their tech in production; and Banks will only work startups that have raised a certain amount of capital (have heard of edge cases, but its around $1m.)

    But the business model does not make sense for every stakeholder. The monthly and yearly pricing for API Providers has traditionally been a barrier for smaller startups, and requires founders to raise preseed rounds just to build the first iteration of their concept. Everyone talks about “the AWS for Fintech” but AWS doesn’t cost a preseed startup an arm and a leg. AWS reduces the technology AND financial burden of getting a software company off the ground. The same still needs to happen in fintech.

  • Platform Lock In For API Providers: API Providers have it rough—as the middleman, they’re getting squeezed by banks and are getting pressured by clients. First off, a lot of the product roadmap for API Providers are unofficially dictated by their partner bank. They aren’t charted financial institutions—they can only offer technology to enable others to create financial products that are approved by their partner banks. API Providers don’t take on the regulatory risk of the underlying financial product, and their roadmaps are restricted by what their partner bank is willing to take on.

    For example, traditionally, banks haven’t been willing to offer their balance sheets to enable cheap lending for neobanks. In theory, if a neobank can acquire deposits and the banks let them lend a certain percentage off of it, a neobank could dramatically reduce the cost of capital for a consumer lending product (the alternative would be a warehouse facility or lending off the money you fundraised which…wouldn’t fly with any investor.) I know of at least 1 bank that’s doing it and two that are looking into it.

    The risk for API Providers? It’s becoming increasingly clear that it makes sense for Banks and Clients to figure out a way to cut out API Providers. Technology heavy clients that see financial services as a core competency will tell investors to give them $50m to build this tech themselves and connect to an issuing processor like Visa directly (this exclude most embedded fintech players FYI.) Banks will say that if they can just charge the neobanks directly if they have API’s that aren’t complete shit (this is a huge if.)

    This is why I previously wrote that infrastructure companies need to get into value added services as a way to lock in customers—because the value proposition for API Providers decreases over time.

  • Poor Go To Market Strategy Selling To Non-Fintech’s: Out of all of these, this is the one that annoys me the most. Because if you look at consultant’s writing blog posts and Fintech Twitter’s nonstop adoration, you’d think that we’re in the midst of an embedded fintech renaissance.

    And while companies are having success selling infrastructure products to non-fintech companies so they can build a service themselves, partnerships between these stakeholders and non-fintech companies is still infrequent. (The only infra company that crushes it on embedded fintech partnerships is GreenDot.) Bank and API Providers especially have an abysmal time figuring out partnerships with non-fintech companies because of a weak go-to market strategy. In my opinion, most embedded fintech startups chase whales like Apple or Uber, when you’d be better off enabling a smaller tech startup with brand value and equity—like convincing Away to start an Away travel branded credit card (well…maybe not in this economy.) Or pitching Glossier to start a virtual card with its own rewards program to drive more frequent purchases and larger cart sizes.

    The real issue is education—you’re not pitching fintech experts. Most people don’t know what interchange revenue, partner bank, or embedded fintech even mean, much less talking about the nuances around being a program manager and KYC.

Luckily, companies like Unit Finance, Moov.io, and Bond are focused on making it simpler and easier for developers to start creating financial products, helping banks become their own infrastructure providers, or making it easier to manage these relationships.

But it’s clear to me the partnerships model has some hole that need fixing, and solving some of the underlying issues requires taking creative risks. Will we see a big bank become the defacto banking-as-a-service platform? How will API Providers decrease platform risk over time? Will neobanks at scale start making more technology in-house? These are some of the questions I’ll be thinking about as we see new and different kinds of partnerships crop up.

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