The Next Waves in US Banking - Part 1: Partner Banks Rising
More change is coming to banking in the United States. 2020 has seen an explosion in digital and online services across every industry, including financial services. But there are underlying trends in play that have the potential to shift the business models and competitive landscape of US banks fundamentally.
Hardly a day goes by without hearing about the launch of yet another digital checking account or payments service, or SMB lending tech in the US. As all of these new players enter the market and merchants try to grow their online capabilities, the 'partner bank' model is poised for rapid growth.
Many new banks will try to join the current set of 30 or so 'partner banks' who work with fintech and other firms to enable them to offer banking services. This space will become more competitive with these new entrants, and the existing partner banks will need to evolve their technology stacks further to attract the best opportunities.
It's not entirely clear how this will play out, but there will be more demand for 'Banking-as-a-Service' (BaaS) and for the banking platform technology that makes it possible.
This is the first in a set of articles that will explore US banking's coming changes, from partner banking to embedded finance, and the diverse group of new players driving these changes. Banking in the US will look very different over the next five years.
How did we get here?
The number of licensed banks in the US declined dramatically, from around 15,000 in the 1980s, to around 8,500 by 2000, to a little under 4,500 banks today.
There were many drivers of this change, including:
Simple industry consolidation, as larger banks took over smaller players in local markets.
Regulatory changes since 2010, after the Global Financial Crisis of 2008. These changes required banks to hold more significant capital buffers - making some small banks unsustainable (and thus prone to being taken over by larger peers).
Generational shifts - the rapid adoption and widespread use of mobile in retail and other sectors by younger customers forced banks to strengthen these channels. The example set by the best retailers and other consumer firms using mobile pushed banks to develop better mobile and online customer experiences.
Technological change - the growth of online and mobile banking drove banks to invest heavily in new technology. It arguably also led to the creation and rise of the global 'fintech' market. Thousands of smaller technology-driven firms brought out solutions to bring the best consumer-driven approaches to banking (& other financial services).
Larger banks responded by making massive investments to build up in-house technology and innovation capability (with a varied success rate - that's a story for another article). Smaller banks found themselves squeezed - unable to fund in-house tech development, and often very dependent on their historical technology providers. Many have not been able to engage meaningfully with fintech or drive their own digital transformation agendas.
All of the above trends made it harder for smaller banks to compete, and apart from the most strategic and agile, many fell by the wayside.
Change has come from unexpected directions
While many people thought the largest technology companies ('Big Tech' - i.e., Google, Amazon, etc.) would directly enter the banking market, that hasn't happened in the way most anticipated.
Instead, we have seen Big Tech pursue more of an alliance model, working with a few industry players to leverage banking only where it complements their existing business models. The most well-known example of this is probably Goldman Sachs (GS) and Apple working together to launch Apple Card.
The Apple Card relationship works for both parties - Apple gets to stimulate purchases of its own products. Goldman Sachs gets to enter further into the retail banking market, which it has been doing steadily.
But there are many other less well-known examples where new players have entered the US banking market in 2020 in unexpected ways:
Betterment & Personal Capital, both renowned robo-advisor / personal investment platforms, have launched their own checking accounts - with higher than average interest rates.
Affirm, a retail lender, entered into partnerships with high-end retail brands like Peloton to offer 'buy now, pay later' (BNPL) financing at point-of-sale (especially online sales).
Accounting software provider Intuit launched its own small business banking account called QuickBooks Cash to provide cash management capabilities to its existing 5 million SMB clients.
These moves are very strategic for the non-banking firms behind them - they are leveraging their existing customer bases and positioning themselves to offer new services in the future. For example, Intuit could quickly expand its offering into lending to SMBs in the future, armed with the data they acquire by being the accounting software provider. (There have been other successful examples of leveraging accounting systems to promote banking in markets outside of the US).
Most of these new entrants are doing so by working with a 'partner bank,' who brings their banking license and other expertise (mainly regulatory) to the relationship. The partner bank gains deposits and other fee income. While they do not own the client relationship, they gain access to large volumes of new business. A generation of first-mover partner banks, including Green Dot Bank, MetaBank, and Evolve Bank, pioneered and shaped the business models in this space.
In addition to the rise of partner banking working with existing established banks, there have been several brand new entrants in the form of 'challenger banks' or 'neo banks.' Some are home-grown in the US, like Chime or Simple (one of the oldest challengers, since 2015, now part of BBVA). Others are trying to come in from outside the US, including Revolut from Sweden and N26 from Germany.
A more crowded banking market
The growth of potential partner banks will increase competition in the space, cause the incumbent partner banks to add functionality, and spur new entrants to find ways to win in a crowded market. The ultimate winner will be end consumers, who will have an abundance of new banking relationship options.
What makes this different from a simple increase in the number of players is that banking will frequently be tied to another service or product, not stand-alone. There are many emerging use cases, but some of the most exciting include:
Small business owners who sell through Amazon or the Walmart Marketplace can be offered loans via these sites via their existing dashboards. This is already on offer via the partnerships in place between both these retail giants and Goldman Sachs. Another payments firm, Brex, is enabling early payment for Amazon resellers via its 'Instant Payouts' product - conceptually similar to invoice factoring.
Similarly, the e-commerce platform Shopify has its own lending business, Shopify Capital, who just reported a record-setting quarter for loans and cash advances to merchants using their portal.
Retail investors saving via robo-advisor Wealthfront are offered a high-interest checking account and debit card backed by a partner bank. The channel to the end customer is via another company, with its own relationship.
In this world, banking becomes a utility, and the change has been brought about not by a Big Tech giant but by a hundred smaller organizations all trying to add value to their customers in new ways. Ultimately this is the world of 'embedded finance' - the term that has gained currency over the past months. While embedded finance is one way to describe the end customer's experience - the "what" - partner banking is the way it is delivered - the critical "how." The next articles in this short series will describe embedded finance more fully and the deeper technical mechanisms enabling partner banking.
Along with many other aspects of the world, 2020 promises to be a milestone year for banking in the USA.