Why fintechs have been buying up banks

Fintechs looking to gain the benefits of bank charters are starting to acquire them again by buying up banks.

After several years of almost no fintech/bank M&A activity under the Biden administration, the Office of the Comptroller of the Currency approved a deal for SmartBiz Loans to buy Detroit-based Centrust Bank, acquire the community bank’s national OCC-granted charter and change its name to SmartBiz Bank.

“We will now be offering loans nationally, and we will be taking deposits to fund those loans,” SmartBiz CEO Evan Singer told American Banker. “We will also be originating loans on our own balance sheet. We can be more efficient doing it ourselves instead of relying exclusively on partner banks, ultimately providing a better experience for small businesses.”

New, or “de novo,” bank charter applications have been historically difficult for fintechs to acquire, with none receiving approval under President Joe Biden and Varo being one of the few to successfully obtain a de novo bank charter as a fintech before that.

Robinhood attempted to get a de novo bank charter from the OCC, but withdrew its application in late 2019. Instead, the investment fintech partnered with Coastal Community Bank to offer a new banking product slated to launch in late 2025.

Fintechs looking at the OCC’s approval of the Smartbiz deal might see a smoother path to getting a bank charter than applying for one on their own. Michele Alt of Klaros Group, the legal consulting firm that advised SmartBiz through the process of acquiring Centrust Bank’s charter, says otherwise.

“I don’t think that anyone should read the news about SmartBiz to indicate that it is somehow easier to acquire a bank than build one de novo,” Alt said. “Regulators scrutinize a bank acquisition at least as much as a new bank application. The difference between an acquisition and a de novo bank process really comes in post-conditional approval.” 

The difference, according to Alt, is speed to operation: With an acquisition, a fintech company can be in business on the same day as the conditional approval, but has some additional work to do with integrating an existing bank’s infrastructure. For a de novo charter there’s a lot of setup work to do, but the fintech starts with a clean slate.

Alt said that choosing between applying for a de novo bank charter and acquiring a bank comes down to the individual needs and goals of the fintech company.

“The advantage of an acquisition is that it comes with an existing bank; the disadvantage of an acquisition is that it comes with an existing bank,” she said. “It’s sort of like the difference between buying something off the rack versus having it custom-made. Both can work depending on the need. When you buy something off the rack you can take it home with you, but it might need some tailoring. On some occasions, it’s worth it to have the item custom-made.”

Some of the pros of having a bank charter, according to Alt, are direct access to federal payment rails, the ability to become a member of the Visa and MasterCard networks, low-cost funding in the form of insured deposits and a direct relationship with regulators.

“Sometimes, as we’ve seen in some banking-as-a-service models, fintechs have found themselves suddenly scrambling to onboard with a new bank partner as a result of pressure put on the bank by the regulators,” she said. “The fintech partners are often in the dark about the regulatory issues of their partner bank, because that information is frequently confidential supervisory information that the bank cannot legally share. So your bank partner may be having problems with the regulators that result in real vulnerabilities to the fintech’s ability to stay in business.”

Alt also noted that if a fintech company wants to stay independent in a rapidly changing environment, having a bank charter is a strategic move toward that end.

“Nobody is super enthused about being regulated as a bank, but it future-proofs your business to get a bank charter. In lending you’re at risk of a capital markets freeze, which has happened periodically over time, and that’ll put you out of business. A bank charter is a hedge against that,” she said.

Currently, there are four types of bank charters financial institutions can apply for in the United States. The first type is a state charter, which is granted by state banking authorities like the Utah Department of Financial Institutions. These are usually granted to small community banks, and for fintechs this kind of charter would be unhelpful as it limits them to only one state of operation.

The second type is a national charter granted by the OCC. This is the most common type of bank charter, and the kind that Centrust Bank held when SmartBiz bought it. 

Several fintechs have seen success with M&A deals to acquire this type of bank charter. The fintech Jiko bought Mid-Central Savings Bank in September 2020, LendingClub Corporation bought Radius Bank in January 2021 and SoFi Technologies bought Golden Pacific Bank in March 2021.

Tom Collins, a senior partner with the consulting firm West Monroe, believes that acquiring a national OCC bank charter was the best option for SmartBiz based on its growth goals.

“The deal allows SmartBiz to, rather than selling the assets into the market post-origination, hold on to those assets and profit from those assets over time,” Collins said. “It really allows SmartBiz to have a real end-to-end digital platform for loan origination. It also gives the combined entity [SmartBiz Bank] the ability to go beyond just SBA loans, through deposits and other products, to develop a more complete and profitable relationship with the clients.”

The third type, in theory, is the special purpose national charter for fintech companies, also known as the national fintech charter. Finalized by the OCC in 2018, the national fintech charter was designed to offer a “mix-and-match” charter solution where a fintech could select one or more of the three elements of a traditional bank charter — payments, deposits or lending — based on the company’s needs.

However, since the fintech charter has been available, no fintech or technology firm has even filed an application for it. In response to a request for comment, an OCC spokesperson told American Banker that the OCC has not issued any special purpose fintech charters at this point.

Some tech companies, like Google and PayPal, explored the option of the fintech charter back in 2019 but ultimately decided not to pursue it. State regulators also filed multiple lawsuits attempting to stop the charter by arguing it goes beyond the OCC’s statutory authority, and fintechs have been avoiding applying for the charter so as to not become embroiled in pending litigation.

The fourth type of bank charter is the industrial loan charter, or ILC charter, offered by the FDIC. The industrial bank has a similar appeal as the fintech charter at the OCC, in that it limits the number of bank supervisors a fintech needs to contend with, because industrial banks are a type of charter that can be owned and operated by commercial companies rather than just bank holding companies. 

The ILC charter is also a viable path for fintech firms. In March 2019, the FDIC approved two ILC applications — one for Square and one for Nelnet — for the first time in over a decade. 

However, this option is also difficult and time-consuming. In Square’s case, the firm had to apply twice over the course of two and a half years before securing its charter. In another instance, a Japanese e-commerce conglomerate called Rakuten filed for an ILC charter in October 2019, then withdrew, re-applied, and withdrew again in the span of just four months.

Overall, fintechs have an assortment of options for acquiring bank charters.

“If you go back five or 10 years ago, there was a lot of concern that the emergence of fintechs was going to compete with and harm the banking industry,” Collins said. “What we’re seeing now is what a lot of us expected, which is that eventually they’ll be blended together. It’ll raise the bar technologically and digitally and deliver a better client experience. As long as the balance sheets and the risks are managed appropriately, I think that it’s a good thing for the consumer. It’s a good thing for small business, and it’s a good thing for the industry.”