Disruption & Scale: Can FinTech Startups Really Have it Both Ways?

There is an interesting term describing a certain type of relationship between FinTech and banks called ‘rent-a-charter’ - a model when banks backstop or formally provide services behind FinTech websites. With the evolving relationships between startups and institutional players, this has become an often cited scenario, especially in lending, bringing certain scrutiny for everyone involved.

The financial services industry is now past the stage of opposition between FinTech startups and banks with a wide range of institutions walking hand-in-hand with startups or being involved in some sort of interbank consortiums. As a result, banks are now mostly well armed with the latest technological advancements in partnership with startups and are therefore able to finance deals secured through the more appealing platforms of their FinTech 'competitors'. Alternative lending is a good example here with flagship deals like BofA & Viewpost, JPMorgan & OnDeck and others. Moreover, some estimates suggest that in the US, around 80-90% of the capital lent through the two largest P2P lenders – Prosper and Lending Club – is institutional money.

Banks are also getting actively involved in the accelerator/incubator space, firmly rooting themselves among young innovators and looking for further partnership deals. The bottom line is that a beautiful friendship, as some may call it, seems to be taking over the competitive atmosphere.

Since collaboration has gone mainstream, for all startups that want to remain ‘free’, the market situation has become rather tense. There is now a dilemma that each startup faces, explained here by the WSJ:

FinTech firms that don’t partner with banks are often at risk when big banks come into their niche, or when market forces turn against them and they don’t have deposits to fall back on. <...> On the other hand, startup firms that do partner with banks can be subject to all kinds of scrutiny and criticism. They are seen as capitulating to incumbents, and increasingly come under the watchful eye of regulators.

Professionals from Moody’s have addressed the same dilemma on Wednesday, suggesting that tie-ups between marketplace lenders and banks can benefit small businesses. Most importantly, as stated in the official press release, the partnerships that small business marketplace lenders (MPLs) are forming with banks could help them lower their non-credit costs by cutting customer acquisition costs and funding costs. <...> Banks could benefit from the tie-ups by increasing their lending volumes and speeding up their review and approval process for clients.

The downside is, however, that partnerships could face several challenges going forward, including model risk, regulatory and loan performance uncertainty, and increasing competition from banks’ indigenous platforms.

While some startups chose partnerships to rid themselves of regulatory and growth struggles, others aspire to make it big on their own, e.g. Mondo, an app-only bank, which just this August was granted a restricted banking license allowing the company to hold customer money for the first time allowing the company to test its products and services with a limited number of customers. Regulatory authorities will lift restrictions after they are satisfied with the performance. N26 is also an example of a FinTech startup choosing to go its own way. This July, the Berlin-based challenger bank was granted a full German banking license that will let it offer a fuller range of products across Europe.

Another example is TransferWise, which until recently was quietly relying on banks to handle the initial link between the customer and the company, but is now is moving away from them and investing time and resources to get its own state licenses.

But not every FinTech startup is a five-year-old unicorn, is it? For entrants across segments, forging their own path without a powerful benefactor is a struggle. Given that regulators are not always in favor of young and edgy players, for small teams with limited resources it's a matter of having a safety net in a sole journey. They can either choose to spend enough time and push their disruptive solutions through the regulatory shredding machine, or partner with an institution and take the chance of losing the purity of the original objective.

Startups that choose to spend time on going their own way, at the moment of getting a license, for example, risk facing a "heavily armed" institutional competitor that meanwhile was gathering more cooperative disruptors under the wing.