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Banks should be 'nervous' as fintechs get closer to bank charters

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Banks should be 'nervous' as fintechs get closer to bank charters

Financial technology companies looking to become banks now have some blueprints to study following two major developments in two weeks, and industry experts say banks should be concerned.

LendingClub Corp.'s announced acquisition of Radius Bancorp Inc. is an appealing "short cut" for fintechs looking to become a bank, but it could be the more expensive option, according to industry experts. Alternatively, fintechs could follow in the steps of Varo Money Inc., which applied for its own charter and recently received approval for deposit insurance from the Federal Deposit Insurance Corp.

The two developments show different paths to securing a bank charter, each with their own positives and negatives. Experts said banks should be worried about fintechs becoming banks as their innovative approaches and digital-savvy products win customers.

"If I was a bank, I'd definitely start to feel quite nervous," said Will White, head of international at 11:FS, a London-based consultancy firm specializing in fintech. "Banks need to make hard choices on the customer experience they provide and the operating expenses they use for technology."

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Bank charters are attractive because they enable the offering of deposit insurance, and retail deposits tend to be among the most affordable funding sources available. Nationally chartered banks are also able to operate across state lines without undertaking a cumbersome state-by-state registration process. To solve these issues, fintechs such as Varo Money and LendingClub have so far relied on partnerships with banks such as The Bancorp Inc. or Cross River Bank.

An acquisition is a quicker and more certain option for fintechs looking to obtain a bank charter, White said. LendingClub estimates it will receive regulatory approval in 12 months to 15 months.

But LendingClub's announced deal for Radius is a cash-and-stock deal valued at $185 million, whereas Varo spent about $100 million on its various applications and compliance activities.

While LendingClub spent more for its charter, it will get a lot more — notably a significant amount of deposits and the executive team that managed those deposits. The higher cost is worth not having to hire those experts and build up that deposit base, Anuj Nayar, financial health officer at LendingClub, said in an interview.

"Without a doubt, LendingClub choosing to spend a significant amount of money on acquiring a bank, they certainly get a shortcut to that banking charter but have paid for the acceleration of that timeline," said Eric Byunn, co-founder of Centana Growth Partners, an investment fund focused on financial services.

Both White and Byunn believe that other fintechs will look at LendingClub's acquisition and consider if they can do the same thing. "It's an appealing route. ... It will be very tempting to some of the bigger fintechs," White said.

Varo founder and CEO Colin Walsh disagreed that buying a bank is the best route to a charter. "Gaining a bank charter through an acquisition is not necessarily a shortcut, and regulatory approval will be required," Walsh wrote in a statement after the LendingClub announcement.

Fintechs could instead consider applying for a national bank charter or an industrial loan charter. Varo applied for a national bank charter and received deposit insurance approval on Feb. 10, almost three years after originally applying for a bank charter in July 2017. In September 2018, the Office of the Comptroller of the Currency approved the company's preliminary de novo national bank charter.

Varo expects to see its formal application approved by the second quarter of 2020, Varo's general counsel, Marina Gracias, said in an interview. At the same time, the company has also filed an application with the Federal Reserve for a bank holding company that it also expects to be approved soon, Gracias said.

"It is a difficult process, and it's not one that is easy or for those of the faint of heart because it takes a lot of time to do it," Gracias said.

Gracias said Varo considered making a bank acquisition to circumvent the application process, but opted for the application route because acquiring a bank would have meant absorbing potential downsides that come with a bank acquisition. Those risks include potential consent orders or integration hiccups. Gracias said it would require the transformation of an established bank brand at a time when Varo Money was trying to distinguish itself from other banks and fintechs.

As different as LendingClub's and Varo's approaches to becoming a bank are, they could become templates for other fintechs to follow.

"It's definitely going to become something that you assume fintechs will consider," 11:FS's White said. "Slave away at the traditional application process or go acquire."