As the world slowly recovers from the pandemic and fintech startups ready themselves for the new normal, their operating models are facing a new and significant challenge in the wake of the recent mergers and acquisitions from the banking sector.
Based on our ongoing analysis of the neo-banking & digital challenger banking space, we believe that neobanks who cater to small and mid-size businesses (SMBs), will emerge as significant players in the fintech ecosystem in the coming years.
In this article, we analyse the way SMB neobanks operate in the US and the challenges and opportunities that they face in the wake of the recent banks’ M&As.
SMB Neobanks: Overview & Customer Segment Focus
SMBs are usually the backbone of a country’s economy in terms of generating significant employment opportunities and contributing massively to international trade. However, the segment itself is extremely fragmented in terms of size, life stage and nature of individual firms who operate in it. Owing to this fragmentation, SMBs are often overlooked by the megabanks and do not have comprehensive access to personalised and contextual banking services. Even FinTechs that earlier concentrated on SMBs, focused only on specific point solutions such as card acquiring, lending, accounting etc. and did not provide a holistic range of financial and business solutions required by SMBs.
This is the opportunity SMB neobanks are going after, where they offer purpose-built banking services to individual business-owners and also offer integrated access to other financial and business services. The last three years have witnessed a launch of more than 10 SMB neobanks in the US, some of which are captured in the table below. Given the diversity of the SMB segment, these neo-banks tend to have a core focus on some of the sub-segments such as traditional SMBs, startups and freelancers and build custom offerings and workflows to help them focus on their business while making access to financial products on-demand, seamless, and intuitive.
Anatomy of an SMB Neobank
Neobanks across the world manage and operate their businesses with a slew of partners who help with access to regulatory licenses, payment rails, data aggregation, technology infrastructure etc.
Sponsor Banks & BaaS Providers
If we look at the anatomy of SMB neobanks in the US, given the complex regulatory environment, they generally partner with a sponsor bank to launch deposit and card products. At times these partnerships are front-ended and/or facilitated by a 3rd party technology provider also known as Banking-as-a-Service (BaaS) provider. It manages the technology infrastructure and integration requirements with the core banking systems of the sponsor banks to facilitate the partnership between neobanks and sponsor banks.
Card Networks & API Aggregators
SMB neobanks also partner with the card networks for card issuance and use account aggregator API providers to connect with other financial institutions to present a consolidated interface to business owners to operate their finances.
Integrated Business Tools
Some of the SMB neobanks, such as Novo, have taken a lead in building an integrated interface with business tools such as Xero for accounting, Transferwise for international payments, Slack for communications, Shopify for eCommerce and Stripe for payments acceptance, among others.
Bank Mergers & Acquisitions trends
Bank M&A in the US has soared in the last couple of months. The COVID-19 pandemic has hastened the confluence of conducive conditions for mega domestic mergers. We categorize the recent bank mergers & acquisitions in 3 different categories, and analyse their impact on the SMB neobanking players in the US:
The first 2 consolidation categories’ examples, as shown in the below table, have the potential to disrupt the operating model of some of the SMB-neobanks who partner with these sponsor banks or use their BaaS offerings to run their banking operations.
Bank M&As and Key Announcements
With the acquisition of BBVA USA, PNC expects to achieve cost savings in excess of $900 million, or about 35% of BBVA USA’s annual noninterest expenses, by 2022, largely through operational and administrative efficiency improvements. Technology standardization, as well as product offering rationalization, are two important ways for PNC to meet their objectives.
- Technology Standardization: The fact that PNC will be bringing BBVA USA’s data into PNC’s applications strongly suggests that PNC won’t be using the real-time Alnova core system that BBVA co-developed with Accenture and deployed in 2012. BBVA Open Platform which is built on top of Alnova will be severely impacted and expected to shut down in such a scenario. On the impact on fintechs, neobanks such as Azlo, Wise and Mercury who currently partner with BBVA for access to technology as well as banking charter will be impacted.
- Product Rationalization: BBVA has already announced the closure of its neobanking offerings Simple and Azlo. The closures may be intended to keep a single digital channel offering and reduce potential cannibalisation of existing products like PNC Virtual Wallet for retail customers and in-house spinoff offering, Indi, focused towards freelancers. For retail users of Simple, BBVA said it will migrate them to its mobile app. Azlo announced scaling back of features and complete account closure by March 31, 2021, for its SMB customers.
In January 2021, Lending Club received the final approval for its acquisition of Radius Bank.
- Partner Switching: Lending Club currently partners with multiple banks such as WebBank, NBT Bank and Comenity Capital Bank for its lending marketplace. It also partners with Opportunity Fund and Funding Circle to offer SMB loans. Radius Bank’s assets such as banking charter and deposits will make Lending Club’s products less confusing for consumers and will save serious money.
- Digital SMB Offering by Radius Bank: In December 2020, Radius Bank launched an enhanced Online Banking and Mobile App Experience for SMB customers. Lending Club is expected to leverage this to further develop the relationship with the business owners through checking account and payment offerings.
Bank M&As: Challenges and Opportunities for SMB Neobanks
The Acquisition of BBVA and Radius Bank has caused significant turmoil on the operating model of their fintech partners as depicted in the table below.
While Azlo is shutting down, NorthOne has announced that they will be switching over to another partner bank and Wise is expected to follow suit. These shutdowns and changes, though disruptive to these banks, would be an unnecessary hassle for the customers operating with these banks as it will require them to either migrate to a new bank or redo their KYC, get a new card and bank account etc.
The existing neobanks such as Novo and Mercury who have a similar target segment as Azlo, NorthOne and Wise are coming to the rescue of SMB customers who are looking to migrate by enabling a smooth transition. Other SMB Neobanks such as BlueVine, Oxygen, Relay etc. and even traditional community banks with a good digital interface can benefit from this scenario by building relationships with the business owners and allaying their apprehensions about the future fallouts.
The Way Forward
The COVID-19 pandemic has acted as a catalyst for bank mergers. Community banks, especially with moderate to high assets or with significant digital assets, are expected to be involved in M&As in the coming years. Some of the fintechs are also looking to obtain banking charters to get the flexibility to run their business cost-efficiently and innovate flexibly. The likes of Varo and SoFi have chosen to procure banking charters, while others such as Lending Club and Jiko have acquired an existing bank. As more consolidation happens, the neobanks who partner with sponsor banks or BaaS Providers will need to find a way to deal with the resulting disruptions while ensuring they don’t compromise on customer expectations.
Note: Research for this blog is limited up to January 2021.