While the financial press is busy obsessing over WeWork and ignoring the anti-trust oligopoly forming in payments, let’s look at another topic with too little discussion in U.S. financial press: the Bank as API. Neobanking or open banking is all the rage in Europe. It’s not clear why U.S. banks have been slow to open their API’s, but one does sense the whiff of a lack of competition in U.S. banking, (a subject that is the central thesis of Thomas Philippon‘s excellent book, The Great Reversal, How America Gave up on Free Markets).
Now, in Europe, open banking starts from the premise that users of financial services have a right to compare like providers, access data and easily switch from one to another, a bit like phone service providers. In the US, the difficulty in accessing and comparing financial service data has created a market for non-bank solutions for accessing bank services such as Yodlee, providing consumers with account information, Geezeo connecting APIs of a limited set of participating banks, through to Synapse sitting between a bank and fintechs to enable fintechs to offer everything from DDAs to virtual cards with ease. There is now a run on picking up the technical slack of US banks coupled with the lack of competition in US banking that is driving a good number of new entrants. (Even we, quite shamelessly, picked-up neobank.law a year ago).
(Ok boomer,) US neobanking players fall into three categories.
1. Financial Institutions where APIs Come First. These are licensed US banks, trust companies or MSBs that position API access as a key distinguishing feature. SVB, BBVA, Evolve Bank and Trust, Prime Trust, Dwolla and Bitgo. The opportunity for these suppliers is that they can serve large numbers of new clients via API with assistance from fintechs as agents. The risk for these suppliers is that they may each be operating dozens of different business models that present a challenge for
2. Technology Platforms Between FIs and Fintechs. These entities avoid taking control or possession of transaction funds and remain primarily data-only gateways Examples include Plaid and Synapse. (Some financial institutions have preferred to own the IP to the APIs that connect to their accounts, a leading example of that would be Stripe). The opportunity for these entities is to earn a piece of transaction volume without having to pay the price of being regulated entities. The risk for these suppliers is that regulators will find them to be MSBs despite their carefully avoiding possession of transaction funds. Because of their tight integration with financial institutions, these platforms make ‘classic’ boomer gateways, like Authorize.net and NMI, look quaint.
3. Fintechs. These entities navigate gingerly between avoiding regulation by relying on their financial partners (see Item 1 above) and being regulated as MSBs. These 50 or so fintechs use APIs of the FI’s identified above to operate their businesses. We have indicated which are the most likely financial services that each has outsourced to the FI indicated and they include DDA, Card issuing, ACH, crypto custody and money transmission. The opportunity for these entities is to decrease the cost of compliance (using FI’s identified in Item 1), decrease the cost of development (using technology identified in Item 2 above) and focus on the business of selling their service. The risk for these entities is excessive reliance on third parties for compliance and technology and the risk that regulators will perceive them as MSBs, even though licensed financial institutions take legal liability for the movement of client funds.
Whether the OCC clamps down on FI’s in the space or state banking regulators deem tech platforms to be MSBs, there is an overwhelming momentum in the US neobanking space that is driven by real demand for competition and variety in consumer and business financial services that we think will be met ever more in 2020. At Adam Atlas Attorneys at Law, we provide commercial and compliance advice for US neobanks, such as they may be.