Now That The Fintechs Can Be Banks, What Happens Next?

Last week, neobank Varo announced that it had been granted a national bank charter by the OCC, with additional approval from the FDIC and Federal Reserve to open its own retail bank. The debate over a fintech charter has gone back and forth for a few years. Varo’s own journey famously required 3½ years, 5,000 pages of paperwork, increased capital to meet charter requirements, support from U2’s Bono, and limitless patience from the startup.

One of the biggest benefits of being able to take proprietary deposits is the ability to lower the cost of capital to make loans; high cost of capital can often kill margins at small lending startups. Still, given the high regulator standards for fintech bank charters, we’re unlikely to see a rush of startups following in Varo’s footsteps soon.

So now that Varo has a banking license, what comes next? Per CEO Colin Walsh, they will use the charter to pursue a few strategic objectives: lower costs, more control, and faster product development. However, the charter could open up even more interesting third-party banking opportunities.

Varo is able to provide financial services through its partner bank, Delaware-based Bancorp Bank. Fintechs rent bank charters and act as program managers to build the clean user interfaces that customers see, while the partner banks own the underlying checking, savings, and credit accounts. Put differently, Varo maintains the front-end, core providers like Temenos T24 (which Varo uses) provide the middleware, Bancorp provides the infrastructure, and they all run on financial rails like ACH and card networks.

By owning its infrastructure, Varo can take more control of its banking stack, allowing it to lower its per-account cost structure (eg. by eliminating servicing costs paid to partner banks). It also means that Varo can develop custom middleware to work with T24 handle banking processes like account management or loan decisioning, tailored to its own front-end and infra. (Unlike more one-size-fits-all solutions from core providers.)

Once it migrates its 2 million user accounts to Varo Bank, N.A., the company plans to introduce its own credit cards, loans and savings products. It should be able to launch these first-party banking products quickly - and inexpensively - now that it is not as dependent on partners.

What is more interesting is the possibility that Varo pivots to providing third-party banking products (banking-as-a-service or BaaS). Could Varo itself now become a partner bank, and white-label not just its software but also its underlying bank infrastructure?

BaaS platforms are a nimble middleware alternative to legacy core providers. They provide API-centric ‘out of the box’ banking software, so that consumer-facing and vertical neobanks like MoneyLion, Moven, Simple, etc. can quickly build fintech products. The most recognized BaaS providers in the US include companies like Q2, Galileo, Synapse, and Bond.

While BaaS platforms provide comprehensive software to roll out banking services, fintechs still need to use FDIC-registered partner banks to provide those services. By acting as both BaaS provider and partner bank, Varo could present a faster, less expensive alternative for fintechs looking to build products more nimbly and get off the ground quickly. Even if it does not license its own banking software, Varo could still lend out its considerable retail deposits as a capital source for other fintechs to make loans (balance-sheet-as-a-service). With that said, if Varo continues to provide first-party banking services, other fintechs may be wary of using it as a software provider given they would be effectively competing with its consumer neobank.

It will be interesting to watch which path(s) Varo takes to capitalize on its charter over the next few years. The company could be a bellwether for other fintechs (such as Square and SoFi, both of which have filed banking applications), or it could continue to be in a class of its own. Either way, it’s exciting to see the fintech model continue to evolve as regulators focus on enabling innovation in financial services.