A Neobank That’s A Bank

How Varo’s bank charter will help prove or disprove the Neobank thesis.

Varo, a Neobank, announced this week that the FDIC approved their banking charter. This is a first for Neobanks, enabling them now to hold customer deposits and lend that money out.

You know, like a regular bank.

This will be a fascinating experiment, one that could make or break the thesis on the potential value of Neobanks.

To understand why, it’s worthwhile to explore the challenges Neobanks (Chime, Stash, etc…) face and how this charter potentially differentiates Varo.

The Problem With Neobanks

First, let’s understand what a Neobank actually is. You don’t deposit your money with a Neobank. Your money is actually held (and subsequently lent out) by a traditional bank.

It looks a little something like this.

That API between what the Neobank controls and the deposit holding bank introduces a set of challenges. It means the Neobank:

  • Can’t earn money by using the deposited funds to lend out at a near-zero cost of capital
  • Is limited in their product development by the API’s available from the underlying bank (or infrastructure provider that sits in the middle).

The bear argument for Neobanks is that they are novel UX layers and marketing channels, which can easily be replaced, to bring deposits in for the underlying bank.

On the bright side, Neobanks do not have the compliance overhead of holding customer’s money. The bull case treats Neobanks as modern finance companies with incentives aligned to their customers.

For example, Neobanks protect you from overdraft fees with warnings and quick loans because they make their money from a monthly SaaS fee as opposed to the penalty fee itself. A traditional bank has no incentive to offer the same protection, it just hurts their bottom line.

The Varo Bull Case

With their charter, Varo is betting that owning the entire stack, from UX to deposits, will enable them to:

  • Build the tech stack that realizes the potential of relationship banking.
  • Better anticipate, qualify, cross-sell and serve customers than banks today and at a lower cost of capital and less friction than other Neobanks.
  • Offer API driven banking infrastructure that others can build on (note: this one is something I’d like to see, not what they’ve publicly stated)

Can Varo do this and challenge incumbent banks in scale and market cap? Maybe.

The charter gives them a unique weapon in their arsenal. Considering it has taken them almost 3 years to get the charter issued it doesn’t appear there will be any fast followers. And with it, we’ll finally see what the value of a fully digital bank is.

Software Is Relationship Banking

Software has replaced relationship banking as the best way to acquire customers and sell new financial products.

This bodes well for the land and expand strategies of tech companies and not so well for the mythical personal relationship banks have with customers.

TL;DR

  • Changing customer attitudes and bank’s antiquated tech stacks are killing relationship banking, leaving banks vulnerable to competition from tech companies.
  • Fintechs have built modern and integrated tech stacks to better serve customer segments more economically.
  • Others (Uber, Shopify, etc…) are leveraging their vertical solutions to sell financial products.

Relationship Banking Test

Relationship banking posits that customers select products from banks they already use and presumably trust. And that these banks are best positioned to understand and serve their customers because of their relationship.

This just isn’t true.

Consumers, particularly younger ones, don’t discover and choose financial products based on their bank relationship. In truth:

  • ~70% bank digitally because they don’t want to visit a branch
  • ~50% don’t think banks are that different from one another
  • 3x more likely to close accounts and switch than older cohorts

Let’s skip the “next generation changes everything” argument. Instead let’s use Frank Rotman’s excellent rubrik (highly encourage reading his full post for more detail).

  1. Is it easier or more economical for current customers to access other products from you? Are you able to qualify customers because of your current relationship that others can’t?
  2. Are you proactively suggesting and moving customers into the best products based on what you know about them?

Ever applied for a mortgage with a bank where you hold an account to find that you are filling out same information that a brand new customer would?

Ever gotten a maintenance charge on a checking account when the bank offers a free option that you also qualify for?

Then you know the answer to these questions is a resounding NO.

Banks are playing a tough hand. Their tech stacks are a mess, cobbled together over 30 years, making it difficult to serve customers across products. It also makes it expensive for them to support the niche segments that tech companies can profitably serve.

How Do Fintechs Stack Up?

Using modern tech stacks, low opex and a technology-driven mindset, fintechs focus on acquiring the best (i.e. most profitable) or underserved customers as wedge into the market. Solving one customer segment’s problem enables them to move into adjacent products and/or customer segments (‘land and expand’).

Their entire business plan is predicated on being able to answer yes to those questions. Let’s look at one of the test questions.

Is it easier or more economical for current customers to access other products from you? Are you able to qualify customers because of your current relationship that others can’t?

Remitly’s core product is an international money transfer service and many of their customers are thin file immigrants who have difficulty getting a bank account or many not have a SSN. No problem, they released a bank account that using international identification documents and no SSN to KYC a user.

How do you think these users will send money internationally from their new bank accounts? The virtuous cycle spins. It’s easy to imagine Remitly growing into loans and other products as well, all to an ignored customer segment deemed too expensive (i.e. risky) by the legacy bank tech stack.

What About “Regular” Tech Companies?

It’s not only Fintech companies the banks need to worry about.

Increasingly, tech companies that you don’t think about as finance businesses are leveraging their customer data to offer financial products more economically than a bank could. It makes sense, it’s getting easier to roll out a finance product and it’s a margin lift for their businesses.

Shopify helps anybody setup a storefront on the web and sell directly to consumers, who pay a monthly fee for the service. But, did you know that they offer loans to businesses or that this is ~50% of their revenue.

That’s a business loan, the same kind you can idealize is taken by a hopeful entrepreneur in the lobby of their local bank. Instead it’s delivered by a technology company that makes data-driven decisions based on the businesses use of their software platform.

Technology is the new relationship banking.

Everybody Becomes a Bank

https://twitter.com/itaidamti/status/1224077443322957824

You could imagine a Shopify competitor giving away the storefront for free to attract businesses and then earn money from loans and payment processing.

We are seeing this happening already in some verticals. Divvy is an expense management platform that is free for businesses. Completely free. They earn money from the interchange fee via use of their issued credit cards and soon through loans issued to business customers.

The permutations are endless depending on the market and pressure points. This is great for customer, not so great for banks.

One Way to Improve Open Finance Apps

Banks need a regulatory push to make our data more accessible and transportable.

Regulation could help here…gulp.

Particularly in the US, our financial data should be more easily accessible and transportable. This would make it simpler for more applications to be built to give us views into our financial life (bank account, brokerage, etc…). That in turn would allow different segments of the population to be better served for their needs. Worried about overdrafts? Remittance fees? There’s an app for that.

Wait. Doesn’t Plaid make financial data easy for developers to access $5.3B different ways? And didn’t Mint begin this trend over a decade ago? Yes and yes.

Notice I said improve in the title though, not enable.

First a quick background on how Plaid, Yodlee, and others work today. Primarily they compile your financial data via screen scraping. They access your account using the credentials you provide and parse the interesting data (account balance, tx dates, etc…) to share through a formal API to an app developer. For the app developer it saves time and allows them to focus on their unique business value rather than plumbing.

To be clear, I’m not condemning screen scraping. I’ve used it in multiple companies to structure data that resides in unstructured formats on websites or PDFs.

It does have serious problems though. For one, it’s brittle. The underlying site changes often and when it does your scraper breaks. So access to some banks is constantly under repair and there is no way to know when. Also, it can break completely when the provider of the website wants to break your scraper. And they have multiple reasons to want to do this.

So what can be done? Why don’t banks adhere to a standard format of making data available? It is your data in the first place. Unfortunately, they have no motivation to do so. They prefer you live within their universe of products and not easily manage finances across banks or have simple access to products elsewhere that would compress their margins.

Europe offers a roadmap to solve this with their PSD2 initiative. Among others things, PSD2 requires banks to adhere to a standard API for data access. Unfortunately, there probably isn’t another way to make this happen among banks that aren’t motivated to do it on their own. More unfortunately, we probably won’t see a similar rule in the US.

This wouldn’t negate the value of Plaid and similar services (see Tink for proof). It would serve to make their APIs more robust and reliable. The winners would be end users benefiting from more ways to manage their financial health. And we should all want that outcome.

Visa, Plaid & Networks

Plaid’s acquisition is a tailwind for the next wave of fintech infrastructure networks.

Big news, $5.3B big. Everybody has takes, including Visa themselves, on why fintech infrastructure is more important than DTC fintech. We’re all geniuses in hindsight.

Unsurprisingly, Ben Thompson has one of the best explanations of the rationale [paywall]. It ties back to the power of a network that can not only provide read-only access to your money, which is what Plaid offers. The future is programmatic read and write access.

Visa today sits in the middle of a 3 sided network.

  • Merchants – who offer products and benefit from a network that extends credit and fixed payment terms
  • Consumers – who need credit and convenience
  • Banks – who have money to extend credit

Plaid today sits in the middle of a read-only 3 sided network, a threat and opportunity to Visa’s business

  • Consumers – who want modern access to their finances
  • Banks – where money resides and earns interest, is lent/borrowed/etc…
  • Developers – building new financial products

Today, Plaid dominates in the read-only use case for developers. Tomorrow, and what drove the acquisition premium is a read+write network that Visa can operate alongside it’s current one. Ben Thompson’s explanation:

More importantly, though, is the power of inertia: as long as it is hard to move money around, the more likely it is that that money will stay in the bank, collecting minuscule interest; or, if customers need value-added services, the path of lowest resistance will be simply getting them from their bank.

An API-based world could change this dramatically: suddenly consumers could commission robo-advisors to move their cash to whoever is offering the best rates, or to automatically refinance debt. Value-added services from multiple vendors would be equally easy to access, meaning they would have to compete on price or terms. In other words, much like the open Internet, banks fear that profits will be rapidly transformed into consumer benefit.

Ben Thompson

Plaid’s founders, team and investors are huge winners obviously. The secondary effect is the rising tide this will provide to the next wave of fintech infrastructure players like Astra, Alpaca & SynapseFi.

Innovator’s Dilemma at Coinbase

Coinbase faces a dilemma in the battle to own the emerging brokerage layer in crypto.

This quote from Brian Armstrong holds the clue to an underappreciated threat to Coinbase.

…many of the companies we think of as cryptocurrency exchanges were actually brokerages, exchanges, custodians, and clearing houses bundled into one….I think we’ll see the cryptocurrency market structure evolve to more closely resemble the traditional financial world, with these functions being separated out…

Brian Armstrong

TL;DR

  • Brokerages are an inevitable evolution of crypto-finance, abstracting investors from exchanges.
  • This is the new battleground in crypto and the winner holds the key to serving users with a full suite of financial products.
  • Coinbase faces a classic innovator’s dilemma. Their exchange business is a cash cow today, but a liability in the battle to own the brokerage layer and winning the next phase in crypto.

The Opportunity

The $100B opportunity over the next decade is to own the brokerage layer in crypto.

Let’s assume Brian is right and crypto-brokerages emerge. The key to appreciating the importance of this trend is that brokerages, not exchanges, own the end user relationship. And owning that relationship is critical.

That relationship is the key to cross-selling banking, savings, borrowing and investing products, crypto or otherwise. Winners in finance offset high CAC by serving all your finance needs. The brokerage has the customer touch points to understand their needs and market other products.

This is why every fintech company follows a land and expand strategy and why Coinbase is expanding from their core exchange business.

The Dilemma

Brokerages own the customer relationship

Coinbase’s strength today, their exchange, may be severely impacted in the battle to own the brokerage layer.

Brokerages execute customer orders at the best price, thus they operate across exchanges tied to no single source of liquidity. A healthy market for crypto-brokerage products would deteriorate Coinbase’s pricing power and volume.

Today all Coinbase retail orders are funneled directly to their exchange. Competing with other high-quality brokerage products would require Coinbase to provide best execution for customers, distributing their order flow across competing exchanges.

This begs the question, will they sacrifice short term revenue for the longer term prize. It’s easy to say yes in theory but hard to do in practice, even for a private company.

Consider that they just raised trading fees! It’s less expensive for them to offer this service over time, but they chose to offset declining volumes by raising fees. Does that sounds like a company ready to sacrifice short term revenue?

Brokerages make the market more efficient in general which reduces cost. So even if Coinbase doesn’t compete directly with other brokerages, they will feel their emergence via reduced margin.

Are you thinking that Coinbase is the 100 lb. gorilla of crypto and will naturally dominate every layer in the stack? Consider though that only ~50M people hold crypto today. A rounding error. The billions of new users will choose their onboarding path via crypto-native brokerages and banks, not directly with exchanges. So Coinbase’s dominance is far from certain.


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Fintech APIs Today

If you’re building a bank today, you’re in luck. Much of what you need is available via API so you can skip the months of legwork to find bespoke banking and compliance partners.

If you’re building a bank today, you’re in luck. Much of what you need is available via API so you can skip the months of legwork to find bespoke banking and compliance partners.

You can start building on day 1.

Here’s a few of the things you can start building quickly by standing on the shoulders of g̵i̵a̵n̵t̵s giants-in-the-making.

KYC/AML

To offer most financial products you’ll kneed to abide by Know Your Customer (KYC) and Anti Money Laundering (AML) rules. This will involve asking the user for personal and financial information and verifying it’s authenticity. These providers automate much of the work required to verify the information collected.

  • ID Verification — Is that picture of their passport or driver’s license they uploaded authentic and actually of them? Trulioo and Jumio will handle that check for both USA and international applicants.
  • Accuracy & Watchlist Scans — Is the address they provided really theirs? Is their legal status free of flags for money laundering or international watchlists? Blockscore handles those checks via its API.

Account Inspection

While onboarding the customer, you’ll often want to confirm and connect with financial accounts they own. Perhaps you’ll want to confirm balances or offer to ACH funds into their new accounts.

Checking

Want to offer a checking account? Skip searching for a banking partner to hold the funds and allow you to onboard customers. These APIs enable you to skip the partnership and plumbing legwork.

Credit Cards

Perhaps you’ve got a spin on the traditional credit card and think you can get into the flow of interchange fees. Maybe a card for teens or one to control your spending?Avoid the upfront fees and convincing card issuing partners and use one of these APIs instead.

Trading Equities

Now that you’ve got millions of people direct depositing their paychecks and spending using your credit card, let’s offer them some investment tools to put their money to work. Sure, they could open an E-Trade account, but wouldn’t it be easier to do this in the same account they already use for their personal finances? You could start the multi-month, multi hundred thousand dollar process to launch a Broker-Dealer, or leverage one these APIs to get started immediate.


These APIs are serving as the infrastructure anybody needs to get finance products to market quickly. The end result will be more products tailored to more market segments and hopefully better finance experiences and outcomes for all of us.

Automated Finance Apps Are Eating Deposits

Apps automating personal finance will improve financial health and relegate bank accounts to commodities offering highest yield and lowest fees.

Banks wage an ongoing war to hold your money. You’ve seen the tactics — higher interest rates and free credit reports are the modern free toaster to open a new account and setup direct deposit.

You get those free toasters because:

  1. Banks earn money by holding your money. 
  2. There’s inertia to deposited money. You’re too busy to move it around optimally, it generally stays where deposited. The bank that gets it first gets to keep making money from it.

In the perfect world, your money would flow from paychecks to where it’s needed at just the right moment. It would earn you the highest return in the right accounts for the right purpose, while ensuring your bills and payments are covered. 

A new generation of apps are changing money management by automating personal finance. These apps will become the primary way people manage their money, owning the customer relationship and ultimately their deposits.

Autonomous Finance apps that improves financial health and save time are the new battleground in finance.

Personal Finance Today

Today, your finances probably look something like this.

Your income flows into a main account and perhaps you move some for savings and bills elsewhere. If you’re like most people, you probably don’t do that, just operating out of that one account.

Banks battle to be that primary account. 

Maybe there are higher yielding accounts elsewhere? Maybe you should be moving set amounts every month for savings? Maybe you’ve exceeded the SIPC insurance limit and really should split money into separate accounts so you’re protected from a black swan? Maybe you’re forgetting to move funds some months and accruing overdraft fees? 

People are busy and distracted. So maybe they do none of these things even though it’s in their best interest.

How Autonomous Finance Apps Change Things

Tomorrow, Autonomous Finance apps will be the primary way you manage your money.

The application manages the movement of funds according to rules you set or that it figures out based on your behavior. 

  • Need $1,000 in your checking account on the 5th of the month? No problem, the app will make it happen and ensure you don’t get hit with an overdraft fee. 
  • Want to put aside $100 each month for a large purchase? Done.
  • A new savings account is introduced that offers higher yield? Easy, the app manages moving funds so you maximize earnings.

The key thing here is that your primary relationship is with the application. The accounts used become commodities that can be interchanged by you or the app itself. Accounts compete purely on their utility for the purpose they serve—interest rate, fees, etc…

Owning the customer will take more than getting them to open an account and setup direct deposit. The software eats the inertia of how accounts are used. Owning that software and providing the user the best experience is the new battleground. 

Who is best poised to create that software? Startups and FAANGs or the banks that most people like less than their dentist?

Autonomous Finance Apps Today

The universe of apps today is large and growing. Each approaching the problem uniquely for their target markets. Here’s a round up of just a few.

Ultimately, only one or two of these businesses are likely to emerge as large, standalone players. We’ll all benefit from how they will rewire the competitive landscape by having more options to manage our money more easily and efficiently.

How to Build a Bank in a Day

Fintech APIs are making it 10x faster and cheaper to bring finance products to market.

Emerging fintech APIs makes this possible….kind of. While you’re not able to actually start a bank in a day, you can get a consumer finance offering to market incredibly quickly now.

Fintech APIs are making finance composable, making it 10x faster and cheaper to get consumer finance products to market.

We’re at a tipping point in finance. Your bank that you know and probably don’t love will fade into the background and consumer brands will own the last mile to the customer. These APIs are powering the revolution.

Let’s say I want to offer a checking & savings account, credit/debit card and a premium service to automatically invest some of your money (like Acorns). I’ll wrap a quirky brand around it and focus my marketing on under or poorly served segment of the market (new grads, unbanked, etc…).

Quick look at what it would have taken to do this as recently as 5 years ago:

  1. Find a banking partner — They’ll hold the deposits and handle the banking compliance. There’s no list of who will do this, so start working the phones. You’ll also have to convince them your no-name startup is an acceptable compliance risk. This will take awhile.
  2. Find card partners — You’ll need a card processor, issuer and payment network partners. You get the picture, this will take awhile also and are individual relationships to be built and negotiated.
  3. Build Hairy Software — You’ll need to weave your modern software stack to use the legacy networks these partners work on. This will be painful.

It’s going to take awhile. Be patient and spend a ton of money, you’ll get there.

Now, let’s look at how you get there today.

  1. SynapseFi — Set up an account and you’ve got the tools you need for your checking and savings account as well as card issuance. Great, that was easy.
  2. Build Modern Software — You’re building on a modern software stack. You’ll be able to deliver and iterate quickly.

OK, this will take more than one day, but you get the point. Once you do get to market you can quickly grow the offering and serve your customers with new products. Want to offer stock trading? No problem, Alpaca has you covered.

Alexa, Can I Get a Loan?

Finance  is shifting from the banks of the gilded age to the design thinking and A/B testing of the apps on your phone and the web.

Soon you’re more likely to deposit paychecks, get loans and credit cards from Google than Chase.

Finance  is shifting from the banks of the gilded age to the design thinking and A/B testing of the apps on your phone and the web.

This  massive shift is being driven by changing customer expectations, the emergence of enabling technologies and the massive reach of consumer platforms.

TL;DR

  • API’s  are making financial products, like checking and lending, a UX and distribution problem, instead of a regulatory & compliance one.
  • High-engagement  consumer brands like Google or Amazon can leverage these API’s and  changing consumer sentiment to offer financial products directly,  cutting out middlemen.
  • To  maintain their positions, banks are in a race to build viral consumer experiences before the consumer tech giants can scale financial products. Guess who’ll win?

Finance, by FAANG

We’re already seeing the first entries with Google checking accounts and the Apple credit card.

It’s  easy to understand the attraction to financial services beyond the  scale of the market size. Financial products capture huge amounts of  consumer data. That data serves as the backbone of better products and  UX to tech companies highly adept at leveraging personal information for  profit.

So, why now? Emerging  Fintech API’s makes it easier to build products like checking and lending today. The API from a bank for deposits separates the regulatory burden (i.e. the historical barrier to entry) from the UX and customer acquisition.

APIs digitize the financial plumbing so that FAANGs can focus on what they are great at, habit forming consumer experiences.

The timing is also right. 71% of millennials would rather visit the dentist than their bank. At the same time, they  are increasingly trusting FAANGs with more and more of their needs.

Who Is In Control?

If  banks control the underlying APIs, then it may seem like they are still  in control. Which layer of the stack matters, and who’s making the  money?

Banks aren’t going away, they serve a valuable purpose and will continue to make money. For now.

The  last mile to the user will be served by FAANGs. Once they’ve aggregated the user demand, they will have power over the supply side (banks). Including the option of building their own banks to serve this demand.


Ben Thompson Aggregation Theory

While  banks aren’t going anywhere, they are facing a future where they are cutoff from the end consumer. Ask media publishers how that’s gone for them over the last 20 years!

Banks  are in a race to build high engagement consumer experiences before the FAANGs can deliver finance products to their massive and engaged userbases.

My money is on the tech giants.

Fintech 3.0

This  trend has huge implications for Fintech entrepreneurs. The biggest opportunities today are in the API’s that help brands deliver financial products quickly.

The  first wave of Fintech (Paypal, E-Loan…) brought traditional financial services online and created self-serve, lower cost options. It was  driven by a small set of users comfortable online and happy to find a  good deal.

The  second wave (SoFi, RobinHood…) paired alternative data sources with novel customer acquisition tactics to deliver services more efficiently.  Fees are compressing and the users were digital natives.

The third wave will see the emergence and growth of API-driven Fintech infrastructure (Alpaca, Mercury…).  They’ll be integrated by consumer brands to bring finance products  directly to users, removing middlemen. Fees will approach zero and the  consumer experience will feel more like Instagram than Chase. The users  are not only digital and mobile native, but have little to no loyalty to  existing financial brands.

For  example, Alpaca offers anybody an API enabling to offer users stock trading. They handle regulations and the product can focus on UX and  user acquisition.

Imagine  every Google Finance page connected to your Google bank and brokerage account. Google could offer one-click trading and deposits, at zero  fees, subsidized by revenue earned elsewhere. They could analyze the user’s finance data to offer other finance products (robo-advisor,  loans, credit cards…), but also mine the data to improve other areas of  their business.

They’d  have such a rich view of the user’s finance history, they could sell incredibly targeted (i.e. high cost) ad space to providers of those  products interested in reaching a very specific audience. They would  also be able to attribute a search ad display all the way to the  purchase of an item, even if purchased offline. That’s an incredibly  value feedback loop for ad buyers.


Hope you enjoyed the post, feel free to reach out with questions & comments. You can reach me on twitter!

Interview with Crypto Gurus

Interview discussing the future of digitized securities and what it means for investors.

Last  week I had the chance to have an in depth discussion with the folks at Crypto Gurus about Fetch, Security Tokens and Open Finance. We delve deep into the thesis that Security Tokens and Open Finance need each  other to grow and prosper.

You can view the view embedded below or directly on YouTube. Enjoy!