August 2024 Fintech Newsletter: Learnings from Fintech DevCon 2024, the Pros and Cons of Becoming A Bank, and More

Learnings from Fintech DevCon 2024: Debating Open vs. Closed Source Models and Apple’s NFC Ecosystem

The a16z fintech team is still digesting what we learned at Fintech DevCon, payments platform Moov’s annual conference for the fintech developer community. This year’s con highlighted the industry’s growth over the past year, as hundreds of fintech developers descended on Austin, Texas, and listened to talks from Sardine CEO Soups Ranjan, Bain Capital Ventures Partner Matt Harris, Gusto’s GM of Embedded Payroll Yi Liu, and more. The conference surfaced issues new and old, including trade offs around LLM model choices, an increase in fraud risks driven by generative AI, and the growing persona of the developer as a buyer.

On the former, financial service firms, like other enterprises, are debating whether to use open source models (e.g., Meta’s Llama 3.1) or closed source models (e.g., OpenAI’s GPT 4o) when embedding generative AI within their products and services. Per an a16z growth team analysis, nearly 60% of AI leaders noted that they were either interested in increasing open source usage or switching to open source, when fine-tuned open source models begin to roughly match the performance of closed source models. We heard this anecdotally at DevCon too, and it isn’t surprising given the industry’s strong emphasis on privacy and compliance. 

At Fintech DevCon, we also saw rich discussions around new platforms and payment options in fintech, driven by the opening up of Apple’s NFC ecosystem for developers to build on, following regulatory pressure in the EU. Developers will now be able to offer NFC contactless transactions within their apps, a feature previously limited to Apple Pay. This could unlock a wide range of interesting use cases inside and outside the Apple Wallet, including car keys, ID badges, government IDs, and event ticketing.

Ramp reports quarterly spend

We’ve been reading Ramp’s 2024 Summer Spending Benchmarks, which highlight AI as the fastest-growing expense in Q2 for Ramp customers. The most striking detail from the report was the dramatic rise in accounts payable (AP) spending with AI vendors, which has roughly 3xed since the start of the year. This is significant because everyone from SMBs to mid-marketing companies tend to reserve AP for longer-term spending and annual subscriptions. Therefore, this shift likely reflects companies seeing AI tools to be business-critical spend, as experimental cost savings and revenue are converted to real value. Retention among AI tools tells a similar story: For businesses that started to transact with AI tools in 2023, 70% still spend with the same vendors after 12 months, vs. 42% for businesses that started spending in 2022.

Private credit market consolidation

Finally, we continue to see consolidation in the private credit markets as firms seek to deploy larger deals and expand their global presence in the $1.7 trillion market. Rising interest rates over the past two years have provided a tailwind for lenders, boosting earnings on floating-rate loans. Most recently, Janus Henderson Group Plc agreed to acquire Victory Park Capital Advisors, which manages $6 billion in assets, adding to Janus Henderson’s $36 billion securitized asset business. Meanwhile, Blue Owl Capital Inc. acquired Atalaya Capital Management, which oversees more than $10 billion in assets. And earlier this year, insurance giant Aflac (NYSE: AFL), entered the private credit market, buying a 40% stake in Tree Line Capital Partners, which has over $2.5 billion in assets.

James da Costa is a partner at Andreessen Horowitz, where he focuses on investing in B2B software and financial services.

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The Case For Becoming A Bank

Last month, Revolut won its UK banking license, adding to its European Central Bank license. Nubank, SoFi, Monzo, and several other of the largest, most successful challenger banks already have licenses. For challenger banks that want to truly challenge the large incumbents, there’s a strong case to become a licensed bank. It’s a part of “growing up.”

Most companies offering financial services start their journey building on top of sponsor banks and banking-as-a-service (BaaS) providers. This allows them to focus on building software and get a product in market quickly with low upfront costs, while outsourcing many related regulatory obligations to the sponsor bank or BaaS provider. 

For companies where financial services are not their primary business model, such as vertical SaaS or marketplaces, this setup can continue to work well as they scale. For example, Amazon, DoorDash, and Mindbody partner with Parafin to offer lending to the businesses on their platforms. 

But for companies where financial services are their core offering and lending will be an important part of their long-term strategy, becoming a bank can be transformational. The most impactful financial benefit of a bank charter is superior lending economics through accepting and lending out customer deposits. You also are more firmly in control of the regulatory process and your product roadmap and able to market yourself as a bank — benefits that will accrue across all your financial services products, not just lending. Pairing these benefits with a fintech company’s unique advantages of distribution, product, and/or brand, a bank charter can accelerate growth, improve profitability, and create a durable competitive advantage.

Sure, a bank charter isn’t without its drawbacks. Obtaining a bank charter means entering a different regulatory paradigm built for banks, not technology companies, and imposes restrictions on how you can run, fund, and grow the business. Not to mention it’s a time-consuming and expensive endeavor with no guarantee of success.

As the majority of neobanks have stayed clear of becoming a bank, we wanted to lay out the case for why doing so would make sense down the line. Subject to the evolving regulatory landscape, we would expect most large neobanks to become chartered banks in the coming decade.

The Case for Becoming a Bank

Better unit economics on lending 

Being a bank can improve a fintech company’s lending unit economics by reducing the cost of funding and fees paid to third parties. Banks have the advantage of a core deposit base, particularly when interest rates rise and credit standards tighten. They can choose to expand their lending capacity by increasing their deposit base or tapping into other low-cost funding sources only available to banks, such as brokered deposits or FHLB borrowings (subject to regulatory requirements). Sofi, for example, has impressively scaled its deposit base to ~$22 billion less than three years after receiving its national bank charter, helping them lower their cost of funding. Fintech companies who offer lending but don’t have a bank charter can’t use customer deposits, which are held with their sponsor bank, to make loans (although they do usually earn interest income on these deposits). Instead, they’re forced to fund their lending book with more expensive alternatives. 

More product control

Working with sponsor banks and BaaS providers brings additional product requirements, restrictions, and unique points of failure. As a bank, there are still potential points of failure for your product, but now you, not your vendors, control them. Some benefits include optimizing your tech stack, improving product defensibility, and improving customer service. 

Streamlined regulation  

Regulators that are brought along on a company’s journey will often look more favorably upon requests to approve new products and services. This is much easier to do as a chartered bank because the company with the charter directly owns the relationship with regulators.

Market yourself as a bank: signal stability and longevity to customers

It’s not lost on customers that banks are highly regulated and afforded special privileges by the government. Becoming a bank can help you stand out in a competitive market. State laws typically permit only companies with a bank charter to market themselves as a “bank” or as conducting the business of a bank. In a number of fun historical examples, companies have called themselves “banc” or “banq” to get around this restriction, including “Banc of America Securities.” 

The case against becoming a bank

We acknowledge most neobank founders already know the challenges of operating as a bank are significant, and there are good reasons most have avoided chartering.  

Bank charter applications have a high opportunity cost for fintechs — applying for a bank charter requires millions of dollars and significant involvement from leadership. If these costs can’t be easily absorbed by the fintech company, they’re likely too early to apply. Bank charter applicants are also often required to show a rigorous financial plan with a path to profitability, generally within three years. 

A bank charter also means stepping into a new regulatory paradigm that will significantly change how you operate your business. New investments and products often need to be approved. You also need to maintain within the bounds of capital requirements and fundraising limitations (often making it more difficult to raise venture capital!). To deal with all of this, you’ll likely need to hire seasoned executives to dedicate time to regulators, which takes time away from core business objectives. 

Fintechs are often worried that securing a bank charter will cause them to “trade like a bank” and hurt their valuation multiple. While we agree that banks are valued differently than fintech companies, worrying that obtaining a bank charter will hurt your business’s long-term equity value is misguided for a number of reasons. We’ll share more soon on this topic. 

When you grow up and want to be able to drive on your own, you get a drivers license. When you grow up and want to be able to have responsibility and ownership over your products, you get a banking license. It’s a decision that’s hard to walk back, but one that can completely change a company’s trajectory and serve as an important stepping stone as fintech companies take on legacy banks and redefine what it means to be a bank in the process.

Alex Immerman is a partner on the Growth team at Andreessen Horowitz, where he focuses on fintech, consumer, enterprise, and crypto/web3 companies.

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Justin Kahl is a partner on the Growth investing team, focused on fintech, crypto, and consumer technology companies.

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More from the a16z Fintech Team

a16z General Partner David Haber and Partner Marc Andrusko interviewed Tim Karpoff, the Global Head of Strategy at Citi, for the latest episode of a16z’s “In the Vault” podcast. The conversation covers the shifting landscape of banking policy and regulation, the increasingly important role startups are playing in partnership with big banks, and where Tim disagrees with the zeitgeist when it comes to the adoption of AI in financial services. 

Partner Seema Amble sat down with podcast host (and CEO of AI-powered accounting software Puzzle) Sasha Orloff for the latest episode of Turpentine Finance: Why a16z is All-In on AI for Finance Teams. The two discuss how AI can empower CFOs and finance teams to focus on strategic vs manual tasks, the impact of AI on valuations in service businesses, and how AI adoption in enterprise might follow the trajectory of other technologies. 

This Month in Fintech News

Nubank reached 105 million customers by 2Q24, more users over the past 12 months than the top five Brazilian banks combined. 

PayPal is making its quick guest-checkout solution, Fastlane, available to all U.S. merchants after testing it with select businesses for a few months.

JPMorgan launched an in-house chatbot as an AI-based research analyst powered by OpenAI for close to 50,000 employees

The CFPB proposed a new rule to classify earned wage access programs as consumer loans, requiring more detailed disclosures from lenders.

Recent M&A Deals and Market Intel

Payoneer announced its acquisition of Skuad, a Singapore-based global HR and payroll startup, for $61 million in cash (and up to $81 million inclusive of additional earnouts and RSUs) on August 7. The acquisition accelerates Payoneer’s strategy to deliver a comprehensive and integrated financial stack for SMBs that operate internationally.

Flywire is reportedly exploring a sale after attracting takeover interest. It is working with Qatalyst to evaluate interest from potential buyers, which include PE firms.

Pagaya announced its acquisition of Theorem on July 30. The combination brings Theorem’s consumer credit funds as well as its engineering and data science expertise under the Pagaya umbrella.

Lemon Squeezy announced its sale to Stripe on July 26. Lemon Squeezy has been processing payments on Stripe since its inception and will help Stripe build a global merchant of record solution. 

OneStream priced its IPO on July 23, raising $490 million by offering 24.5 million shares (26% secondary) at $20.00. It traded up 34% on its first day. OneStream offers enterprise software for financial management and reporting. 

Robinhood announced its acquisition of Pluto, an AI investment research platform, on July 1. The team will help accelerate Robinhoo’s product roadmap in advisory as well as help integrate AI-powered capabilities across the platform.

Bain Capital will acquire Envestnet for $4.5 billion, adding the financial software vendor to its portfolio.