As SoFi and a Handful of Challenger Banks Grow Up, Traditional Lenders Should Be Nervous

There are challenger banks, and now perhaps there’s everyone else.

Over the last several years, there’s been a rise of digital-only firms with little more than a slick, user-friendly interface in front of a prepaid card.

The target was those for whom a traditional banking relationship wasn’t wanted, needed and/or too expensive to support.

Underpinning it all would be relationships with traditional financial institutions (FIs), in a “rented” fashion, where the outsourced bank, the brick and mortar kind, would hold deposits.

The end result was a mishmash of fragmented services that basically put a couple of basic banking functions into a single app.

But now, the rise of FinTech banks has embraced a new strategy: Where digital-only firms become FIs, complete with national scale — offering a broad range of services and products — by well, consuming (and absorbing) a bank and being granted a banking charter by the Office of the Comptroller of the Currency (OCC).

Doing that allows them to sidestep the need to start a bank from scratch yet offer the same services that the more traditional players do.

Buying a bank is a relatively quick way for FinTechs to obtain the national bank charter that lets them accept deposits and make loans. Eliminating the third party — that “rented” bank — also lets the FinTech control costs.

In the latest example, as reported last week, SoFi Technologies has completed its acquisition of Golden Pacific Bank. The bank has $150 million in assets. Post-acquisition, SoFi intends to offer automated savings and what it said would be “differentiated checking and savings accounts for easy budgeting.” SoFi had received prior approval to become a national bank from the OCC and the Federal Reserve.

Read also: SoFi Concludes $750M Purchase of Golden Pacific Bank

SoFi thus joins LendingClub, Block (formerly Square) and Varo as examples of digital upstarts that have sought banking charters and, in many cases, have folded banks into their operations.

Varo was the first of the consumer FinTechs to receive a national bank charter from the U.S. government, and in the past roughly year and a half since obtaining that charter, it has come to market with several offerings that let account holders gain early access to their paychecks, take on installment loans and open free checking and savings accounts.

LendingClub, of course, at the beginning of last year, closed its $185 million acquisition of Radius Bancorp, which in turn has given the company the runway to launch a full suite of banking services in branchless fashion. We contend here that the general goal is to have a platform in place with new offerings in a way that cements cross-pollination, where building up savings on one side of the consumer (and even business customer) equation can be used to pay down debt elsewhere.

Anuj Nayar, vice president and U.S. financial health officer at LendingClub, told PYMNTS’ Karen Webster in the wake of the Radius acquisition that LendingClub sees its more direct competition as the SoFis of the world, where personal finance is the focus. “But now,” with Radius in the operational mix, “we can add savings into the puzzle,” he told Webster.

Square, for its part, launched Square Financial Services last year — and here, with a nod to its small business clientele, lets the firm launch checking and savings accounts for those enterprises. Square’s goal is to become a primary point of financing for those firms.

Read Here: Square Circles Traditional Banking Services

The Real Challenger Banks

It may be time to recognize Square, LendingClub, SoFi and Varo as the firms that can truly wear the mantle of “challenger bank” as they have leveraged, and will leverage, banking infrastructure (bought, and in some cases built) to do much more than launch debit cards and basic accounts.

Platforms help, of course. National ambitions are much more easily realized when there’s standardization in the mix, when apps can help build brands without having to have the costs tied to physical branches thrown into the mix.

But in the battle against the traditional banks, the key battlefront is trust. As we noted last year in a Digital Banking report, we found that only 7 out of 100 consumers join up with digital-only banks. As many as 11% still interact with FIs mainly through physical locations.

It’s no surprise that younger consumers are interested in making the leap to digital channels: More than half of Gen X and millennial consumers would be interested in shifting to those models. But interest, we note, does not translate into swift action, and a wait-and-see approach may be settling in. As many as 47% of those not inclined to make the switch cited data security as a chief concern.

In the meantime, the digital banks will continue to fund operations from raising funds from institutional lenders and on interchange until critical mass sets in and they make enough on lending activities to help supplement innovation. The traditional FIs have an inherent advantage in terms of scale and trust — but it remains to be seen how long those advantages might last.

Focusing on Niche Audiences

None of this is to say that the challenger banks are entirely on a path to disintermediate traditional FIs. But by focusing on different segments — different niche audiences, in other words — these challengers move beyond the realm of being mere digital banks.

The key differentiator may be this: Many of the challenger banks can make a name for themselves with outcomes-based services and products.

In a world where more than 50% of consumers live paycheck to paycheck, and 40% of people who earn at least $100,000 annually live paycheck to paycheck, consumers are looking for firms that can help them move toward a state of financial wellness. Real time data and analytics — here, LendingClub is another example.

In a separate interview with Webster, CEO Scott Sanborn noted that consumers more adroitly match their cashflow (via paycheck inflows) and expenses. He said the cloud and the platform model allow LendingClub to unlock deep analytical capabilities and create engaging experiences. Sanborn pointed to billions of data points gleaned over 15 years to make the most efficient lending decisions.

In this way, the challenger banks — offering banking services, yes, but to well-defined audiences and cross-selling new products as needs arise — are leaving the days of prepaid cards gussied up by user interfaces well behind them.