“How many times did I say this on my blog? A lot! Financial services entrepreneurs (even very smart, well-capitalized ones) can’t compete with federally-guaranteed deposits, federally-guaranteed mortgages, and federal student loans…
…as prices (rates) are distorted by the government below the level that properly compensates for the risk. The private sector can’t compete against these below market (for many) rates and terms. (And I am not even discussing here, how federal deposit insurance distorts free-market banking and the Federal Reserve distorts just about every financial decision and almost the entire economy.) These well-intended government distortions are hindering free market competition and innovation in financial services and free choice and economics tells us that ultimately consumers and institutions will pay for these government distortions in higher regulatory costs (passed through by banks) and higher profit margins for the larger, mostly Too Big to Fail Banks.”, Mike Perry, former Chairman and CEO, IndyMac Bank
Banks and Fintech Firms’ Relationship Status: It’s Complicated
Disrupters and big lenders, often seen as rivals, are finding some success in playing together
Lenda CEO Jason van den Brand, left, and staff in an astro-carpeted communal meeting area in their office building in San Francisco. PHOTO: BRIAN L. FRANK FOR THE WALL STREET JOURNAL
By Daniel Huang
Joshua Reich co-founded mobile-banking app Simple six years ago with an indirect shot at the nation’s largest lenders: “By not sucking,” he wrote after starting the firm, “we will win.”
That was before he decided to sell his startup to the U.S. unit of Spanish megabank Banco Bilbao Vizcaya Argentaria SA. Now, the West Coast entrepreneur is singing a different tune.
“We had a little bit of bravado back then,” Mr. Reich said in an interview. “But there’s a reality that to be in financial services, you have to work with banks.”
Financial technology—or “fintech”—upstarts have drawn billions of dollars in investments on the premise that they will shake up finance the way Uber or Airbnb have shaken up the taxi and hotel industries. But despite a variety of setbacks ailing big lenders—from billion-dollar mortgage fines to low, profit-sapping interest rates—banking has proved a tougher business to crack.
How the upstarts adjust to the realities of the financial sector will have a significant impact on the success of venture capitalists and other investors who have poured $64 billion into fintech investments since 2010, according to industry tracker Dow Jones VentureSource.
Banks not only compete with the upstarts for customers but also provide some of the key infrastructure they need to grow. The lenders can provide financial startups with capital as well as legions of depositors and expertise in dealing with regulators. Simple, for instance, has more than doubled the number of customer accounts since its acquisition by BBVA Compass, a subsidiary of BBVA, last year and is increasing users at 10% each month. Banks, meanwhile, are hoping for greater access to younger customers.
Those perceived benefits have driven an increase in cross investments between longstanding banks and the new fintech cohort. As of September, the six largest U.S. banks or their clients had participated in 25 fintech investment deals this year, including Prosper Marketplace Inc. and Circle Internet Financial Inc, compared with 26 in the first nine months of 2014 and 14 for the same period in 2013, according to Dow Jones VentureSource.
“The classic narrative is the Silicon Valley firebrand who’s taking on the system,” said Matt Harris, managing director of Bain Capital Ventures, an early Simple investor. In financial services, though, “that’s just not going to be a winning narrative.”
The shift has picked up just in time for fintech’s first major shakeout. Two of the biggest publicly traded fintech stocks, LendingClub Corp. and On Deck Capital, have fallen 49% and 56% this year respectively. Uncertain market conditions led nonbank mortgage lender loanDepot Inc. to postpone its initial public offering this month, while payments startup Square Inc. proposed an IPO price that valued the company about 30% below an earlier funding round.
“Time humbles you,” said Ben Milne, co-founder of Dwolla, a digital payments platform that also linked with BBVA this year to offer real-time money transfers. Working with banks, he says, is the difference between running a sustainable business and “just another venture-funded experiment.”
Brett King, CEO of mobile-banking app Moven, wrote in 2010 that “the death of retail banking is here.” Now, Mr. King counts meetings with potential bank partners among his biggest priorities. Last year, Moven was tapped by Toronto-Dominion Bank in Canada and the New Zealand unit of Australia’s Westpac Banking Corp. to provide mobile capabilities for their customers.
“If I have my disrupter’s hat on all the time, they will just see me as the enemy,” Mr. King says of his more traditional rivals.
Even staunchly antibank firms need to play ball with banks. Lenda, an online mortgage lending platform launched in San Francisco three years ago, doesn’t deal directly with banks, but its loans often pass through a bank before reaching investors.
“If I get my way, we take over the entire mortgage business from them and do it the right way,“ says CEO Jason van den Brand. But for now, ”we have to play in the sandbox until the day we get big enough and are able to bypass the banks completely.”
At Bank of America Corp.’s annual Technology Innovation summit each fall, around 16% of the more than 230 startups that have attended went on to sell their services to the bank.
“It’s too simple to say all these banks are stupid,” says Qasar Younis, a partner at the Silicon Valley seed fund Y Combinator.
Some fintech firms, though, remain skeptical of bank overtures. Lenda has turned down banks’ offers to invest in the company, instead picking backers that include venture firms Winklevoss Capital and 500 Startups. Many of the firm’s 12-person staff had their own bad experiences working with banks before the crisis. Other fintech executives are concerned that banks will join with startups long enough to steal their ideas and then eventually stifle their business prospects.
The complex relationship was underscored recently when J.P. Morgan and other large banks temporarily cut off the flow of information to some popular websites and mobile applications that aggregate consumer financial data. The banks cited the need to manage heavy server traffic and the security on their websites. The financial aggregators have maintained their sites are secure.
Mr. van den Brand, shown in Lenda’s office in San Francisco, has said he’d like to take over the entire mortgage business from banks. PHOTO: BRIAN L. FRANK FOR THE WALL STRE FOR THE WALL STREET JOURNAL
Still, banks can no longer ignore fintech companies. Citigroup this summer brought Chief Executive Michael Corbat and other executives to meet San Francisco-area fintech executives at an exclusive club in the city’s financial district. “We recognize the need to be strongly connected with what’s happening outside,” said Deborah Hopkins, CEO of Citi Ventures, Citigroup’s venture-capital arm.
“There were no events five years ago that banks were inviting [fintech firms] to,” Dwolla’s Mr. Milne says. “Now, the banks are paying for lunch.”
Last year, BBVA paid $117 million for Simple and has so far granted the tech firm near-complete autonomy, from separate human-resources staffers to branded company T-shirts. Mr. Reich has also kept his CEO title, reporting directly to the Simple’s board, which includes BBVA executives.
“We want to keep away the antibodies that could crush a startup,” says Jay Reinemann, executive director of BBVA Ventures Group.
Simple turns away more than 70% of requests by global BBVA executives to visit, says Enrique Gonzalez, BBVA’s liaison between the two firms. “The main criteria is to let in those who can really add value to the relationship,” he said.
When a team of BBVA bankers and lawyers recently stopped by Simple’s headquarters in Portland, Ore., they got to know their colleagues by playing arcade games in the office common room and sampling craft beers at the Oregon Brewers Festival.
“We’re a little younger and nerdier,” said Simple spokeswoman Krista Berlincourt. “But I like to think of us as one fantastic extended family.”
—Peter Rudegeair contributed to this article.