In 2021, Square, Inc. (“Square”) announced that it had commenced banking operations under its independent industrial banking subsidiary, Square Financial Services (“Square Financial”). The announcement comes after Square successfully completed the charter approval process with the Federal Deposit Insurance Corporation (“FDIC”) and the Utah Department of Financial Institutions for an Industrial Bank/Industrial Loan Corporation license ( “ILC”). Square Financial will offer business loan and deposit products, beginning with underwriting and issuing business loans for existing Square sellers who use its card reader and other point-of-sale services.

As a financial technology (“Fintech”) organization, Square’s expansion into the traditional banking space may seem contrary to the start-up nature of Fintech companies. In fact, to date, the most common business arrangement for Fintechs is to partner with more traditional financial institutions (“FIs”). This setup gives FIs access to Fintech innovations and in return provides Fintechs with an established customer base and network. Nevertheless, the highly efficient and advanced characteristics of Fintechs make them natural competitors to FIs, which are generally much larger and less nimble.

In addition to Square, fintechs Grasshopper and Varo Money have also been approved for bank charters (in May 2019 and July 2020, respectively). With the many advantages fintechs have when competing with traditional FIs, it is predictable that more fintechs will expand into the traditional banking space and build their own customer bases. Four of these advantages are detailed here and show why Fintechs are a natural choice for banking operations and excellent in the financial technology and innovation sector.

Fintech Advantage #1: Low Cost Products

Fintechs are able to offer customers lower cost products (compared to those offered by FIs) by maintaining online-only platforms and avoiding physical branches and offices. Many FIs are starting to provide online resources and applications, but their overhead and operational costs are still far above what is required in a Fintech, and these costs are passed on to the consumer. Additionally, Fintech apps like Venmo or CashApp eliminate the FI middleman and eliminate interest rates and transaction fees when borrowing money or making payments to friends and family. This allows Fintechs to provide the same or similar products to customers at a lower cost.

Fintech Advantage #2: Increased accessibility and inclusion

By erecting a relatively low barrier to entry, Fintechs create a more inclusive and accessible banking system. For example, Fintechs more easily reach regions of the world where participation in the banking system is low (such as sub-Saharan Africa) and offer alternative avenues to lending (including crowdsourcing) that provide opportunities for entrepreneurs or entrepreneurs. other people with low credit ratings who struggle to get approved by traditional FIs.

More importantly, Fintechs offer accessibility solutions for people with physical disabilities. These people have always struggled to access traditional services from large FIs because in-person visits to physical branches are impractical or impractical. Using the services of a Fintech does not require you to be physically present at an ATM or branch to deposit checks or transfer money. Some fintechs also offer touchscreen functionality that allows people with visual or reading disabilities to hear a verbal description of the button they are about to click. These technological advances used by Fintechs create a banking system that is more accessible to a larger portion of the population than what is traditionally employed by large FIs.

Fintech Advantage #3: Innovation

In a world where people are becoming increasingly tech-savvy, Fintechs have leveraged consumers’ technological intelligence to deliver an array of innovative techniques that make banking and financial activities more attractive. Due to their start-up culture mentality, Fintechs have innovated around the use of artificial intelligence, blockchain, and biometric applications, among other emerging technologies, to improve banking services. Many – if not most – FIs have not been nimble enough to move easily to these types of innovations.

Innovative approaches to banking processes and products are not new; At one time, ATMs and credit card chips were considered state-of-the-art for FIs. Fintechs are pushing the boundaries of innovation much faster and at scale, and the ability to modernize and transform the way global banks are not to be taken lightly. Even the United States Securities and Exchange Commission (“SEC”) has recognized the importance of fintech innovation by establishing a dedicated fintech innovation center (called “FinHUB”) at the SEC to meet the needs of the agency — according to the SEC’s Hester Peirce at an Institute of International Bankers Conference on March 1 — “patchy response to fintech innovation.” A regulatory recognition that Fintech innovation is so essential and paramount to their very existence that regulations relating to it will require “…a deep appreciation of growth and ingenuity in the digital asset space” is significant. It also speaks to the unique position Fintechs hold in the market and speaks to their status as a viable player in the financial industry.

Fintech Advantage #4: Combine agility and traditional banking charter

Acquiring a bank charter provides Fintechs with the unique ability to maintain their agile business models while independently competing on the same playing field as FIs (instead of partnering with them). A bank charter can also give clients the same institutional confidence they have in FIs and alleviate concerns for those who are unwilling to fully embrace emerging technologies like cryptocurrency.

The banking charter process is rigorous and challenging – Square’s charter was granted in March 2019 after a 3-year process and its bank did not begin operations until March 2021. Fintechs who stay the course and get a charter find themselves with a unique combination of state-of-the-art technologies and traditional banking in good faith. This is perhaps the biggest advantage of a fintech banking charter; it offers customers an alternative to the traditional banking structure and access to the low-cost, accessibility and innovation products described above.

Expect the trend to continue

Fintechs are well placed to compete with FIs and it is only natural that more of them are creating their own banking operations instead of just partnering with FIs. Brex, a San Francisco-based fintech best known for offering banking services to start-up companies, filed on February 17, 2021 with the FDIC for an ILC charter. Since its inception in 2017, Brex has relied on partnerships with FIs, but has now determined that a banking license would make it easier to deliver its products to customers. Given their unique structural advantages, we shouldn’t be surprised to see more of these bank charter enforcement announcements from fintechs in the future.