Banks look to FinTechs to grow deposit base

July 2020 | SPOTLIGHT | BANKING & FINANCE

Financier Worldwide Magazine

July 2020 Issue

Banks pursuing growth broadly have two options: grow organically, by attracting more customers or widening the product and service range they provide to existing customers, or grow inorganically through mergers and acquisitions.

Organic growth through customer acquisition and deepening customer relationships is costly and time consuming, making this route less attractive for many banks. Increasing competition in the form of direct lenders, neo-banks, FinTechs and specialty finance providers has made it even more challenging for banks to acquire and retain customers across a full suite of banking products and services.

When unable to achieve desired organic growth in a risk-reward adjusted and cost-effective manner, banks often pursue growth through M&A. Historically, inorganic expansion strategies have involved the acquisition of smaller banks, competitor branch networks or performing customer loan portfolios, which offer a captive customer/depositor base. This strategy has been particularly effective to achieve scale through regional and domestic consolidation of specific borrower demographics across the US as well as Western, Central and Eastern Europe. To build a customer base in a specific geographic region, a bank can, for example, acquire branches that service customers locally or a portfolio of local customer and small or medium-sized enterprise (SME) loans. Similarly, a branch can pursue acquisition targets with customers from desired demographics to diversify its customer and deposit base.

Banks are increasingly interested in other methods of capturing customers and distribution channels to facilitate growth. A recent, notable trend is banks’ pursuit of FinTech companies, with deal volumes growing in recent years. FinTech companies with substantial bank account-based customer relationships are of particular interest to growth-oriented banks, as are FinTech companies with online offerings, platforms or products that may help banks to deepen their relationships with existing customers. FinTech targets typically feature different customer mixes than traditional bank and branch targets. For example, FinTech customer bases tend to be less geographically concentrated and include, in some cases, underbanked customer segments, such as gig economy workers and solopreneurs.

FinTechs with such attractive customer bases are often attractive acquisition targets for banks, and in some ways can be seen as the modern alternative to bank or branch acquisitions. FinTech acquisitions may offer another benefit (depending on the nature of the transaction and the assets involved): a bank’s acquisition of a non-bank FinTech, as opposed to another bank or a branch, may be subject to less cumbersome regulatory filing, notice and consent requirements. By mitigating the most onerous of these requirements, banks can speed up deal timelines and reduce transaction uncertainty. For these reasons, it is likely that FinTech acquisition strategies will become increasingly widespread throughout the banking sector.

Strategic considerations

When conducting due diligence on the customer base of a potential target FinTech, a bank should consider where the customer’s deposit accounts reside. Many FinTech business models – for example those of neo or challenger banks – involve a partnership between a FinTech and a depository institution. In these partnership models, it is common for the FinTech to market the product offering and acquire customer relationships. The FinTech’s customers sign up as users of the FinTech’s platform or other services, but if a bank account is involved – as is common in debit card, personal financial management and related FinTech businesses – customers will often become direct customers of the partner bank as well. In such circumstances, the underlying customer bank account agreement would likely be between the partner bank and the customer.

If the acquiring bank is interested in acquiring the underlying bank accounts – which is increasingly common as a growth strategy – regulatory considerations come into play. In the US, the federal Bank Merger Act requires a regulatory filing prior to completion of a transaction for which an insured depository institution directly or indirectly acquires the assets of, or assumes liability to pay, any deposits made in any other insured depository institution. To avoid the complex and time-consuming application process required under the Bank Merger Act, deal structures in which the original customer account is closed, and a corresponding new account opened at the acquiring bank – the so called ‘new establishment’ route – may be preferred. There may be other filings, depending on the facts and circumstances involved, related to the FinTech itself (e.g., if the FinTech is a licenced financial services company, such as a lender or money transmitter) and from the perspective of the bank or its holding company.

The feasibility of such a deal structure will often be dictated by a second key consideration: what commercial agreements are in place between the FinTech target and its existing partners, particularly its bank partners? Commercial partnerships agreements commonly include termination and transfer assistance provisions that grant the FinTech the right to terminate the partnership and obligate the partner bank to cooperate in the transition of customer accounts to a new partner bank. However, such provisions can be subject to differing conditions. For instance, partnership termination rights are frequently coupled with termination fees. Depending on their relative magnitude, termination fees may affect the underlying economics of a proposed acquisition. Termination and transition provisions (and associated termination fees) may also have timing restrictions that necessitate a longer transaction timeline than desired by the acquiring bank.

A third key consideration is user agreements – which entities are party to agreements with those of the FinTech’s customers in which the acquiring bank is interested, and what notice or consent rights are granted to customers? In a scenario where a FinTech refers customers to a partner bank to create bank accounts, the account agreements will likely be directly between the partner bank and the customers. Although the commercial agreement between the FinTech and the partner bank may allow the FinTech to terminate the relationship and cause the bank accounts to be moved to a new bank, any such account migration would be subject to the rights of customers under the account agreements. Even absent express contractual obligations, deposit accounts involve liabilities owed by the banks to their depositors, and it is generally not permissible to change the obligor for such a liability without the consent of the creditor (i.e., the depositors).

A fourth, and related, key consideration is what communications will be made to the FinTech’s customers in connection with the acquisition. Often, an acquisition can be structured so that neither the acquiring bank nor the FinTech target would be affirmatively required by US consumer financial law to provide any specific notice or seek any specific consent from customers. However, US federal and state regulators have the authority to bring enforcement actions for unfair, deceptive, and in some cases, abusive, acts and practices.

As a matter of best practice and to mitigate regulatory risk, a FinTech (and the bank acquiring its liabilities) would be best served to ensure that the appropriate party provides reasonable prior notice and disclosures to customers, particularly regarding any transfers of bank or other customer accounts. The US Consumer Financial Protection Bureau, for example, advises the industry to practice best principles of transparency and informed consent vis-à-vis consumers.

Pratin Vallabhaneni and Hyder Jumabhoy are partners and John Wagner is an associate, at White & Case LLP. Mr Vallabhaneni can be contacted on +1 (202) 626 3596 or by email: pratin.vallabhaneni@whitecase.com. Mr Jumabhoy can be contacted on +44 (0)20 7532 2268 or by email: hyder.jumabhoy@whitecase.com. Mr Wagner can be contacted on +1 (212) 819 7609 or by email: john.wagner@whitecase.com.

Pratin Vallabhaneni, Hyder Jumabhoy and John Wagner

White & Case LLP