Coasian Finance Revisited

The Rise and Fall of Banking-as-a-Service

As most readers know, I’m based in the UK which means my banking relationships are predominantly with British institutions. For domestic transactions, they serve me well. Selling my car, for example, was a joy thanks to Faster Payments which, at zero cost, eliminated any counterparty risk I might otherwise have faced. Doing business abroad, though, is not so frictionless. Whether it’s paying for drinks in a Parisian bar or taking US Dollar-denominated subscriptions for this newsletter, unless I want to give up fat fees, traditional financial institutions are loath to help. 

Fortunately, a range of financial technology firms have emerged to fill the gap. We’ve talked before about Revolut: I now no longer head to Heathrow without my Revolut-branded debit card. We’ve talked, too, about Wise, formerly Transferwise. The subscriptions that unlock the best parts of this newsletter (thank you, paying subscribers!) get routed to Net Interest Towers via first Stripe and then Wise. It’s not efficient, but it saves $$.

Yet neither Revolut nor Wise operate as banks (yet). To process transactions in US Dollars, they partner with local lenders. In common with other consumer-facing fintechs, they maintain the app, offer analytics, provide customer support – but connectivity to the US Dollar financial system comes via a partner bank.

In Wise’s case, the partner used to be Arkansas-based Evolve Bank and Trust; in October, it switched to Community Federal Savings Bank (CFSB). As a Wise customer, I now have an account at CFSB’s branch in Woodhaven, Queens, which is where my Stripe funds get swept. I’ve very possibly driven past it on my way from JFK to Manhattan, but otherwise it’s not a place I’ve visited, nor is it a bank I’d heard of (although, confusingly, I used to work at a bank called CSFB). Soon, though, I’ll be the lucky holder of two accounts at CFSB because Revolut is in the process of migrating there as well, from its former partner, Metropolitan Commercial Bank.

Community Federal Savings Bank isn’t an old bank. It was founded in 2001 and taken over by its current owners ten years later. Seeing value in their bank license and spotting an opportunity for growth, they courted fintech companies and currently have a partnership roster of around 17. Since 2020, assets have doubled, to $857 million, and revenues have tripled on a headcount of 154. The bank’s common equity tier one capital ratio is high, at 24%, so even with two accounts there I can feel safe.¹

Yet as CFSB expands its fintech business, others have been retrenching. Regulators started looking more closely at partnership agreements back in 2022 and have fired off a number of enforcement orders. Last year, Revolut’s former partner, Metropolitan Commercial Bank (MCB), was fined for not properly overseeing its relationship with payments company MovoCash, whose customers began opening fraudulent accounts at a rate of 60,000-80,000 a week during the pandemic. The bank was held responsible for failing to maintain compliant anti-money laundering provisions, and soon exited the business altogether.

“The decision to terminate these financial service partnerships will reduce the Company’s exposure to the heightened, and evolving, regulatory standards related to these activities,” it announced in March.

Other risks are also coming to light. While CFSB contracts directly with fintech partners, some banks use specialist technology companies as intermediaries. These intermediaries provide a technology layer that allows fintechs to plug into bank balance sheets. But they are not always as efficient as promised. One of them – Synapse Financial Technologies – recently entered bankruptcy and a court is currently convened to untangle the mess that has left end-customers at fintechs such as Yotta not being able to access their funds at bank partner Evolve Bank and Trust. “This is a potential disaster,” said the judge overseeing the case. 

Perhaps there’s a reason why banking, uniquely across industries, remains so firmly vertically integrated. To see what’s going on, read on.