Bank, Credit Union, or Fintech?
Happy Friday, Fintech Takers!
I trust your week has been excellent and that you are planning a restorative weekend!
I’ll be in Washington, D.C. for a couple of days late next week, and I have a bit of free time on my schedule. If you’d like to meet up in person, drop me a line!
- Alex
Bank, Credit Union, or Fintech?Copy anchor linkCopied
When someone like Chamath tweets something like this:
Everyone with a brain in their head gets mad because it’s not true. MrBeast didn’t buy a bank. Step isn’t a bank. It’s a neobank that partners with the most incompetent sponsor bank in the history of BaaS.
Legally, it is not a bank. Not everything that looks like a bank is a bank.
And, conversely, sometimes things that don’t look like banks are, in fact, banks.
Toyota is a bank. Ford and GM are becoming banks (again). Honda doesn’t own a bank, but it did help to set up a credit union (Honda Federal Credit Union) for its associates and their families.
Understanding these legal distinctions is important. Honda doesn’t own Honda Federal Credit Union because credit unions are nonprofits owned by their members. Ford and GM are becoming banks, but they are not becoming bank holding companies because the type of bank charter they have acquired (an industrial loan company charter) does not qualify them as a "bank" under the Bank Holding Company Act.
(If you’re curious to learn more about ILCs and why it is absolutely outrageous that GM has been approved for an ILC charter a second time, read Kiah Haslett here and here.)
This stuff is important.
But it’s not the only way to think about it. In fact, sometimes it’s not the most useful way to think about it.
When How You Behave Doesn’t Match Who You AreCopy anchor linkCopied
I think of my job here at Fintech Takes as just wandering through the financial services ecosystem, looking for things that don’t make sense, and then studying them until I understand them.
Today’s essay is about a category of confusing things that I have discovered over the last 5 years, which I would describe as “companies that don’t behave the way that they’re supposed to.”
What do I mean when I say “supposed to”?
Well, that brings us back to the distinctions that I mentioned above, between banks, credit unions, and fintech companies. We tend to assume that the legal definitions of those three types of financial services companies correspond to a set of specific attributes:
- Customer Scope: Do you serve a broad, diversified population? Or a narrow, defined segment?
- Profit Orientation: Are you trying to grow quickly and maximize shareholder value? Or is profit merely a means to serve customers?
- Vertical Integration: Do you own the full stack (including a charter and balance sheet)? Or are you modular, building on top of others?
Traditionally, those attributes have been bundled together in specific ways for each category of financial services company:
- Banks serve broad customer bases, maximize profit, and are vertically integrated.
- Credit unions serve defined groups, don’t care about profit, and are vertically integrated.
- Fintech companies focus on narrow customer segments, aggressively pursue growth and profitability, and are modular rather than vertically integrated.
You can picture it as a Venn diagram:
I think this is an important lens to look at financial services companies through because it’s less reliant on legal definitions and more attuned to differences in business strategy.
Sometimes those two things are the same. For instance, when SoFi moved from being a fintech company to a bank, it made a clean and easy-to-understand transition, legally and strategically, from a modular provider of student loan refi for students at top universities to a vertically-integrated digital bank offering a broad portfolio of products to a large cross-section of U.S. consumers.
However, at other times, they are not the same. Sometimes, a financial services company will change strategies without changing its legal designation. And sometimes a financial services company is just born into the wrong circle, right from the start.
I’ll give you three examples.
The Bank That Was Actually a Fintech Copy anchor linkCopied
After Silicon Valley Bank failed, I spent some time studying its history and how it had grown to become the 16th largest bank in the U.S.:
In very simple terms, SVB’s playbook over the last 40 years can be boiled down to:
- Build relationships with the customers you want to serve and work to understand their unique financial needs.
- Leverage your unique understanding of those customers to build tailored products for them and make you comfortable taking risks to serve them that others would be uncomfortable with.
- Reinvest your profits in strengthening your relationships with your customers.
The key to this strategy is focus. You make a big bet on your ability to serve a specific customer segment better than anyone. And when that bet pays off, you double down on it. And then you double down on it again. And again.
In the context of this strategy, diversification is rightly viewed as a distraction. If you look at the 40-year history of SVB, you will find very few attempts at diversification.
As I observed in that essay, what I just described doesn’t really sound like a bank. It sounds like a fintech company cosplaying as a bank.
And that mattered because the strategic focus that made SVB so popular among its tech startup customers also created the conditions that led to its failure. Here’s me again:
The actual cause of SVB’s failure was an asset-liability mismatch that became untenable due to faster-than-anticipated deposit outflows.
The proximate cause of SVB’s failure, I would argue, was specialization.
Everything that made SVB successful came back to its obsessive focus on the tech startup ecosystem. Its goal was to be, by far, the most convenient and enjoyable place for a founder to bank. If you kept your deposits there, you could get free international wires, non-dilutive venture debt financing, and even personal loans based on your equity (and your VC investors’ commitment to that equity). As a result, tech startups loved banking with SVB, and SVB acquired and retained a dominant share of the tech startup banking market.
Because SVB wasn’t in the business of saying no to startups, it took in a massive amount of deposits (liabilities) between 2019 and 2021 as funding in tech startups swelled due to low interest rates. And because startups don’t have the same need for traditional lending products that your average SMB does, SVB had limited options for deploying those deposits to generate a return, which led to it reaching for too much yield on long-term, fixed-rate securities.
Put simply, SVB acted like a fintech (aggressively pursuing growth and profit by serving a specific customer segment better than anyone else), but because it was a vertically-integrated, charter-holding bank, there was no diversified balance sheet sitting underneath it, acting as a firewall (the way that a well-run BaaS sponsor bank can for its fintech partners).
The Credit Union That Is Actually a Bank Copy anchor linkCopied
Golden 1 Credit Union was founded in 1933 to serve California state employees.
However, over the years, Golden 1 has changed significantly.
In 2015, it struck a deal with the Sacramento Kings to be the named sponsor of the Kings’ home arena (The Golden 1 Center) for $120 million over 20 years. The average annual value of the deal ($6 million) is one of the largest naming rights deals for a single-tenant NBA arena, and the first time a credit union has put its name on a major sports facility.
In 2018, Golden 1 became the first state-chartered credit union in California to be granted a statewide field of membership, allowing it to serve all Californians (the company claims to have approximately 1.1 million members today).
And in 2023, the state of California published, for the first time, a report on the amount of revenue generated by California credit unions from overdraft and NSF fees, and guess what? The report found that, in 2022, Golden 1 generated a whopping $28 million from such fees, or roughly 23% of the credit union’s net profit that year. For comparison’s sake, that ratio at Wells Fargo (a bank that has rightly received tremendous criticism for its fees) was approximately 10% in 2022.
Serving a broad, diversified customer base? Advertising through lucrative professional sports sponsorship deals? Generating an outrageous amount of money from a product that is, more often than not, harmful for customers?
I’ll quote from Aaron Kline at the Brookings Institution (who has done great work on this issue):
Do these business practices sound like those of nonprofits designed to provide basic banking services to people who share what the law calls a “common bond,” such as a workplace or other connection required for membership? Or are they what we would expect from for-profit banks?
The Bank That Is Actually a Credit Union Copy anchor linkCopied
And now we get to the most interesting example.
Erebor is a newly chartered national bank. The first de novo national bank to be approved by the OCC under the second Trump administration. Its stated mission is to serve the "innovation economy," specifically targeting B2B services for AI, defense, manufacturing, and crypto industries. The bank has raised an eye-popping $600 million (across two rounds) and is currently valued at $4.35 billion.
And yet, despite that lofty valuation, Palmer Luckey — founder of Oculus VR, Anduril, and, most recently, Erebor — evinces no interest in making money with this new bank. Here’s a quote:
I’m a VR guy. I love VR for the sake of VR. … That is not how I am with finance. I don’t love finance for the sake of finance. I’m not a finance bro. I want something like Erebor to exist because of my love for all these other technologies. … So it’s a little weird. [Erebor is] one of the few finance companies started by somebody who wants it to be in service of all the other true interests they have.
Indeed, Luckey seems like he would be perfectly happy if Erebor never took any risks (he has playfully poked at SVB’s failure by saying that Erebor will implement cutting-edge risk management concepts like accepting that “the market sometimes goes down") and basically just sat on customer deposits (he has said that the bank will have “the most conservative loan-to-deposit ratios of any bank in history”).
As I wrote a few weeks ago, this is not how banks work. Banks take risks to generate yield. They hedge those risks by acquiring a diverse mix of customers and assets. They evince at least some interest in growth and profitability and returning value to shareholders.
Erebor (at least so far) does none of those things. If Luckey is to be believed, it may never do those things. Instead, it may just choose to operate conservatively (and sub-optimally from a profitability perspective) and focus on supporting the narrow segment of customers that Luckey cares about.
As Kiah pointed out in our latest Bank Nerd Corner Squared podcast, we have a name for financial services companies like this.
Credit unions!
The Labels We Choose to UseCopy anchor linkCopied
Does any of this matter?
Does it matter that the fintech-like focus and customer obsession that made SVB so successful ended up contributing to its failure? Does it matter that credit unions are increasingly acting like (and occasionally acquiring) banks? Does it matter if Erebor voluntarily acts less like a fractional reserve bank and more like a credit union?
I think it does.
The labels we choose to give to different types of financial services companies reflect not only their legal status, but also our collective assumptions about how they will behave. And those assumptions guide our decisions about how to regulate those companies and how to shape the competitive dynamics between them.
In today’s rapidly changing environment — in which charters are easy to acquire, and the motivations for founding banks, credit unions, and fintech companies are more diverse than ever — these labels are becoming less and less useful.
MORE QUESTIONS TO PONDER TOGETHER
Big news for the endlessly curious (yes, you): I’m collecting your fintech questions on a rolling basis.
What’s keeping you up at night? What great mysteries in financial services beg to be unraveled? Think of it this way, if a stranger is a friend you just haven't met yet, your question is a Fintech Takes conversation waiting to happen.
One that could headline a Friday newsletter or be answered in an upcoming Fintech Office Hours event.
Drop your question here, whenever inspiration strikes!
Thanks for the read! Let me know what you thought by replying back to this email.
— Alex
Join 2,444 other finance and fintech leaders in the Fintech Takes Network
The conversation doesn't have to stop here
Keep learning and connecting in the Fintech Takes Network
EVENTS | FEED | LIBRARY | DIRECTORY
