The payments company Square (SQ -4.53%) is looking to disrupt more than just the payments space. On Thursday, it submitted an application with bank regulators to obtain a charter for an industrial loan company, which is essentially a bank that's owned by a nonbank company.
The move raises a host of questions for banks, which have long been insulated from outside competition by the chartering process. Assuming Square's charter is granted, the move seems to portend an acceleration in the pace of disruption that the financial services industry is already experiencing.
To get a better sense of the role that charters play in the minds of fintech leaders, I spoke with Colin Walsh, co-founder and CEO of Varo Money, a mobile banking company that applied for a bank charter in July. What follows are portions of our conversation, edited for organization and flow.
Colin Walsh, co-founder and CEO of Varo Money. Image source: Varo Money.
The Motley Fool: What's the benefit to a fintech company of obtaining a charter, be it for a traditional bank or an industrial loan company?
Colin Walsh: We've applied for a full national bank charter. We've gone right to the federal regulators, the Office of the Comptroller of the Currency, and said we want to be the first in the United States to get a charter for a bank that's designed for people who bank on their smartphones.
We currently have a partner bank that we work with to collect deposits. And on the lending side, we're a nonbank state-licensed lender, so we go state by state to get our licenses. We then wire everything together on the front end for the customers. It's not the most efficient model.
Becoming a national bank will allow us to offer products on a nationwide basis. We'll also be able to introduce a broader array of products. That will enable us to go beyond the core direct deposit account and basic savings account, to offering a range of savings products, including CDs and IRAs, as well as a broader range of lending products, including credit cards and home equity loans.
TMF: Why did Varo Money apply for a traditional bank charter, not an industrial loan company charter like Square?
Walsh: Our principal business is banking. We see ourselves as a bank. We see ourselves as helping to create what banking will look like in the future. For Square and SoFi, they have other business interests, but they want to be in banking as well. So an industrial loan company charter makes more sense for them, because it allows for nonbank companies to own a bank.
Also, getting a bank charter is less controversial than getting a charter for an industrial loan company. When Wal-Mart (WMT -0.35%) tried to open an industrial loan company in 2005, 2006, and 2007, for instance, it met a lot of resistance. It's not a bank, and its application was opposed by community groups and community banks. More recently, SoFi has stirred that pot up when it applied for an industrial loan company charter earlier this year.
An iPhone displaying Varo Money's user interface. Image source: Varo Money.
Square and SoFi are going to meet some of the same resistance Wal-Mart did. That being said, I think it's a great thing for both Square and SoFi because collectively this is about the future of what banking is going to be, which is companies using technology to deliver lower cost solutions to consumers or small businesses in a way that helps their end customers better solve financial problems.
So for us, applying for a traditional bank charter was a simple decision. Because we want to be a bank, we can avoid this resistance by just going right into it; that's our core business.
TMF: How will the granting of charters to fintech companies change the bank industry?
Walsh: It helps level the playing field in terms of access to secure capital, which has been problematic for fintech companies in the past. The real innovation and disruption will then come when companies entering the space combine technology and access to a secure source of capital to radically transform the experience for consumers.
We've seen this in other industries, where suddenly it's easy to get the answers that you want, it just requires a few clicks on your phone. Whether you're dealing with a cash flow issue or savings or borrowing, technology helps all of these come together quickly, which disrupts the existing model. Why would I pay more for a worse experience at an incumbent player when a new player can give it to me in a cheaper and more seamless way?
All that being said, I don't think there's going to be a flood of fintech companies applying for charters. I think there will be a handful of them. They require a lot of capital and a huge amount of expertise, not only in terms of how to manufacture financial products and comply with complex regulatory regimes, but also how to use consumer technology in a way that can deliver this type of transformation.
TMF: How important is access to FDIC insured deposits for a fintech company?
Walsh: From a funding perspective, a charter and FDIC insured deposits will allow fintech companies to offer more affordable solutions to their target customers. And then you combine that with a better experience, and that's a classic disruption story. How did Amazon succeed? It offered more affordable prices and a better customer experience.
To the extent that fintech companies use that to create more affordable solutions for customers, that's going to be challenging for banks to compete against. Banks have a lot of overhead; a lot of fixed expenses. Between legacy technology and physical distribution, the costs at these incumbent institutions are really high.
TMF: Have regulators been receptive thus far to Varo's application?
Walsh: Absolutely. They've been clear that they're not compromising any of their standards. It's a high bar we have to clear. But they recognize the fact that our mission revolves around helping customers improve their financial situation.
I think the regulators recognize that we have deep experience in financial services, both at the executive team and board levels at Varo. And they see that we have access to a lot of capital resources. We're backed by Warburg Pincus and we've got a number of other investors. All of that puts us in a good place with regulators.
