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Here's Why PayPal and Square Don't Want Traditional Banks to Fail

By Matthew Frankel, CFP® – Updated Nov 11, 2020 at 3:38PM

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The fast-growing fintechs want to disrupt the banking industry -- but not that much.

Should the big banks be worried about fintech disruption from PayPal (PYPL 1.04%), Square (SQ 1.58%), and others? Or are they in no real danger of going away? On our October 19, 2020 Fool Live recording of our "Industry Focus: Financials" show, a listener asked host Jason Moser and contributor Matt Frankel, CFP, and here's what they had to say.

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Jason Moser: Genghis Ahn asks, "What do you think the big banks need to do to fend off the fintech companies, let's say BofA versus PayPal? The flip side, what does PayPal need to do to drive more nails into a traditional bank?"

If there is a battle there, I mean, what the big banks need to do? I don't know. It feels like they need to, first and foremost, to me, make sure that they're making those investments in tech and adopting, in some cases, perhaps even imitating what some of those fintech companies are doing.

You mentioned the point earlier about how transactions online or mobile are just a fraction of what they would cost in person, which makes a lot of sense. I think I saw on the Wells Fargo (WFC 0.93%) call, they still have 100,000 employees working from home. I don't get very many checks these days, Matt. But every once in a while, I get a paper check in the mail for something. I certainly am not going to go to the bank to deposit. I don't even go through the drive-through deposit. I just use my phone and deposit via the phone, which then begs the question, how many tellers does the world really need? I don't know. It feels like we're going away from that model. But what do you think?

Matt Frankel: Well, on the second that he makes, "What does PayPal need to do to drive more nails to traditional banks?" I don't think PayPal wants to drive nails into banks. To my knowledge -- and correct me if I'm wrong, you know the company a little better than I do -- PayPal does not have a banking charter.

Jason Moser: That's a very good point there. We said this, I think, on last week's show with the Venmo card. PayPal is dependent on a bank. They partner with Synchrony Financial (NYSE: SYF). They need the bank because of your point right there. They are not a bank; they don't have that banking charter.

Matt Frankel: They don't want to be a bank. Being a bank has a lot of regulatory requirements that a company like PayPal properly doesn't really want. If they have a lot more capital, it just really limits the other businesses you could pursue. There's a reason like Bank of America (BAC 1.62%) and JPMorgan (JPM 1.73%) don't acquire non-banking businesses to run, and it's because of regulatory roadblocks. Same reason Berkshire Hathaway (BRK.A 1.90%) (BRK.B 1.58%) doesn't want to become a bank, because it would just increase the regulation. PayPal doesn't really want to be a bank; they want to take a lot of market share in terms of deposits and just general everyday payment transfers.

But they don't want to do what banks do. They don't want to be a direct mortgage lender, for example. They don't want to loan money, loan millions of dollars to oil companies like traditional banks do. They don't want an investment banking operation. PayPal doesn't want to be the underwriter of IPOs. There's a lot that traditional banks do that is just beyond the disruption caused by these war-on-cash companies. PayPal doesn't want to be an investment bank. I don't think they want a trading desk. That's just not their business model.

With the regulatory headaches, I think PayPal and Square and all these other fintechs want to take the surface of what banks do in terms of deposits in general like checking accounts, things like that, maybe some minor lending, but you still have to partner with the bank to do that. They want those types of aspects of bank. They don't want to drive nails into the banks and fully take over the financial system, because they don't want that.

Jason Moser: Yeah, I think generally speaking, you're right. I will say there's a little bit of a difference there in Square and PayPal. That Square has filed for that banking charter with the goal of Square Capital, I guess is what it's going to be called, or Square Financial Services, one or the other. But that seems to be a little bit less about disrupting big banks and more to becoming more vertical.

How we talk about companies, and oftentimes we talk about companies in the tech space that are vertically integrated, which means they essentially control the entire thing from start to finish, from soup to nuts. They're innovating, they're producing, they're manufacturing, they're protecting their IP by this vertical integration and less dependent on outside suppliers. Maybe that's what is Square's thinking, is becoming a bank in that sense gives them the opportunity to serve their small and medium-sized business customers better than actually having to deal with or partner with banks that are all going to want a piece of that transaction.

Listen, you got Square doing it one way, you got PayPal doing it another. It's not to say one's right, one's wrong. They're different, and I guess in time, we'll see if PayPal changes their mind and wants to try something else; who knows. But I think to your point there, it does feel like it's more about figuring out how the banks can serve as partners throughout this, because those regulations, that is real. Like to be a bank, man, that's like an entire wing of your business that just has to constantly deal with regulations, ratios, and red tape. That three Rs that you just don't want to mess with.

Matt Frankel: Even with Square, they're becoming a bank for very specific reasons.

Jason Moser: Yeah.

Matt Frankel: They want to cut out the middleman. They're already a business lender. They went through a partner. They're just trying to cut out that middleman. They don't want to necessarily takeover everything Bank of America does.

Jason Moser: Yeah.

Matt Frankel: That's not what they want. Maybe on the consumer side, they want to do most of what they do. On the business banking side, Square is never going to take over like Bank of America is really big business lending.

Jason Moser: Yeah, you're right.

Matt Frankel: Well, currency trading desk or anything like that. They're becoming a bank for a very narrow reason, it's worth mentioning.

Jason Moser owns shares of PayPal Holdings and Square. Matthew Frankel, CFP owns shares of Bank of America, Berkshire Hathaway (B shares), Square, and Wells Fargo and has the following options: short September 2022 $155 calls on Square, short January 2021 $23 puts on Bank of America, and short November 2020 $22.5 puts on Wells Fargo. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares), PayPal Holdings, and Square and recommends the following options: long January 2021 $200 calls on Berkshire Hathaway (B shares), short January 2021 $200 puts on Berkshire Hathaway (B shares), long January 2022 $75 calls on PayPal Holdings, and short December 2020 $210 calls on Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.

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