Mid-Sized Banks Turn to Fintech Partnerships as Traditional Revenue Streams Dry Up

Mid-Sized Banks Turn to Fintech Partnerships as Traditional Revenue Streams Dry Up

Mid-sized U.S. banks are confronting a revenue crisis that's pushing them toward an unlikely lifeline: the same fintech startups that were supposed to disrupt them out of existence.

Over the past four years, these institutions have watched their net interest margins—the spread between what they earn on loans and pay on deposits—steadily compress, according to data published this week by fintech newsletter Fintech Takes. With interest income comprising roughly 75% of total revenue for mid-sized banks, the squeeze has been severe. The remaining quarter of their revenue faces its own headwinds as overdraft fees disappear under regulatory pressure and payments revenue migrates to larger banks and non-bank competitors.

The timing couldn't be worse. While mid-sized banks struggle, private fintech companies have experienced explosive growth in venture funding, with one in every five venture capital dollars invested in 2021 flowing to fintech firms. In the fourth quarter of 2021 alone, U.S. fintech companies raised $18.2 billion.

But here's where the story takes an unexpected turn: those flush fintech startups need something mid-sized banks possess—a bank charter. Without one, fintech companies can't legally offer many financial services directly to consumers.

Enter banking as a service, or BaaS. Cornerstone Advisors defines it as a strategy where financial institutions partner with fintechs or other non-financial companies to provide financial services to the partner's customer base, leveraging the bank's charter and capabilities including account management, compliance, fraud management, and payment or lending services.

The economics are compelling. The roughly 30 U.S. banks currently dominating the BaaS space are achieving return on equity and return on assets metrics that significantly outpace their peers, according to research from Andreessen Horowitz cited in the Fintech Takes analysis. For banks facing a multi-year revenue recession, BaaS represents an efficient distribution strategy that monetizes their regulatory infrastructure without the traditional costs of branch networks or customer acquisition.

The arrangement creates a curious symbiosis. Fintech companies get the regulatory permissions they need to operate. Banks get access to fintech customer bases and a new revenue stream that doesn't depend on interest rate spreads. It's the rare case where the disruptor and the disrupted need each other to survive.

The question for CFOs at mid-sized banks is no longer whether to pursue BaaS partnerships, but how quickly they can build the operational capabilities to support them. The revenue pressures aren't going away, and the fintech funding environment shows no signs of cooling. For banks sitting on underutilized charters, the asset they took for granted may turn out to be their most valuable one.