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

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

Mid-size U.S. banks are facing a revenue crisis that's forcing a strategic pivot toward an unlikely lifeline: the same fintech startups that were supposed to disrupt them out of existence.

The numbers tell a stark story. Over the past four years, mid-size banks have watched their net interest margins—the spread between what they earn on loans and pay on deposits—steadily compress. This matters because interest income represents roughly 75% of these institutions' total revenue. Meanwhile, the remaining quarter of their income faces its own headwinds as overdraft fee revenue evaporates under regulatory pressure and payments fee revenue migrates to larger banks and non-bank competitors.

At the same time, private fintech companies have experienced the opposite trajectory, with valuations climbing sharply since 2018. Venture capital poured $18.2 billion into fintech companies in the fourth quarter of 2021 alone, part of a broader trend that saw one in every five venture capital dollars last year flow into financial technology firms.

In most industries, this would be a straightforward disruption story—struggling incumbents versus well-funded upstarts. But financial services has a twist: those mid-size banks possess something the fintechs desperately need. They have bank charters.

The BaaS Arbitrage

Enter banking as a service, or BaaS—a model where traditional banks partner with fintech companies to provide financial services to the fintech's customer base. According to a recent Cornerstone Advisors research report, these arrangements let banks leverage their charter and core capabilities—account management, compliance, fraud management, and payment or lending services—while fintechs handle customer acquisition and interface.

For banks struggling with traditional revenue generation, 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 data from Andreessen Horowitz.

The arrangement functions as an arbitrage of sorts. Fintech companies, flush with venture capital but lacking regulatory infrastructure, need access to the federal banking system. Mid-size banks, rich in regulatory permissions but poor in growth prospects, need new revenue streams that don't depend on net interest margins or fee income under political siege.

What makes this particularly interesting is the cost structure. BaaS represents "an incredibly cost effective distribution strategy," as Cornerstone Advisors describes it, because banks aren't building consumer-facing technology or spending on customer acquisition. They're essentially renting out their balance sheets and compliance infrastructure—assets they already own—to companies that have solved the distribution problem but can't legally hold deposits or originate certain loans without a charter.

The model's growth comes as fintech funding shows no signs of slowing, creating sustained demand for banking infrastructure. For mid-size banks watching their traditional business lines deteriorate over what appears to be a multi-year horizon, that demand represents something increasingly rare: a growth opportunity that plays to their regulatory strengths rather than their technological weaknesses.

The question now is whether this partnership model represents a sustainable business line or merely a temporary arbitrage that closes once regulatory frameworks evolve or larger banks crowd into the space.