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 them to rethink their entire business model, and many are finding their salvation in an unlikely place: the very fintech companies 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 difference between what they earn on loans and pay on deposits—steadily compress. This matters because interest income accounts for roughly 75% of these banks' total revenue. The remaining 25%, non-interest income, faces its own headwinds as overdraft fee revenue disappears under regulatory pressure and payments fee revenue migrates to larger banks and non-bank competitors.

Meanwhile, private fintech companies have experienced the opposite trajectory, with valuations soaring over the same period. 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 startups.

In most industries, this would be a straightforward disruption narrative—struggling incumbents versus well-funded upstarts. But financial services operates under different rules. U.S. banks, despite their revenue challenges, possess something every aspiring fintech competitor desperately needs: a bank charter.

This regulatory reality has given rise to what's known as banking as a service, or BaaS. According to a recent Cornerstone Advisors research report, BaaS is "a strategy where a financial institution partners with a fintech or other non-financial institution to provide financial services to the partner's customer base, leveraging the financial institution's charter and capabilities like account management, compliance, fraud management, and payment and/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 that significantly outpace their peers, according to data from Andreessen Horowitz. For banks struggling with compressed margins in their traditional lending businesses, BaaS represents an incredibly cost-effective distribution strategy—a way to generate fee income without the balance sheet risk of holding loans or the overhead of maintaining physical branches.

The arrangement works because it solves problems on both sides. Fintech companies get the regulatory infrastructure they need to offer banking products without spending years and millions of dollars pursuing their own charters. Banks get access to fintech customer bases and a revenue stream that doesn't depend on interest rate spreads or legacy fee structures that regulators are systematically dismantling.

What's emerging is less a story of disruption than one of symbiosis. The question for CFOs at mid-size banks isn't whether to pursue BaaS partnerships, but how quickly they can build the operational infrastructure to support them—and whether they can move fast enough before the window closes and larger banks dominate this space too.