Rich People and Relationship Banking Don’t Mix
By Alex Johnson
#1: Rich People and Relationship Banking Don’t Mix
First Republic Bank was taken over by the FDIC and sold to JPMorgan Chase this weekend:
Regulators took possession of First Republic on Monday, resulting in the third failure of an American bank since March, after a last-ditch effort to persuade rival lenders to keep the ailing bank afloat failed.
JPMorgan Chase, already the largest U.S. bank by several measures, emerged as winner of the weekend auction for First Republic. It will get all of the ailing bank’s deposits and a “substantial majority of assets,” the New York-based bank said.
JPMorgan is getting about $92 billion in deposits in the deal, which includes the $30 billion that it and other large banks put into First Republic last month. The bank is taking on $173 billion in loans and $30 billion in securities as well.
The Federal Deposit Insurance Corporation agreed to share losses on mortgages and commercial loans that JPMorgan assumed in the transaction, and also provided it with a $50 billion credit line.
JPMC would appear to be getting a pretty good deal here, but I’ll refrain from commenting on the specifics until more reporting comes out. This literally just happened.
Instead, allow me to share a broader observation, based on the failure of First Republic Bank (and Silicon Valley Bank before it) – rich people and relationship banking don’t mix well.
A lot of banking boils down to this basic reality – banks make money by exploiting customer inertia. Their ability to borrow short and lend long is only possible because most customers don’t constantly move their deposits around to chase the highest available interest rate.
How you view this reality depends on your perspective. If you’re a strict free market capitalist, you see this as laziness on the part of most customers. If you’re the CFPB, you see this as big banks trapping their customers by making it impossible to switch providers easily. And if you’re a bank, you refer to this as “relationship banking,” and you explain that the reason customers don’t move is that they value the full experience of working with your institution more than the extra bps they could get by constantly shuttling their money around.
I think the truth is somewhere between all of these perspectives, but I am sympathetic to the relationship banking argument. I do believe that banking, when it works well, provides holistic benefits to customers that lead to a healthy inertia, which, in turn, allows banks to engage in the business of maturity transformation.
However, since the meltdowns of Silicon Valley Bank, which became famous for its largess with startup founders and VCs, and now First Republic, which has been weighed down by the absurdly generous mortgages that it gifted to its wealthy clientele, I think it has become clear that this relationship banking model does not work, sustainably, if your customer base is entirely composed of super wealthy consumers, as this article from Bloomberg nicely sums up:
Happy customers were a fixture in First Republic’s advertisements, with millionaires and business leaders extolling its customer service and dubbing the firm a “partner for life.” If homebuyers also parked cash at the bank, it could plow the money into other investments to burnish returns on those relationships. So many wealthy families, entrepreneurs and businesses deposited funds that surpassed the Federal Deposit Insurance Corp.’s $250,000 coverage limit, that some $119 billion — or two-thirds of the bank’s total deposits — were uninsured at the end of last year.
That unraveled when interest rates rose. In interviews, clients said they saw more opportunities to earn higher returns elsewhere. And when other banks with outsize piles of uninsured deposits started teetering this year, First Republic’s clients yanked their money, too.
#2: Cross River Crossed the Line
Cross River Bank is working through a consent order with the FDIC:
Cross River Bank, a partner of financial technology companies and crypto firms, received a cease-and-desist order from the Federal Deposit Insurance Corp. over what the agency said were “unsafe or unsound” practices related to fair-lending laws.
The bank failed to establish and maintain “internal controls, information systems, and prudent credit underwriting practices,” the FDIC said Friday. Cross River reached a consent agreement with the agency, dated March 8, without admitting or denying any charges or violations.
So, here’s the situation:
- Cross River Bank provides a marketplace lending platform, which enables fintech companies to offer lending products to consumers and businesses, which are originated by Cross River and then sold to third-party investors in the marketplace.
- This is a very efficient model for everyone involved – the fintech company can offer lending products without needing to acquire lending licenses or a bank charter, the investors get access to assets across a wide risk/return spectrum, and Cross River collects fees without having to do the marketing to acquire borrowers and without needing to hold the loans on its balance sheet.
- The problem with this model is the incentives. Cross River generates fees based on the volume of loans that it originates, so obviously, it wants to bring as many fintech partners onto its platform as possible. To do this, Cross River needs to be easy to work with. It must be careful not to overwhelm its fintech partners with too many burdensome legal or operational requirements.
- This consent order from the FDIC essentially says that Cross River made itself too easy for its fintech partners to work with and that this led to fair lending compliance failures, dating back to 2021.
- So the FDIC is requiring Cross River to make a bunch of changes to how it onboards and monitors its fintech partners to prevent these types of compliance failures from continuing.
- The problem for Cross River is that while this consent order is in effect, it must submit any new fintech partners to the FDIC for “non-objection” (asking for approval, basically). This is a burdensome process that will make it really difficult for Cross River to grow. Its best path forward (and I’m sure the one it’s pursuing) is to address the FDIC’s concerns and get the consent order lifted as soon as possible. We’ll see how long that takes.
A new fintech company emerged from stealth:
Having the ability to load up a digital wallet to pay for goods and services at businesses you frequent, and then earn rewards for those purchases, would be convenient and well, rewarding.
But as of now, few merchants outside of retail giants such as Starbucks offer that ability.
Ansa is a startup emerging from stealth today that wants to change that.
Founded last year by former Adyen product manager Sophia Goldberg and ex-Affirm software engineer JT Cho, San Francisco-based Ansa is building what it describes as a white-labeled digital wallet infrastructure to help businesses process small payments and offset high credit card fees for smaller transactions.
Or as Goldberg describes it, Ansa is building a “wallet-as-a-service,” or embedded customer balances to let any merchant launch a branded flexible payment instrument.
I’ve gotten to know Sophia a bit over the last couple of years (and I’m a huge fan of her book!), so it didn’t surprise me to see that she has been working on something cool like this.
The core idea is that smaller merchants need the ability to offer an alternative, closed-loop payments functionality to address frequent, low-dollar transactions (coffee, transportation, etc.) that are just too expensive to run on the card rails.
Ansa is giving merchants a headless, white-label, closed-loop payments platform that allows them to integrate user balances into their overall product offering.
I’ll be very curious to see what merchants are able to do with this capability.
The benefit of offering a reloadable closed-loop wallet to customers is obvious for the merchant. The benefit of using such a wallet for the customer (especially if it requires work on their part to fund it) isn’t always so clear. Building clear and compelling customer value propositions will be key.
2 FINTECH CONTENT RECOMMENDATIONS
#1: If The U.S. Bans TikTok, Where Will Gen Z Go For Financial Advice? (by Ron Shevlin, Forbes) 📚
This is the right question from Ron, who notes in his article that 34% of Gen Zers obtain financial advice from TikTok.
I think an interesting follow-up question is this – how can banks and fintech companies leverage what finfluencers are clearly great at (engaging an audience on financial topics) within the context of their own products and experiences?
A while back, I wrote about a fintech company called Follow, which is doing some interesting stuff in this area. Might be worth another look.
#2: Growth Lessons for Early-Stage Fintech Infrastructure Companies (by Jareau Wadé, Batch Processing) 📚
I enjoyed this one from Jareau (and have been enjoying his writing at Batch Processing, more generally). In particular, I found the impedance matching metaphor for payments companies interesting (and not at all tortured!)
1 QUESTION TO PONDER
This one has nothing to do with fintech, but I’m assembling a list for this summer, so I’m going to ask it anyway:
What is the best fiction book you’ve read recently?
I’m up for anything – fantasy, science fiction, spy thrillers, cozy mysteries – as long as it is well written. Give me your best recommendations, please!