The Future of Niche Banks

Jim Marous (00:00):

Hello and welcome to Banking Transformed the top podcast in retail banking. I'm your host, Jim Marous, founder and CEO of the Digital Banking Report and co-publisher, The Financial Brand.

Jim Marous (00:23):

Fueled by the growth of plug and play banking infrastructure, startup niche banks have emerged that catered to a varied assortment of segments, including specific nationalities and genders, income and age stratifications, occupation and hobbies, and even personal values.

Jim Marous (00:39):

The majority of these starters have a licensed sponsor bank, as well as a digital banking infrastructure that offers specific products that consumers or businesses can't get elsewhere.

Jim Marous (00:50):

The challenge has been how do you differentiate? How do you achieve scale? How do you fund marketing and acquisition? And even more importantly, how do you build loyalty beyond a debit card?

Jim Marous (01:02):

My guest in the Banking Transformed Podcast is Alex Johnson, founder of Fintech Takes. We discuss the future of niche financial institutions where funding has become more difficult, and scalability continues to be elusive.

Jim Marous (01:16):

With so many competitors in the banking space, it's hard to stand out and even harder to achieve scale. While the proposition is to serve a unique financial need for a segment, is it enough for a business to be built on?

Jim Marous (01:29):

For many niche banking firms and for the challenger banking segment as a whole, the past several months has been a perfect storm of bad news from an uncertain economy to the failure of Silicon Valley Bank, to questions around the viability of even the biggest digital banks.

Jim Marous (01:47):

Many industry observers are wondering if niche banks will survive. So Alex, before we begin, can you introduce yourself to our audience and share a little bit about your background?

Alex Johnson (01:57):

Yeah, absolutely. So, I am the creator and publisher of a newsletter and podcast in the fintech space called Fintech Takes. It's a newsletter that comes out twice a week and a weekly podcast as well.

Alex Johnson (02:12):

And I've been working on that for the last three years or so. My history in financial services and fintech goes back more than 15 years including stops at Cornerstone Advisors, working with our friend Ron Shevlin, as well as Fair Isaac FICO, the credit scoring company, Mercator Advisory Group, and a small fintech company that no one's ever heard of called Zoot Enterprises.

Alex Johnson (02:36):

So, I've worked in and around Fintech and financial services for the last 15 plus years, and just utterly fascinated by fintech and all of the different sort of intersecting trends lines that you guys talk about on the show.

Jim Marous (02:48):

So, I'm going to reference it later, but if anybody has not already subscribed to Alex's both podcast and his newsletter, please do so. It is a really good deep dive that he publishes regularly and it's extraordinarily good thinking process and he's actually one of the newer players on the block with regard to content, but certainly no newbie in the field.

Jim Marous (03:11):

So, you recently published a really great article in the future of fintech and niche marketing institutions where you raised as many questions as you provided answers. So, in a nutshell, what do you see in the marketplace with regards to what I'll call or what you call niche financial institutions?

Alex Johnson (03:30):

Yeah, absolutely. Well, so asking questions is my specialty. I don't always have the answers, but I have a lot of questions. And one area that there've been a lot of questions about recently and that have sort of popped up on my radar is, as you said, this sort of niche financial services, niche neobanking space.

Alex Johnson (03:47):

And I think in 2020 around then we saw this sort of explosion of all of these digital banks that were focused on serving very specific customer segments. And those customer segments could be defined based on identity. They could be defined based on occupation; they could be defined based on values or affinity.

Alex Johnson (04:06):

But basically finding some segment of customers defined in some other way than geography, which is the way that historically we've segmented customers within the financial services space with community banks and branch networks, any other way besides geography. There's all of these new digital banks popping up to serve these different segments.

Alex Johnson (04:26):

And what I've noticed recently within the last six months and certainly within the last month, is that a lot of those niche neobanking companies are really starting to struggle. Aspiration, which is a digital bank that's focused on serving sort of climate conscious consumers and those who want to sort of bank in a way that's going to be better for the climate and the environment.

Alex Johnson (04:53):

They recently laid off 180 employees as part of a larger sort of restructure that they're doing and kind of pivoting away from the neobanking space and doing more sort of climate infrastructure type work.

Alex Johnson (05:06):

So, not necessarily going out of business, but definitely a big change in the way they're trying to go to market.

Alex Johnson (05:13):

Another one was Kinly which was acquired by one of its competitors Greenwood. Both Kinly and Greenwood are digital banks that are focused on serving black consumers in the U.S. So, kind of a very sort of identity focused neobank.

Alex Johnson (05:31):

And then another identity focused neobank Daylight, which is focused on serving LGBTQ+ consumers recently announced that they were going to be shutting down after I believe about five years or so in market.

Alex Johnson (05:44):

So, all of these niche neobanking companies are really struggling right now. And I think the question that I was sort of wrestling with in this piece was, is this just sort of part of the broader slowdown that we're seeing in Fintech and a bit of a pullback from VCs and concerns about the rising rate environment?

Alex Johnson (06:04):

Or is there something more specifically concerning about this niche neobanking segment that we should be talking about more or thinking about more?

Jim Marous (06:12):

Alex, one of the first questions you asked, and it was really a good foundation, was whether enough customers ... sorry.

Jim Marous (06:22):

Alex, in your write up, one of the first questions you asked, which is really foundational to the whole element of niche banking is are there enough consumers that will select their finance institution based on their identity? What was your take on that?

Alex Johnson (06:38):

Yeah, I mean, so I don't have data on this just to be clear. And I always sort of feel Ron Shevlin over my shoulder going like, "Well, why do you say that? Do you have data?" I don't have any data. So, let's just be clear.

Alex Johnson (06:49):

Maybe there's some good consumer survey data out there on consumer's preferences for working with different types of financial services providers. Maybe some consumers are interested in working with ones based on their identity or based on their values.

Alex Johnson (07:01):

I will say I don't always trust that consumer survey data, even when it is available, because a lot of times people will say, "Oh yeah, I'd be happy to switch to a different bank," but no one actually switches banks. It's like actually very, very rare in practice.

Alex Johnson (07:14):

And so, the data I think is a little bit murky, but just sort of more fundamentally, I think the question is, as you say, is someone likely to select where they get their banking services and their banking products based on some characteristic about themselves?

Jim Marous (07:32):

Yep.

Alex Johnson (07:32):

And I don't think that for the majority of the market, that's likely. Now in the piece that I wrote, I sort of compared this to hybrid and electric vehicles, which have had this sort of slow introduction into the automotive space over the last 20, 30 years.

Alex Johnson (07:49):

And I remember in the early days when the sort of early generation of hybrids were coming to market like the Prius, there was definitely a segment of consumers that jumped right on it.

Alex Johnson (07:59):

They were climate conscious. They wanted to demonstrate that they were doing their part to sort of protect the environment. And it was really a statement of, I drive a Prius and I want you to know that because I want you to know what I believe.

Alex Johnson (08:12):

So, there's always that sort of early adopter segment. And I think that segment exists in banking too. There is a certain segment of consumers who are going to get some type of sort of soft benefit or value in terms of sort of confirming what they believe or who they are when they pull that brightly colored debit card out of their wallet.

Alex Johnson (08:31):

So, I do think there is a segment there within each of these niches that is going to be sort of an early adopter. But I think what we've seen in the automotive space, and I think this is true for banking as well, is most consumers, the mass market doesn't move until they see more tangible value that they can get by making a change, right?

Jim Marous (08:51):

Right.

Alex Johnson (08:51):

And so, I can be a member of whatever identity group or occupation or have whatever affinities or values, but I can be fine banking at Chase until you show me an alternative that's substantially better.

Alex Johnson (09:03):

In the same way that hybrid and electric vehicles are getting better gas mileage and have better fuel performance that are more fun to drive and maybe are cooler, have a better design. Those more tangible characteristics are what drive the mass market.

Alex Johnson (09:16):

And I think that's what we haven't seen in a niche neobanking space so far, is those tangible differentiated value propositions.

Jim Marous (09:25):

And it does get to identity. You mentioned the Prius, and I never will forget the highway between Los Angeles to San Diego used to be completely filled with people driving Prius’.

Jim Marous (09:39):

You'd be hard pressed today to see very many Prius’. What they are driving are Teslas. You'll see a lineup at a stoplight of seven or eight Teslas. Again, that's identifying with a certain belief in the public as part of their identity.

Jim Marous (09:54):

But what's interesting, and you brought up about credit cards and debit cards, it's one thing for me to have my Cleveland Browns credit card, but do I really want to open a completely new banking relationship beyond a debit card or a credit card?

Jim Marous (10:08):

Will I really open a CD, get a mortgage or build a profitable relationship based on who I am or who I aspire to be, given all the things that are going on? I think you get to a good point. It's a value transfer. What is that value going to be?

Jim Marous (10:25):

Have you seen any niche banking organization that has really built, just from your perception — no measurement, Ron Shevlin, who's really built a good enough value proposition where they'll move more than just their debit card to this organization?

Alex Johnson (10:44):

Yeah, I mean, I think that there are analog examples in the traditional banking and credit union space.

Jim Marous (10:53):

Yes.

Alex Johnson (10:53):

That have succeeded using this model. So, we know that there are community banks out there that are maybe defined geographically and actually have a really strong relationship with people in their community.

Alex Johnson (11:05):

And so, you have consumers out there, even young consumers. I know this is mind blowing to Fintech, you even have young consumers that bank with local banks and credit unions because they really like the connection to the community.

Alex Johnson (11:17):

I live in Bozeman, Montana. I went to Montana State University. "Go Bobcats." Like you, I enjoy having a Montana State, MSU Bobcat debit card. So, there is that sort of geographic model that we know works to an extent.

Alex Johnson (11:30):

We also know that credit unions for a long time have had fields of membership that are very similar to this. Whether that's occupation, you had credit unions for teachers, for nurses, for doctors, for airline pilots, for the military, obviously I think USAA and Navy Federal-

Jim Marous (11:49):

Yes.

Alex Johnson (11:49):

And Pentagon Fed are probably some of the most sort of obvious examples of large scale brands that have been built around these niches and serving them well and doing it in a multi-product fashion, as you're saying.

Alex Johnson (12:01):

I think the thing that I have not seen yet, and maybe it's just too early, is these new niche neobanks. So, not a banker or credit union, there's no banking charter. They're working with a bank on the back end using banking as a service.

Alex Johnson (12:16):

These niche neobanks, I haven't seen them sort of cross that chasm and offer something that has that sort of value exchange that consumers are looking for. And it touches on something that you mentioned, which is most of them are all just debit cards. And the debit cards are nice. They're lots of different colors. I have quite a few of them in my wallet because I'm a bit of a sort of tinkerer when it comes to new Fintech apps.

Jim Marous (12:37):

Oh, exactly.

Alex Johnson (12:38):

They're very nice, and so they're very nice debit cards, but they're not multi-product offerings. And the reason for that is, again, all of these niche neobanking offerings are built on top of banking as a service. And banking as a service is today really well optimized for offering a checking account and a debit card and two-day early access to your paycheck.

Alex Johnson (13:00):

But if you wanted to offer a mortgage or you wanted to offer wealth management and investing, or you wanted to offer buy now, pay later, most banking as a service partners and the infrastructure behind all of these niche neobanks is not robust enough to support that. And so, maybe it's too early, but I have not seen a lot of examples of the sort of durable niche neobank that you're asking about.

Jim Marous (13:22):

So, it's interesting, I am aware of some very, very successful open banking models that combine both financial and non-financial services to serve as special needs such as young consumers by location and also by Emirates NBD.

Jim Marous (13:38):

And they do this as a profit where the money actually is coming from the outside providers that enjoy the massive numbers within that niche that that bank's serving.

Jim Marous (13:49):

But these have scale and they're part of a larger financial institution. So, our niches may be better served by traditional financial institutions.

Jim Marous (13:58):

And the second part of the question, which is probably more importantly, will they serve these needs as these underserved segments that continue to be out there, just because we may not be the niche banking environment to serve it, those needs still exist.

Alex Johnson (14:14):

Absolutely, yeah. So, I think the key point that you're hitting on here is banks, whether they're community banks, credit unions, slightly larger regional banks, they have a, as we've seen especially over the last year or so, they just have a business model advantage over Fintech companies.

Alex Johnson (14:31):

Because they have a bank charter, their costs are lower. They have the ability to lend, they have the ability to offer sort of the full suite of products. And so, they're not limited in the same way that a fintech company building on top of a banking as a service bank is limited.

Alex Johnson (14:46):

And so, I do think from a business model perspective, banks are in a much stronger position to serve all of these different niches. And if you're a community bank and you're looking at it and going, we've kind of reached the limits of what we can do to grow within our geographic community.

Alex Johnson (15:03):

Or we're not seen as many young consumers sign up with our institution the way that their parents or grandparents did because now everything is digital and they're not coming into the branch. We're starting to see that shift in behavior. How can we attract more sort of new members or new customers into our organization?

Alex Johnson (15:23):

And I think this niche strategy is one that's really interesting. And there actually have been a number of sort of community banks that have actually started spinning up these little digital niche businesses to go after different segments.

Alex Johnson (15:36):

For example, there's a credit union in Michigan that's focused on serving sort of the university system within Michigan. That's kind of their original field of membership.

Jim Marous (15:46):

Michigan State University, I believe it is.

Alex Johnson (15:48):

Yeah, exactly. Yeah, MSU again, right?

Jim Marous (15:51):

Yep.

Alex Johnson (15:51):

And so, this one's Michigan State, but it's really focused on serving those sort of graduates and the alumni of that organization.

Alex Johnson (16:00):

But what they realized is they didn't really have a great digital offering for recent graduates that was tuned to what a recent college graduate might be looking for. Needs to be digital first, needs to have tools like debt consolidation because they might have student loans or other debt that they need to deal with.

Alex Johnson (16:18):

They actually have some very interesting charitable contribution capabilities built into it. So, consumers who are just graduating college and trying to go off into the world and do good, have the tools to do that.

Alex Johnson (16:27):

And I'll admit it's not probably the absolute best digital banking product that I've ever seen, and I've looked at a bunch of them, but it's fine. It's good. And I think to your point, it's just good enough to be a great add-on for this credit union in Michigan.

Alex Johnson (16:46):

So, it doesn't need to be perfect because this credit union already has a bunch of other advantages. This credit union doesn't need to bet its entire future on this new digital spinoff that it's doing, just a small part of what it's doing. If this digital spinoff brand just helps them acquire a few more young members, well then it was probably successful for them.

Alex Johnson (17:05):

And so, we're starting to see a bunch of those new niches being defined and served by community banks. And I actually think, if you think about the future of community banking, broadly speaking, it's like, do we continue to try to operate geographically? Do we pivot and start doing banking as a service?

Alex Johnson (17:24):

Or maybe do we think about this niche neobanking strategy where we're the bank behind it, but the brand is something other than our 120-year-old brand that doesn't really appeal to younger consumers. So, that's I think the discussion that's happening right now.

Jim Marous (17:38):

It's interesting because I look at KeyBank in my backyard in Cleveland and they've done a really good job of serving niches of the small business universe, doctors and dentists and things of this nature and other professional groups.

Jim Marous (17:52):

And when you think about it, credit unions could make this pivot fairly easily, especially knowing that they've done this in the past. They were used to niches of usually employment based.

Jim Marous (18:03):

And now when you can so easily in a digital world go nationally or internationally, obviously, you have the ability to serve niches that wouldn't be big enough in your community, but are certainly big enough in the universe.

Jim Marous (18:18):

But given that, there's obviously roadblocks and challenges to the development of a strong niche banking strategy, what do you think those might be?

Alex Johnson (18:27):

Yeah, great question. I think the biggest one, if you're a community anchor or credit union that wants to do this is just operationally, this is not what you're set up to do.

Alex Johnson (18:37):

And so, a really good analogy that someone shared with me that I kind of haven't been able to forget since it was shared with me is, if you think about the way that traditional banks and credit unions grow and operationally what they're set up to do really well, you have to think about it in terms of like, how easy is it for you as a community bank to open a new branch.

Alex Johnson (19:00):

And it's not easy. There are challenges to it. You have to staff it, you have to find the right location, you have to attract new customers in that area. But there's a playbook-

Jim Marous (19:09):

There's money.

Alex Johnson (19:09):

For doing it.

Jim Marous (19:10):

Yeah, right?

Alex Johnson (19:11):

There's, yeah, you have to make an upfront investment. There's an ongoing operational cost, but there's a playbook for doing it. All of these community banks and credit unions know how to open up a new branch. They know what it takes, they know what the expectations are, they know what the cost is, and they can make that cost benefit analysis.

Alex Johnson (19:28):

And when they make that investment decision, typically that investment decision goes pretty well. It's not like, oh, we're opening up a branch, we have no idea if it's going to work or not. If you've made the decision to open up a new branch as an experienced banker or credit union, you know what you're doing and you know that you have a pretty good expectation of being successful.

Alex Johnson (19:46):

That same operating rhythm and playbook needs to be built for these new strategies. So, if you're doing banking as a service, well guess what? Every new fintech partner that you sign up with, it's basically the equivalent of opening up a new branch.

Alex Johnson (19:59):

If you're going to do this niche neobanking strategy and you're going to launch these new digital brands to go after these different niches, and to your point, these are massive niches. It's a niche segment, but it can be national or international.

Alex Johnson (20:11):

So, it can be a very large segment of customers. If you're going to go after one of these new niches, what's your playbook for doing that? How operationally are you going to stand that up? What sort of guardrails do you have in place to deal with potential compliance concerns that come up when suddenly you are operating in a bunch of different states that you've never operated in before or whatever the challenge might be.

Alex Johnson (20:31):

So, I think that the biggest thing is just shifting the way that you think about expanding your business and growing. And you if you're a community bank that's trying to get into this sort of niche neobank space, I think that's the biggest thing to think about.

Alex Johnson (20:48):

And one of the things that you see a lot in Fintech, and I think community banks and credit unions could learn from this, is it's really worth experimenting. I think this is one of those things where because it's digital and we're not actually talking about going and buying real estate and building new branches, you can spin this stuff up a little bit quicker and a little bit lower cost.

Alex Johnson (21:10):

There are even partners out there, like Nimbus I know is one that does a lot of work in this area Yeah. Where they'll actually sort of help community banks or credit unions stand these new digital brands up.

Alex Johnson (21:21):

There are partners that you can work with just to test this idea. And I think just sort of testing it and dipping your toes in the water can be a really great way to learn and develop that playbook. And maybe this turns out to be a strategy that has some legs to it.

Jim Marous (21:34):

It's interesting as you speak about this, I just think that the biggest hurdle may be the legacy thinking of what banking is. So, for instance, I know you talked about organizations can turn on and turn off a segment.

Jim Marous (21:47):

Well, banks are not used to turning anything off. So, they want to go all in on something that's completely proven that where there's no risk is the model of banking has always been risk avoidance as opposed to risk management.

Jim Marous (22:00):

In addition, rethinking what scale is. So, when I visited WeBank in China during the beginning of COVID, what was interesting is they have a massive consumer base, but they're willing to build products that serve a customer base that has very low income, if not any income, on an individual basis for the masses, but scale that and all of a sudden you have something of value.

Jim Marous (22:27):

When I look at open banking and looking outside of banking, almost the reverse of embedded banking, but a bank looks for partners of what that niche goes after.

Jim Marous (22:37):

So, I'm going to take my Cleveland Browns example and say, okay, if an organization really dug deep into this, they could build partnerships to provide ticket discounts, to provide entertainment discounts at the location where the Browns play. There may be apparel, other things can do.

Jim Marous (22:54):

But another legacy thought process is we're not used to charging for that affinity. People willing to pay for it, I mean, heck, I pay over $130 a year for my affinity with Amazon. The reality is you got to build the value proposition in a different way than banking's ever done. And the fallback for many financial institutions is, I don't want to charge for it.

Jim Marous (23:17):

Well, as you said, why not test that model? Because I think, again, to your point, the niches need to be served in many cases. I'm not sure if it needs to be served strictly in a financial way, but let's take one of those niches, any of the niches and say, what does this niche use outside of banking that I can bring to them at a discount a more conveniently, older consumer or a younger consumer with regard to either Uber Eats or Uber transportation the way American Express has done. There's ways to build against these niches.

[Music Playing]

Jim Marous (23:53):

So Alex, let's take a short break here and recognize the sponsor of this podcast.

Jim Marous (24:00):

Welcome back to Banking Transformed. So, today I'm joined by Alex Johnson, the founder of Fintech Takes. We've been discussing the status and future viability of the niche banking market.

Jim Marous (24:11):

So Alex, just because it's close to impossible to create and sustain a niche bank, that certainly doesn't eliminate the need of these segments that were sought to be served. What do you believe is the go forward, go-to market strategy to serve underserved markets?

Jim Marous (24:29):

So, I'm not even going into the niche strategy as much as even Chimes and others that have tried to serve the underserved, they're even struggling to a degree. So, what's the best go-to market strategy that you envision going forward?

Alex Johnson (24:42):

Yeah, I mean I think it touches on something you mentioned before, which is figuring out new value propositions for these consumers. So, just to sort of level set, in the U.S. we are very fortunate and have made a lot of progress to the point where there are actually very few truly unbanked households in the U.S., right?

Jim Marous (25:04):

Yeah.

Alex Johnson (25:04):

That number has been going down and going down and going down and we still need to get it to zero. And we're not there yet. We're making great progress towards that. And so, I wouldn't say that there's some massive number of consumers that have no banking options whatsoever.

Jim Marous (25:17):

Undeserved, yeah. Right.

Alex Johnson (25:19):

Yeah, exactly. People have bank accounts by and large. The challenge is most of those bank accounts, particularly sort of that very baseline level where we're just talking about basic banking services, they're somewhat indistinguishable from each other.

Alex Johnson (25:33):

And for better or worse and maybe it's better because a lot of these sort of lower income consumers can't afford to spend a lot of money on basic banking services. Most of these products are given away for free.

Alex Johnson (25:44):

We've trained consumers to expect checking accounts, debit cards, a lot of these basic products to be free or to be close to free.

Alex Johnson (25:54):

I don't think that's necessarily bad, but going to what you were saying before, it does create a challenge in terms of how you monetize these different customer segments. Because people just don't like to pay for checking accounts. They don't like to pay subscriptions for checking accounts or debit cards.

Alex Johnson (26:12):

And yeah, there's a little bit of room, I think, on the margins to bundle your checking account or your debit card with other value-added services like cell phone protection and credit cards have things like AAA and triple protection and all these kind of things, you can bundle in other benefits that you are just aggregating on behalf of consumers. That's one way to do it.

Alex Johnson (26:35):

I think the better way to do it though, in the age of digital banking and the ability to just build software products is think about what the unsolved money adjacent challenges are for a particular segment of underbanked consumers that you want to serve.

Alex Johnson (26:51):

And this gets back into like defining those niches and who you're going after. But one thing I've observed is that in the B2B world, so working with businesses, with small businesses, there are a lot of money adjacent problems relating to just sort of basic back office functions. Accounting, scheduling payments and money and money movement touches almost all of those processes.

Alex Johnson (27:15):

There's an opportunity there to build software to help expedite or make those processes more efficient. And money and banking can just be built into those products. But the core thing that the product is doing is solving a different challenge, not a, oh, I need a checking account challenge.

Alex Johnson (27:31):

So, it's a money adjacent back office problem that banking services can be built into. You can charge a subscription fee for that.

Alex Johnson (27:39):

On the consumer side, in B2C it's the same thing, except instead of it being a back office efficiency challenge, it's oftentimes a relationship challenge. And so, if you think about different problems that underbanked or unbanked consumers might have, a lot of them don't really relate so much to having access to a banking account or a debit card. It's more about the relationship challenges that money causes.

Alex Johnson (28:02):

So, to give you a specific example, what if you are divorced, but you are co-parenting a child or multiple children with your divorced ex-spouse? That's a very complex process. It's very fraught emotionally. Who pays for the soccer lessons? Who gets paid back for that trip that the other person took? There's a lot of very fraught emotional difficult conversations that money is wrapped up in.

Alex Johnson (28:33):

Well okay, we have expense management. We have Ramp, we have Brex, we have all of these great systems that are designed to help mediate expense management challenges across a large number of different stakeholders.

Alex Johnson (28:46):

Why is there no Ramp or Brex for divorced parents that are co-parenting a child? There should be, that's a software product that someone could build. Banking could be built into that, payments could be built into that, credit could be built into that. Insurance could be built into that, savings, investment.

Alex Johnson (29:01):

All of these financial services products that you want to get into these consumers’ hands could be built into software like that. And not only would you make money from those banking products in the passive ways that we make money, debit, interchange, assets under management fees, all the typical things that we use to make money, you could also charge an upfront explicit subscription fee for access to that software because you are solving a new problem for that segment.

Alex Johnson (29:25):

So, to me, that's where the much bigger opportunity lies when thinking about how you serve these different niches.

Jim Marous (29:31):

It's interesting, I also believe with ChatGPT, having come on board last November and evolving so quickly, the power of content for especially the consumer marketplace, but even the small business market, if you can build a great content strategy, which is made more easy now than ever from ChatGPT functionality where if you are able to help a new homeowner, how do you manage your finances? How do you manage your expenses that you're paying for upkeep of the house or remodeling the house?

Jim Marous (30:04):

Who are some providers in your market to do painting, to do little things? If you build a strategy around helping people in need, in general that all have to do with payments in certain ways or in financial services, you have brand new ways of reaching out and solving the questions, which many times are not solved by banks today, but are made more easy to solve based on ChatGPT and content.

Jim Marous (30:33):

I think organizations are going to find ways and it really gets down to personalization of digital banking services to even deeper provide personalization that will really solve these niche problems for those organizations who want to do it.

Jim Marous (30:48):

Again, you talked about the combination of in the small business marketplace, again, I'll bring up KeyBank in their medical community, they served a lot of things with regard to educational expenses for the educational loans that they had, equipment management and equipment financing, all these things that are really specialized to the medical community. That can be done for almost every community.

Jim Marous (31:12):

So, with this being said that there's still a need out there, there's still an affinity out there in many cases. Do you see open banking being the ramp to growth and also possibly acquiring some of these niche financial institutions who've already had some of the trials and tribulations in the marketplace?

Alex Johnson (31:34):

Yeah, it's a good question. I mean, I do definitely think there's going to be consolidation in the market. I think that we've already seen some consolidation of different niche neobanks acquiring each other.

Alex Johnson (31:46):

I think some of the ones that have gone out of business or maybe are sort of teetering on the edge of going out of business would be really good acquisition targets. And I think that banks and credit unions should be thinking strongly about how they acquire those businesses because again, the thing that banks and credit unions struggle with is not so much the basic banking services under the surface. Obviously, they do that every day.

Alex Johnson (32:08):

They have charters, they have all of the compliance processes built out, that's the part they're really good at. They know how to make money by providing banking. The thing they are challenged with is going out and acquiring these new segments and building products and experiences and content, to your point, that speaks to those different segments.

Alex Johnson (32:25):

And that's what these Fintech companies have been spending a lot of time over the last couple of years building. And so, I think there are some really interesting assets out there that people should be looking potentially at acquiring.

Alex Johnson (32:36):

However, I think to your broader point about open banking, I think that's a really interesting question, because Director Chopra and the CFPB have made it very clear that their intended purpose for 1033 rulemaking and sort of this new wave of open banking that they're trying to push in the U.S. is really about competition and making it easier for consumers to switch from one bank to another.

Alex Johnson (33:02):

And I think that on the one hand potentially makes it much more likely for consumers. Again, going back to that point we're making about survey data, oh yeah, I'd be totally willing to switch to a different bank if they were offering me this great service that was built around my identity or my niche. But no one ever actually does it.

Alex Johnson (33:22):

With open banking, the theory is you should be able to just push a button and everything moves over and it's much simpler to switch.

Alex Johnson (33:28):

So, if we can knock those switching costs down to zero or close to zero, potentially you get more of that intention to switch actually turning into action where people are switching. So, I think on the one hand that's interesting.

Alex Johnson (33:40):

On the flip side, I think the other thing that's kind of interesting though to think about is in the wake of Silicon Valley Bank and First Republic and sort of some of these banking failures and sort of challenges that we've seen in the banking space, one of the interesting questions that has come up is how sticky are customers and how sticky are customer deposits?

Alex Johnson (34:01):

And in the age of digital, in the age of open banking where you can just push a button and your money moves, it's a little bit more challenging to keep deposits inside your walls, particularly in a rising rate environment.

Alex Johnson (34:13):

And because of that, it becomes a lot more challenging to manage your balance sheet and to loan money and to do the things that you do as a bank.

Alex Johnson (34:19):

I do think that niche neobank or niche banking that's focused on serving some of these different customer segments might if it can work well, and if you can actually build these durable value propositions that we've been talking about, it might actually be a way to make customer relationships a little bit stickier, right?

Jim Marous (34:39):

Yeah.

Alex Johnson (34:39):

So, to use a specific example, going back to like Aspiration and ATMOS and some of the, the neobanks out there that are focused on serving climate conscious consumers, one of the strongest value propositions of those neobanks is we promise that all of the deposits that you keep here, which are then kept by our partner bank or partner banks, none of those deposits will go towards funding or investing in the fossil fuel industry.

Alex Johnson (35:06):

And if you think about it, if you're a consumer who cares about climate change, not funding the oil and gas industry is probably the biggest thing you can do as an individual to sort of shift the impact that you are having. That's one of the biggest impact things that you can do.

Alex Johnson (35:22):

Chase doesn't give you that option. If you keep your money at Chase, they're going to invest in a lot of stuff including oil and gas. Same thing for pretty much all other banks and credit unions out there.

Alex Johnson (35:31):

I think it's really an interesting concept to think about, if you can attract customer relationships and deposits based on some value proposition that doesn't have to do with price, or doesn't necessarily have to do with basic banking functionality or basic mobile banking functionality, customers might keep their deposits there even though there's a better mobile app down the street or a better price on a savings account down the street.

Alex Johnson (35:56):

You're giving them some other maybe less tangible, but more emotionally important reason to keep their relationship and their money with you. So ironically, I think niche neobanking could actually make some banking relationships stickier and more durable, which is again, something that I think all banks are thinking very strongly about right now.

Jim Marous (36:16):

So, it's interesting when you're bringing that up, I'm looking at the opposite side saying, if you had a niche proposition that was benefiting the American Cancer Society or pick your charity-

Alex Johnson (36:26):

Sure.

Jim Marous (36:27):

But in a real tangible way where it's not … it's the old school, banking relationship that we’ll do this if you do this, you have to pick a big segment again.

Jim Marous (36:37):

Now the big question then is, we're talking about niche banks, but we're also in a way talking about challenger banks in general because one of the biggest threats that's come up in the last nine months is lack of funding and lack of scale, even from the biggest financial institutions, the new challenger banks.

Jim Marous (36:56):

What's the most important challenger bank trend that you see in the future? Because Varo, Chime, all these organizations are being challenged to scale and not just become another bank. What do you see as the most important trend?

Alex Johnson (37:11):

Yeah, I mean, I think if you look at those challenger banks that are more sort of mass market challenger banks, I guess would be the way you'd describe it. Like they don't have a specific niche so much as they have just, we work with a broad segment of sort of underbanked or sort of dissatisfied banking customers.

Alex Johnson (37:29):

The model there, as you say, is really about scale. We're not going to make a tremendous amount of money on any one individual customer, but if we can scale up efficiently and we don't have branch networks, we don't have the same cost structure, then we can generate positive unit economics. That's kind of the general idea.

Alex Johnson (37:45):

I think what we've seen is that those unit economics are much harder to build even at a lower cost structure than maybe we initially thought back in 2018, 2019, 2020 when fintech investment was really hot.

Alex Johnson (38:00):

And I think most fintech VCs are cooling off on the idea of that sort of mass market neobanking model ever reaching the same level of scale and profitability that a traditional bank would.

Alex Johnson (38:13):

Now you've seen some neobanks like Varo pursue and acquire their own bank charter in order to slightly solve that unit economic problem. I think that's one model and I do think you may see some other neobanks go down that route.

Alex Johnson (38:30):

Obviously Square acquired an industrial loan charter, they're not using that for Cash App and their consumer business. But I could see that happening in the future. Obviously, LendingClub acquired Radius Bank. There've been a number of SoFi now has a banking charter. So, I think you'll see some of these neobanks become banks as a way to solve that unit economic problem.

Alex Johnson (38:54):

But I also think the other thing, and we're starting to see this with Varo and I think we will see this with Chime, is they're not doing the one thing that we know for a fact helps banks be profitable and make money, which is lending.

Jim Marous (39:07):

Yep.

Alex Johnson (39:08):

And I think it's telling that they haven't gotten into lending so far, even though that's obviously the next thing that should be on their product roadmap. I think lending to their lower FICO, lower income consumers is going to be a challenge to do in a profitable way.

Alex Johnson (39:24):

But I think that's the next unlock for a lot of those neobank, whether they get a charter or not, is figuring out how to lend the money profitably. And honestly, that's going to be a challenge as we head into this next sort of phase of the economy and as the credit cycle continues to turn.

Alex Johnson (39:42):

There will be companies that make money from lending, but you're going to have to know what you're doing in that environment in order to do it profitably.

Jim Marous (39:48):

It is in a way why I'm a big fan of SoFi overall because they've kind of already been in the lending space. There's a lot of operational — that they have to deal with, but as a digital niche bank, they can make it happen.

Jim Marous (40:01):

So finally, I'm going to throw wild card your way, and that is probably two of the most profitable and loyal niches out there are Amazon customers and Apple customers. They have both more than dipped their toes in financial services.

Jim Marous (40:18):

They both have a revenue stream and an ongoing stream of revenue from services outside of banking where they can offer a checking account to a consumer through a partnership that would probably be able to pay me to have my account regularly and then get discounts along the way.

Jim Marous (40:36):

I mean, I've always imagined what would it be like if Amazon said, "You pay me $130 a year, how about if we cut that in half? If you open a checking account with me and keep it open." All of a sudden you're paying me $70 a year to have a checking account.

Jim Marous (40:49):

But on top of that, you give me discounts along the way on products and services that I want. They know this information already. Or Apple gives me ... there's nothing more loyal than an Apple customer in most cases that you give me other service and other benefits out there if you open a checking account with me.

Jim Marous (41:06):

Now, the governmental issues, we could get into that, but there's probably arm's length ways of doing that. They've already done it with almost every other product. Do you see this happening?

Jim Marous (41:17):

I'm using niche banking in a really broad sense right now, but is that the real threat that's out there is able to use information and data to provide a value proposition where you actually pay me to do banking with you that I then can pay off over time?

Alex Johnson (41:35):

Yeah, no. I think absolutely yes is the answer. I mean, that's the sort of existential threat that's sort of looming over the banking industry broadly is, and I think you put your finger right on it, Amazon and Apple are the two big ones.

Alex Johnson (41:48):

And if you think about banking as a business generally, I think there are two things that have always sort of been true. And this ebbs and flows a little bit over time, depending on the environment. But broadly speaking, over hundreds of years, we know these two things are true.

Alex Johnson (42:03):

Banking is a captive business in the sense that the most successful banks sort of trap you within an ecosystem that's so convenient to you that you have no desire to leave.

Alex Johnson (42:15):

And historically the way that worked was it was geographic. You'd be walking around your town, there was a branch on every corner-

Jim Marous (42:21):

You knew your banker.

Alex Johnson (42:23):

Yeah, you knew your banker, you saw him at the T-ball game over the weekend. When your kid went off to college, that same bank had a branch that was on the university in your local college. So, it was all just sort of in this ecosystem.

Alex Johnson (42:35):

And sure you could bank with some other bank that was located in a different town, but are you really going to drive 70 miles every week to go deposit checks and do that? No.

Alex Johnson (42:45):

So, banking is a captive business by definition, I think is one thing that's been sort of historically true.

Alex Johnson (42:51):

And the second thing about banking that's been true is, it's a business that depends on cross subsidization. So, you're not going to make money on every single product or service that you offer. Some products and some segments of your customer base are going to pay for the sort of free services that you offer that bring customers in.

Alex Johnson (43:09):

So, it's a business where different products and different customer segments cross subsidize each other. Those two things are true.

Alex Johnson (43:15):

Well, if you think about today, just generically across the entire board, which companies are best positioned to have a captive customer base that they can cross subsidize in all kinds of different ways. It's big tech companies, right?

Jim Marous (43:28):

Yeah.

Alex Johnson (43:28):

It's Apple and it's Amazon. And so, Apple and Amazon's goal, I think when they look at banking and as you say, they're already in the midst of doing this right now, particularly Apple is figuring out ways that they can make it even more convenient to just stay in our ecosystem.

Alex Johnson (43:43):

Don't leave, don't go somewhere else. Don't think about switching, don't think about buying a computer from some other provider. Get everything from Apple and every incremental thing you do with us is going to make your life a thousand times easier.

Alex Johnson (43:55):

And Amazon's the same way. They just want you to live within their ecosystem. They don't want you to Google what's the best product to get for this particular category. They want you to go to Amazon and then type that into their search part. They want to disintermediate anyone else from having control over the choices that you make.

Alex Johnson (44:09):

Now that's a little bit of a dystopian description that I gave and in the old days with banking, yeah, banks made a sort of captive ecosystem, but it was just your banking choices that were being sort of restricted to that one bank. It wasn't every choice you make in your life.

Alex Johnson (44:24):

I think going to your point about government and regulation, the concern is do we really want consumers to sort of voluntarily trap themselves in ecosystems for all the services that they get, groceries, electronics, healthcare, financial services.

Alex Johnson (44:42):

And I think that's where we're going to see regulators put some of the breaks on this vision, but I absolutely think that's what Apple and Amazon and perhaps one or two other tech companies have a vision of doing. As you referenced before with China, it's that super app model. That's what everyone wants.

Jim Marous (44:59):

Right, right. Alex, it is always such a joy. I'm glad we finally did one that we actually recorded for prosperity.

Alex Johnson (45:06):

I know, I know. We've done a bunch of podcasts without recording them.

Jim Marous (45:10):

Exactly right. Um, congratulations on your newest child. One more time.

Alex Johnson (45:15):

Thank you.

Jim Marous (45:15):

How do people follow you both your podcast and the writings?

Alex Johnson (45:20):

Absolutely. Yeah. So, the podcast and the newsletter, if you just search for Fintech Takes, it'll come up. The podcast is on all of the big platforms, Spotify, Apple, wherever you get your podcasts. And the newsletter, just google Fintech Takes and it'll show up.

[Music Playing]

Alex Johnson (45:37):

And then I'm also on Twitter and LinkedIn. Twitter probably too much. But I'm AlexH_Johnson on Twitter. So, would love to connect.

Jim Marous (45:48):

Alex, thank you so much, and congratulations again.

Alex Johnson (45:53):

My pleasure. Thanks Jim.

Jim Marous (45:55):

Thanks for listening to Banking Transformed, the winner of three international awards for podcast excellence. If you enjoy what we're doing today, please give us some love in the form of a five-star rating.

Jim Marous (46:06):

Also, be sure to catch my articles on The Financial Brand and check out the research we're doing for the Digital Banking Report.

Jim Marous (46:12):

This has been a production of Evergreen Podcasts. A special thank you to our senior producer, Leah Haslage, audio engineer, Sean Rule-Hoffman, and video producer Will Pritts.

Jim Marous (46:21):

I'm your host, Jim Marous. Until next time, remember, serving the needs of an underserved community continues to be important. The question remains, how is this best achieved?