Digital Banking: A Look at the Playing Field
By: Carl White
There is more competition than ever in the provision of banking services, and financial technology (fintech) developments have turbocharged this trend. Traditional commercial banks, thrifts and credit unions are vying with fintech firms and other enterprises for customers or are pairing up with these new competitors to widen offerings, improve speed of service and take advantage of new technologies. Some of these nontraditional providers are specializing in one product or service, or are targeting a very narrow customer base. A number of them are obtaining bank charters, while others are seeking alternative charters.
What’s in a Name?
The new competitors have been given a variety of labels, including neobanks and challenger banks. While some use these terms interchangeably, there are technical differences between them. The term neobanks typically refers to companies that use applications—desktop or mobile—to offer financial services to customers. Even though some of these companies have “bank” in their names and operate much like banks, they have no physical presence and are not chartered or regulated as banks; instead, they rely on relationships with existing chartered banks to provide services.
Neobanks typically target specific customer groups, such as small business owners, gig workers and students, and many offer nontraditional products and services—early access to paychecks, for example—as well as checking and savings accounts. Financial management tools such as budgeting and person-to-person payments are other popular offerings. Chime, Dave, and MoneyLion are among the industry’s leaders in transactions volume and number of users.
Challenger banks, on the other hand, are chartered, regulated financial institutions with brick- and-mortar locations and fintech-based services. Because challenger banks have bank charters, they can offer customers traditional banking services like credit cards and mortgages, as well as applications-based ones. Other advantages of a bank charter may include access to the Federal Reserve’s discount window and direct access to the payments system. One of the best-known challenger banks is Varo, which obtained a national bank charter in the summer of 2020.
Return of the Industrial Loan Company
A few fintech companies have sought and obtained industrial loan company (ILC) charters. ILCs are state-chartered financial institutions that have typically specialized in financing the products of a corporate partner, like an auto company.1 Five states currently charter ILCs: California, Indiana, Minnesota, Nevada and Utah; the vast majority of ILCs are Utah-chartered. In exchange for their charters and access to the federal safety net—including federal deposit insurance, the Federal Reserve discount window and the payments system—ILCs must comply with federal safety and soundness and consumer protection laws that apply generally to institutions insured by the Federal Deposit Insurance Corp. (FDIC). ILC parent companies that are nonfinancial in nature are not supervised by the Federal Reserve. This feature, among others, has made ILCs controversial, and the FDIC imposed a moratorium on new deposit insurance applications between 2006 and 2008 when Walmart and Home Depot both sought them. Another three-year moratorium was imposed in the Dodd-Frank Act.
In the last several years, a number of fintech firms have expressed an interest in an ILC charter, and the FDIC has approved deposit insurance applications for Square, a payments service provider, and Nelnet, an originator and servicer of student and other consumer loans. Several applications remain in the pipeline.
A Crowded Field
Digital banking options, like the online banking option for traditional banks, received a boost from pandemic-induced shutdowns of bank branches and limited banking hours. Most analysts expect double-digit growth rates in users and transactions to continue as more competitors enter the field. As digital banking companies increase in prevalence and market share, competitive, regulatory and consumer issues will become more important. We will be exploring these topics in future posts.
Notes and References
¹. For a detailed discussion of the origins of and public policy issues surrounding ILCs, see Neely, Michelle Clark.
“Industrial Loan Companies Come Out of the Shadows.” Regional Economist, July 2007.