Getting licensed - A business in itself

With regulators worldwide becoming more and more demanding and processes to get licensed becoming more and more costly and complex, obtaining a license from a regulatory authority has become a full business in its own.

Not only are there (lawyer) firms (such as FLA = Financial Licensing Advisors, Simont Braun, Four & Five…​) specialized in composing these types of license files, but many financial service companies also try (often in very creative ways) all kind of work-arounds to avoid having to go through this painful and complex licensing process and this for multiple reasons:

• The cost and effort spent on obtaining the license, i.e. not only the cost of writing and defending the filing, but also to make the necessary adaptations to processes and IT systems to comply with the imposed restrictions. E.g. in the US, Varo Money is considered to be the first consumer Fintech to obtain a nationwide banking license/bank charter (after approval of Federal Deposit Insurance Corp in February of this year). This process is however estimated to have cost them around 100 million dollars.

• The outcome of a licensing process is difficult to predict, as the assessment of the regulators is not an exact science. Instead it is often a matter of having the right network (you need to be already part of the community, before being able to enter the community) and making sure the right lobbying and political support are in place. Regulators are often reluctant to grant a licensing request, as a new player increases the overall inherent risk of the financial landscape and with the regulator having a limited number of resources for controlling financial services companies, every new party which needs to be regulated, means less time to properly monitor the existing institutions. As such regulators are keen to keep the status-quo, unless of course necessary (political) pressure is enforced.

• The time-to-market, as certain licensing trajectories can take months if not years to complete. Even in a small country like Belgium, it took the cooperative, ethical and sustainable bank NewB almost 9 years (between May 2011 and January 2020) and over 30 million euros to obtain a banking license.

• The capital requirements associated to each license, i.e. the amount of capital in the form of cash to guarantee the operation of the bank, with a sufficient buffer for exceptional situations.

• The resulting increase in operational cost after obtaining a license, due to all kinds of reportings, audits, certifications…​ to be delivered on regular intervals.

The most common workarounds to avoid obtaining a full banking license are:

• Obtaining a lighter type of license, like a Payment license, EMI license, broker license, credit agent license…​. These licenses often allow to offer banking services which resemble very strongly to the services of a fully licensed bank, while regulatory requirements are much lighter.

• Applying for an exemption on certain licenses, e.g. working via a commercial agent model, imposing restrictions on the usage of the money managed by the institution (in order not to qualify as eMoney)…​

• Buying over an existing smaller player (i.e. an already licensed player), with the main purpose to obtain a license. E.g. in February of this year, LendingClub bought Radius Bank (a small Boston-based bank) to short-track the process of obtaining a banking license. Such an operation is however very capital intensive (e.g. LendingClub paid $185 million to acquire Radius Bank) and numerous past examples show that this is a strategy with no guarantee of success.

• Partnerships with existing banks taking care of the distribution and servicing of the product or partnerships with licensed "Banking as a Service" firms (such as Mambu, Railsbank, Fidor…​) which allow the non-licensed institution to build a full distribution layer on top. E.g. in the US, Monzo is partnering with Ohio-based Sutton Bank to deliver its banking services, although Monzo bank also claimed it will apply for a nationwide bank license as well.

These alternatives are being explored by many (B2C) Fintechs, in their struggle to become more profitable and acquire more customers. Often due to their lack of a (nation-wide) banking license, they cannot present to their customers an offering, which is sufficiently diversified and compelling (the lack of a license imposes too much restrictions).
Still some Fintechs (like Varo Money, Square or the cryptocurrency exchange Kraken) take on the bold challenge to obtain a full banking license, as this is probably the only way to compete head to head with the incumbent banks. In licensing, it’s usually better to be over-licensed than to be restricted by your licensing boundaries.

While most financial services companies struggle with the ever increasing and continuously changing regulations, these same regulations often form a though barrier for Fintechs (and more specifically neobanks) to cross, especially when they want to expand internationally. Not only are the customer needs and legal and tax requirements very different from country to country (making it difficult to come with one standardized digital platform), but also from a regulatory point of view, often a license in 1 country is useless for another country (with the exception of the European Union, which allows to passport licenses from one country to another).

The extra regulation that comes with a more extensive licensing can however also have negative effects (cfr. my blog "How too much compliance might actually increase the risk of financial service companies" - https://bankloch.blogspot.com/2020/10/how-too-much-compliance-might-actually.html). Not only does it tend to lead to bureaucracy and blocking the creative process of innovation, but it can sometimes even lead to bigger risks. For a Fintech, which finds its existence in digital-first, innovative services, which are delivered in a very agile way, the regulatory constraints linked to banking licenses (i.e. being able to justify every action using processes, controls, checks, and logs to keep an audit trail as evidence) can work paralyzing to the organization. As such Fintechs and smaller banks wanting to expand internationally need to carefully design a licensing strategy that fits their strategic objectives and company culture.