Vertical Neobanks

March 2020

A few people have written about “embedded finance”: nonfinancial software companies that have a material financial product. Shopify is the poster-child: SAAS + payments = subscription revenue + transaction margin, in an all in one solution with few peers, riding the wave of offline to online payments and commerce. Everyday, more and more examples of this trend emerge, most built on Stripe Connect.

Vertical neobanks are an emerging flavor of embedded finance, that happen to be on the issuing side rather than the acquiring side. They offer a product with core financial benefits, that differentiate them from the majors (Chase, Wells, BofA, Citi). Typically these benefits will include one or more of the following:

  • Faster time to money
  • savings on money-movement,
  • additional earning in some way,
  • risk shifting/insurance (I’ve not seen many good examples of this last one)
Most examples I mention below are simple logical extensions of what’s out in the marketplace. The economics are there - deposits can be monetized via float and spend can be monetized via interchange, and the data exhaust might make for interesting lending opportunities. The technology to do this is also available if still a bit tough to work with. This market is currently bounded by imagination and execution, mostly of operators who haven’t historically been in financial services.

You can think of a vertical neobank as a checking account + debit card product, focused on a specific customer segment (rather than focused on a broad swath of “consumers”) that solves a money movement problem for that customer segment segment, and monetizes by capturing the balance available to that customer segment at the end of the money-movement. Most vertical banks look like: “Checking account + money-movement tool that automates something that was previously really manual and error prone”. I use money-movement here because it’s not exactly a payment - sometimes the same customer is on both sides of the transaction. The important parameter is that they are in a financial flow, and they materially impact the flow of funds, rather than simply providing information, visibility, or analytics about the customer's money.

The two categories I’ve been able to identify thus far are 1. Software or tech enabled companies with a large user base, offering financial services to their specific userbase, and 2. Brand new startups building both the moneymovement product and the checking account from scratch, in parallel.

  • Mercury: Vertical neobank for startups. (in category 2)
    • Product = checking account + APIs.
    • Benefits: move money programmatically
  • Square Card: Vertical neobank for micro merchants. (in category 1)
    • Product = checking account + Merchant Processing
    • Benefit = low cost reliable payment processing and point of sale
  • Uber: Vertical Bank for drivers (in category 1)
    • Product = checking account + ride payments
    • Benefit = instant access to funds, and discounted access to driver supplies

In writing this I realized several of the companies that led me to this insight not yet public, so I can’t list them here just yet. I'll update later with their permission or after they launch publicly.

Why companies like this

A few things make a vertical neobank strategy very appealing to a company with a captive segment, operating at scale:

  • When the company starts taking deposits (on a bank partner) they can also monetize interchange (& more rarely float), in addition to their core business. In non-consumer cases, this is monetizing commercial debit or commercial prepaid, which is higher than consumer debit interchange.
  • These companies have already built some financial discipline into their business as they’ve been moving money, and have some prior art around fraud, risk, etc.
  • The customer segment already trust these businesses with their money and financial data,
  • The captive bank account/balance construct removes one hop from the moneymovement flow. For instance, Square Card sellers previously had their payments flowing into an external bank account after using a Square terminal. The Square Card removes that additional transfer, and all the associated latency, exceptions, operational intensity and so on. In addition, it enables “instant” access to funds for no incremental cost to the seller.

Why customers like it

This arrangement will also have appeal for the customer segment for a few reasons. First, Chase, BofA, Wells and others have always been quite horizontal. They’ll take your deposits, make money off you and charge fees, but their offerings are roughly equivalent to one another, and roughly equivalent regardless of your needs as a customer. In addition, lots of customer segments have unique payment, financial or tax related problems that have grown complex enough to warrant a whole industry that solves only the non bank problem; think of things like bookkeeping, payments, taxes, etc. To focus on one, would seem like a distraction and call into question why Chase (or it’s peers) are not focused on the others.

Second, Chase, Wells and others would not perceive it as their responsibility to build a solution to a problem that’s not traditionally a banking problem (even though it is a material financial problem to you as a customer in that segment). Finally, the majors actually make it incredibly hard to open a business bank account. I once spent 4 weeks opening a Chase business banking account; it involved sending 4 faxes, calling back twice and walking physically into branches twice to hand verify a piece of paper I had previously faxed. All this after signing up online. There may be some unspecified good reasons for a “Globally Systematic Important Bank” to do this, which I won’t discuss, but regardless, it is not a good experience for any customer.

In the future, as issuing platforms become more mature and less expensive to experiment with, I anticipate you’ll see even more vertical neobanks. As the barrier to entry for issuing drops, you’ll see one of these from every company that has aggregated a captive segment of customers, and stands in their money flow. Some fun examples:

  • Styleseat: Vertical neobank for hairstylists.
    • Product = checking account + booking & payment processing
    • Benefits = cashback on supplies
  • Shopify: Vertical neobank for shopify sellers.
    • Product = checking account + POS + payment processing
    • Benefits = discounts on popular shopify apps
  • AirbnBenefits: Vertical neobank for Airbnb hosts.
    • Product = checking account + deposit Airbnb payments
    • Benefits = instant access to Airbnb payments
  • ThumbCard: Vertical bank for Thumbtack professionals
    • Product = checking account + payments
    • Benefits = instant access to funds + cash back
  • FaireCard: Vertical bank for independent retailers
    • Product = checking account + working capital
    • Benefits = discounted access to inventory
  • Getaround: Vertical Bank for Car owners
    • Product = checking account + getaround payments
    • Benefits = instant access to funds
  • InstagramCard: Vertical Bank for influencers & creators
    • Product = checking account + instagram & brand payments
    • Benefits = instant access to funds, discounted access to creative equipment
  • SpotifyCard: vertical bank for musicians and podcasters
    • Product = checking account + spotify payments
    • Benefits = instant access to funds, discounted access to recording equipment etc

I could go on, but you get the picture. A big hurdle to this stuff happening today is that the banking-as-a-service platforms that exist are so intensive to integrate with, that for most companies I’ve listed above, it’s still too expensive to run this experiment; they can't even get a prototype up during a hack week because they need a whole BD team to go negotiate with most BAAS platforms prior to issuing an instrument.

As far as I can tell, you need at least two things to successfully run a vertical neobank program; proprietary customer acquisition in a specific segment, and differentiated financial benefits for the segment. This is not unlike co-branded cards of yesteryear. Programs like the Costco card and the United MileagePlus card worked really well for years because United had massive scale customer relationships through its loyalty program. This meant essentially that Chase (as the financial partner) could acquire a relatively high quality customer segment for incredibly low CAC (cost of acquisition would essentially be the deal economics with the brand). The same is true for category 1 companies, and the main difference is, because they are in the money flow they can compete for deposits, and in competing for deposits, they don’t have to be especially good at credit or underwriting to succeed. And if they do well on the deposit/debit side, at some point the tail wags the dog.

Thanks to Temi, Femi, and Bo Jiang, Roberto Medri, Jim Esposito, and Justin Overdorff for reading this in draft form.

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