Fintechs have been challenging traditional banks for a few decades now. Since the inception of the sector, fintech service providers were aiming to solve the inefficiencies present in legacy models: provide better coverage, accelerate transactions, reduce transaction costs. The umbrella term covers a diverse lot of companies from peer-to-peer payment services to automated portfolio management and trading applications, but in some sectors fintechs have been particularly successful.

By the end of the last decade only 4% of global consumers were unaware of money transfer of payment fintech services, while three out of four consumers were using at least one service from these categories, EY estimated (their analysis included technology-enabled services from incumbent institutions, as by that time many established players, not just challengers, had started to invest in such solutions too). What was appealing to consumers is that fintechs were providing services that were “at once personalised, accessible, transparent, frictionless, and cost-effective”. What had been seen as disruptive in the mid-2010s became a prerequisite for all market participants.

The pandemic gave a further boost to fintech services. Researchers from the University of Zurich found that the spread of Covid-19 led to between 21% and 26% increase in the relative rate of daily downloads of financial apps – that is around 900 million downloads that probably would not have happened had not the pandemic stricken.

While all financial service apps saw a rise in adoption, bigtech and fintech ones experienced a further relative increase of 9% over the growth rate of traditional institutions, and this differential widened over time. The largest share of downloaded apps can be attributed to general banking apps, those that bundle services, but unbundled services (payments, lending, insurance) grew at a relatively higher rate.

That is to say, innovative capabilities of providers, those associated with targeted and niche products and lower costs, turned out to be significant drivers of adoption. Over 70% of interactions with banks globally now take place through digital channels, McKinsey states, and the fintech sector is projected to grow at roughly three times the overall banking industry’s growth rate between 2022 and 2028.

One more crucial outcome of the pandemic was the acceleration of digital solutions’ partnerships with financial institutions. A prominent example would be Apple’s collaboration with Goldman Sachs in terms of provision of savings accounts in 2023. For fintechs the benefits of cooperating with banks are even more straightforward than for bigtechs. They provide the technology, while banks have funding, customers, and compliance infrastructure, and these can produce an obvious symbiosis.

The pandemic made this potential particularly noticeable: almost 90% of senior bank executives in the UK regard technology, automation, and digital investment as their top strategic priority in the next 12 months, while in the US 39% of banks report having already partnered with fintechs for payment facilitation and money movement (and another 39% are planning to do so). As a result, on average a bank now has 9.4 fintech partners, as per Gartner. Barclays partnering with Form3 to develop an access solution to Europe’s SEPA Instant payment scheme would serve as a good example.

Some fintechs might prefer to become banks themselves rather than to cede some of their customer value to partners. Take Klarna that started in 2005 as an online payments solution, but 12 years later secured a banking license. The company explained at the time that this was ‘a natural next step’ for it, enabling it to broaden its product portfolio for both companies and merchants.

Right now, fintech service providers operate under a variety of license types. In the UK, for example, there are EMI (Electronic Money Institutions) and PI (Payment Institutions) licenses. The latter, unlike the former, cannot issue electronic money and can only manage funds within regular bank accounts in order to facilitate payment operations.

For example, Wise was operating as a PI at first, but later transitioned to an EMI license to be able to issue payment cards and provide multi-currency accounts. If fintechs aspire to become banks in the UK, they can go through a two-stage process, where at first, while they do not yet fully meet all regulatory requirements, they obtain a banking license ‘with restrictions’ and then go through a ‘mobilisation’ process – that was the path challenger banks like Starling and Monzo took.

In the EU a company can obtain the licenses of PI (Payment Institution), PSP (Payment Service Provider), or EMI (Electronic Money Institution) – the latter is obligatory for those companies that provide their clients with electronic wallets that allow them to withdraw money. These licenses also come in the form of small, restricted, and specialised for companies with a smaller set of services or with monthly limits on transactions.

Then there are specialised banks, for which the capital requirement stands at only 1 million EUR. Such a license can be issued by the ECB through the Bank of Lithuania, and it only restricts the recipient from providing investment advisory services, securities brokerage, investment fund management, and similar services.

Then, finally, there is the full banking license. Becoming a bank comes with certain trade-offs. On the one hand, this allows a fintech company to provide a wider array of services to clients (including taking deposits) as well as to invest its clients’ assets into a wider array of instruments. Moreover, in certain jurisdictions it alleviates the burden of having to secure specific licenses for different types of services (lending, money transfers) or, in the case of the US, for different states, not to mention the opportunity to become part of deposit guarantee schemes.

On the other hand, being a bank means more stringent regulatory oversight, in particular having to comply with stricter capital and liquidity regulations and compliance measures – and those are becoming even tighter as countries around the world are finalising their Basel III regulations, which would cover both more banks and more risks (the US would be an obvious example in this regard, where the final Basel III has become a battleground for banks and regulators). Apart from capital and liquidity it will also be necessary to significantly increase the level of backoffice and infrastructure sophistication, as well as internal functions and processes. This will take time and resources.

Moreover, becoming a bank implies having a bank balance sheet – with its non-liquid clients’ assets, credits, and more – which makes capital tied up and less flexible, thus limiting a company’s growth potential in the middle to long term. That, in turn, restricts valuation, which becomes anchored to a more standard bank’s price/book metrics. Further growth in this case becomes highly dependent on additional capitalisation.

Getting a banking license is not a straightforward step anyway, where the extent of hardship depends on jurisdiction. Take Figure Technologies, a blockchain and lending startup: it had waited for years for an answer from US regulators before finally deciding to withdraw the application for a bank charter in the summer of 2023. By doing so, Figure followed in the footsteps of other fintech firms that had given up on the idea of seeing their banking-charter applications through. This list includes, among others, the British online bank Monzo.

To avoid these difficulties, some fintechs have chosen a different approach – instead of becoming banks they resorted to buying already existing ones to secure a charter. LendingClub was a pioneer in this regard in the US.

The recent rate hike cycle has underlined another rationale behind fintechs’ efforts to become banks. As the rates climbed, although having more opportunities to monetise clients’ balances, fintechs did not directly benefit from either higher rates that consumers had to pay on their loans or the increased demand for deposits that normally follows rate increases.

At the same time, rising rates contributed to financing for fintechs dropping to its lowest level since 2017 in 2023, a 50% decrease year-on-year, according to CB Insights – which makes scaling up problematic, particularly when it comes to consumer offerings. This estimate pertains to the wider fintech industry, and it is not, of course, homogenous. For banking startups things were even grimmer, as funding in this subsector plummeted by 72% in 2023. Payments were doing better than average though and remained the most well-funded subsector.

However, certain trends still work in fintechs’ favour. Figure’s founder Mike Cagney explained the decision to refrain from further pursuing a banking license in an article for Fortune. Apart from pointing to the problem of banks’ trading on a multiple of book value, not earnings, he argued that the recent push for tighter capital requirements for banks could drive some lending out of banks and towards non-bank intermediaries, including fintechs.