What’s important when pursuing a sponsor bank strategy

In this rising-rate environment, sponsor banking is becoming a more relevant and appealing strategy because it represents a way to grow deposits and boost both interest and non-interest income without as many operational and fixed costs as physical branches. And it can further accelerate the innovation of fintech products that offer more human-centered value propositions to consumers and businesses alike.

Sponsor banking is not a strategy that should be entered into lightly. There should be careful consideration into how to best pursue sponsor banking, making strategic decisions based on an institution’s unique needs.

When pursuing a sponsor bank strategy, banks must decide if they want to have a direct banking-as-a-service model or work with a BaaS provider. One of the most important factors to consider is the resources the bank can dedicate to BaaS to oversee compliance, put all the pieces together and manage the program on an ongoing basis.

The regulatory environment around BaaS has intensified over the past year, with more attention than ever on bank-fintech partnerships, and more specifically, BaaS programs. Banks pursuing a sponsor banking strategy must ensure they are able to integrate compliance analysis with ongoing project management to maintain a strong compliance stance throughout to avoid fines and scrutiny.

Another critical factor is the existing tech stack. Will the bank’s current infrastructure be able to support complex BaaS use cases? This can be especially concerning for those that are leveraging dated technology and legacy core banking solutions that might not have the flexibility and sophistication to handle robust BaaS offerings.

Transaction volume also plays a role. Will the bank generate enough revenue from BaaS per month that they’d be able to afford building and maintaining the infrastructure to offer BaaS directly and generate ROI from continued incremental growth?

Trying to be everything to everyone is a common mistake in financial services. To avoid this misstep, banks pursuing a sponsor bank strategy should determine a specific niche or affinity group of end users to target. For example, maybe a bank decides to prioritize fintech partnerships that benefit small businesses or commercial customers. Or, perhaps the focus is on subprime consumer lending. Either way, there should be a clear focus.

Prioritizing a specific niche creates greater operational efficiencies. Banks save time, effort and employee hours dedicated to serving end customers. Laser focus allows banks to gain valuable expertise, access to accelerators, intellectual property and competitive contract terms. In essence, a niche strategy allows banks to more effectively create a meaningful differentiator – something that has become increasingly difficult in the current community and regional banking space.

Having a specific focus can also enable synergistic opportunities between a bank’s fintech partners. For example, let’s say the bank is focusing on small-business fintechs. It becomes possible that a specific SMB-focused fintech becomes even more valuable when combined with other similarly focused, non-competitive fintechs that are also focused on small business. Because the fintechs focus on better serving a particular group of end customers, there are likely strong complements between the technologies, which drive greater value when combined.

Even though the sponsor banking strategy isn’t for everyone, the path has notable benefits for those who execute it well. However, those who are pursuing this avenue should do so with their institution’s unique strategic objectives, strengths and weaknesses in mind, considering whether a direct or BaaS partnership model is the best fit for their institution, as well as which segment to prioritize. Those that strategically approach sponsor banking have the potential to gain broader wallet share, create new revenue streams and form stickier customer relationships.

Tim Hamilton is founder and CEO of Praxent