The regulatory reckoning for the banking-as-a-service space is still in early innings, according to the CEO of Pathward.
Sioux Falls, South Dakota-based Pathward, which offers payments, card issuing, consumer credit, and tax solutions through its banking-as-a-service business, counts a little over 30 partners, said CEO Brett Pharr. The branchless bank, a frequent partner to fintechs, had about $7.6 billion in assets as of Dec. 31, 2024.
Pharr dubbed Pathward – formerly MetaBank – one of the “pioneers” of the BaaS space, having jumped into the payments business about two decades ago. He joined the bank in 2019, after a stint at Citizens and more than three decades at Bank of America.
Following a recent fintech boom that brought new entrants into the space, some BaaS players are “crashing and burning,” which has contributed to regulatory pressure, Pharr said during a recent interview. Last year’s collapse of fintech middleman Synapse highlighted some of the blind spots in the business model.
“There have been such high-profile failures that particularly hurt consumers, and nobody will tolerate that,” Pharr said. While he expects some regulatory relaxation more broadly, he doesn’t think that’ll extend to the BaaS space.
Editor’s note: This interview has been edited for clarity and brevity.
BANKING DIVE: Do you think the regulatory reckoning for BaaS is winding down, as regulators and banks have learned more about the business?
BRETT PHARR: Some people think we’re a long way through this. I think we’re just getting started. There are topics that haven’t been hit yet. Most of the focus up to this point has been around ledgers and reconciliations, and Bank Secrecy Act/anti-money laundering. There hasn’t been a deep dive into third-party, nested third-party, fourth-party arrangements, or deep investigations into compliance topics like Regulation Z (Truth in Lending) and Regulation E (Electronic Fund Transfers). I think there’s another whole round of regulatory scrutiny that’ll continue to put pressure on the space.
Do you expect the focus on third-party risk to remain, despite changes at bank regulatory agencies?
You’ve got to have enough integrity and confidence to know whether you’re hurting the consumer, and third-party risk management is how you do that. You’re supposed to track complaints and have a complaint management system on your partner, but newer BaaS banks did not set up a complaint management system; they don’t even know what the complaints are. It’s that kind of thing.
Some of these middleware providers, that sit between the bank and the fintech, that’s a business model that’s not going to work. Generally, we do three-party agreements, so we have line of sight. That customer that has money in my bank is my customer, because I'm the one that's providing pass-through FDIC insurance. I have to have that direct agreement.
Do you expect more banks will get in or out of BaaS?
There are banks that have gotten into this in the last three to five years, sometimes with a single product. Some will decide to get out, some will decide to invest heavily. It depends on the segment. Most of our business, early on, was based on interchange income, through swipe fees at merchants. An increasing part of the opportunity in BaaS is no longer related to interchange, and that means all banks can play, so you can have very large banks in this space, too.
More banks will get out, because they’re not able to solve the problems they want to solve, or they’re not willing to invest. We saw deals being done that made no economic sense, because they weren’t pricing in the cost of compliance. If you’re not doing that, the partner business model doesn’t work. Some of the partners are going to go out of business, too. You’ve had a first round of fintechs that have kind of washed out. We may have another round, because they can't just do customer acquisition. You actually have to make a profit.
What kind of opportunity is Pathward seeing as banks leave the BaaS space?
It comes in two forms. One is, a bank is getting out and somebody wants a new bank. Or, we’re seeing a lot of, I don’t want to keep all my eggs in one basket with one bank; I want to have two banks, so that they don’t get left hanging in case somebody has a problem. We’re seeing that in the payments side but also in the marketplace lending side. It’s given us some good opportunities.
Are you worried about banks losing their place in this ecosystem if more companies obtain bank charters?
History is filled with non-banks that got a bank charter and either gave them back or wished they could. I have a great partner in H&R Block; they got rid of their bank charter. You’ve got some that have bought banks for a charter. There’s a real problem when you have something bigger running the bank. Everybody that’s not a banker that gets a bank charter has no idea what it’s going to take to run that bank. Banking is a culture.
I’m not worried about it. There will be some that obtain bank charters, no doubt. But they’ll spend an awful lot of time trying to figure out how to own a bank.
Lessons learned from the New York attorney general’s investigation, which said Pathward unlawfully froze customer accounts and transferred money to debt collectors?
It’s about third-party management. We operate as a national bank in 50 states. You have to have a specific procedure in place in each of the 50 states, and that speaks to the complexity of it. Things were missed, no doubt about it. We very quickly worked with them and resolved it. It was one partner in one state that was the problem, in one topic, which speaks to how complex third-party risk management is.
You could be partnered across 50 states, 120 rules across different states, and you miss one. It’s going to happen in this space. The question is, what do you do about it and how do you fix it?
