Square, Inc. officially launched its own bank earlier this month. This news comes after a regulatory approval process with the FDIC and Utah Department of Financial Institutions that took several years. The new entity, Square Financial Services based in Salt Lake City, will focus initially on offering business loan and deposit products to its customers that already use Square for their payment processing services. Any new products will add to the business loans Square Capital already offers which were issued in connection to a partner bank.
The plan to bring banking in-house will allow Square to broaden the offerings to its customer base as well as be more agile and flexible with operations.
The company does not expect this to impact the financials much this year. They will limit their balance sheet exposure by selling loans to third-party investors.
This move will also differentiate them from other competitors in the merchant services and business lending spaces as it is not common for fintech companies to obtain bank charters.
The competition in the segment of the industry in which Square Capital competes, now with its bank Square Financial Services, will intensify. This move should not be underestimated by anyone including even traditional banks. Square will likely keep scaling and add to their maximum lending amounts. Since the FDIC approval for this bank happened about a year ago, I am sure most competitors have been strategically planning and have taken some actions already.
Although I believe it’s still an industry in between the growth and shakeout phase, this development will move the industry definitively into the shakeout phase. Companies like Paypal, Enova-who recently acquired OnDeck, and Bluevine are all industry leaders with considerable stakes that have also expanded products to stay ahead of the curve. Bluevine for example launched its own business checking accounts.
Smaller companies will be forced to make tough decisions. There have been several mergers, acquisitions, and lenders closing over the past year, some of this due to the pandemic. I expect that to continue as these lenders fight for market share and create strategies that they can keep pace with Square or move ahead.
The main competitive advantage for many alternative financial institutions is data. Square gains more of this internal resource from a client that uses its Square processing systems which then is used to offer loans to those businesses. The more data they obtain, the better the pricing on the loan because of less risk. For the competitors that don’t have this processing data, they have to use other means of obtaining data in their underwriting models that may be slower and have more friction. For example, having to receive PDF bank statements or customers linking their bank account using a third-party company to verify transactions via software integration. Even then, they don't control the accounts money is flowing through.
By becoming a bank Square will add to the data sources as they will have a more complete banking ecosystem for merchants. This will help the merchant in better user experience and opportunities while also possibly increasing market share for Square as competing firms fail to acquire enough customers, cannot compete with the products or the cost of funds Square can offer.
The competitors who are smaller, have a higher cost of capital and thus compete at higher price points for loans, or other alternative lending products like merchant cash advances, may not for the foreseeable future be able to compete with Square. They will concentrate their efforts on those merchants that aren’t in the Square ecosystem, or won’t qualify for Square or similar technologically advanced lenders. Whatever their intended strategy formulated previously may need to be adjusted. They will need to improve efficiency and technology to stay competitive in their pricing segment and ultimately survive long term.