For more than a decade, payments has been the natural entry point for fintech firms seeking to enter financial services. Facilitated by regulatory initiatives such as the various Payment Services Directives in Europe, payments offered new entrants a scalable, capital-light business model capable of attracting customers rapidly and at relatively low risk.

Unlike lending, payments generates fee income without requiring firms to take on significant balance sheet risk, while also benefiting from network effects and comparatively simple operating models. For these reasons, many of the sector’s most successful firms, including Revolut, Wise, Stripe and Adyen, initially concentrated on payments.

But payments alone limits profitability. For firms that have successfully established payments franchises, acquiring a banking license offers the prospect of expanding into core banking services and accessing new revenue streams.

In practice, this means developing capabilities in the two activities that lie at the heart of retail banking: lending and deposit-taking. Both offer significant commercial opportunities, but they also introduce operational, regulatory, and risk management challenges that differ fundamentally from the payments model.

The real economics of banking lie in lending. While payments businesses primarily earn transaction fees, lenders benefit from net interest margin, creating a potentially larger and more diversified revenue stream. In addition, lending creates opportunities for deeper customer relationships and broader product cross-selling.

Yet lending represents a fundamentally different business model. It requires the ability to assess creditworthiness, manage loan portfolios and absorb losses during economic downturns, all within a far more demanding regulatory framework. Managing credit risk is a whole new world for former payments providers, many of whom have little lending culture and have struggled to recruit personnel with the requisite experience.

Retail banks are ultimately in the business of credit underwriting. Lenders must be able to assess customer affordability, probability of default, and the value and convertibility of collateral. Lending must also take account of economic cycles. While payments businesses tend to perform relatively consistently, credit losses can rise sharply during recessions, unemployment shocks and housing downturns. Lenders must also guard against concentration risk across customer segments, sectors, and geographies.

Developing a credit risk culture is not achieved overnight; rather it is the work of years, even decades, and must address:

• Credit policies
• Loan approval authorities
• Collections
• Recoveries of delinquent debts
• Provisioning for bad debts
• Loan portfolio management

It is not hard to see how an organization rooted in technology might underestimate the difficulty of building these capabilities.

Meanwhile, a retail deposit franchise is one of the most valuable assets in banking which explains why a banking license is so highly prized.

In addition to being cheaper than wholesale funding, retail deposits are typically more stable and diversified. They are also relatively ‘sticky’, whereas wholesale funding can become scarce during periods of market stress, as witnessed during the Global Financial Crisis.

Becoming a retail deposit-taker, however, invites far greater regulatory scrutiny. Not least is capital adequacy, as banks must hold sufficient regulatory capital to support their lending activities.

The transition from payments provider to deposit-taking institution represents not merely a product expansion, but a significant organizational transformation. The commercial opportunities presented by lending and deposit-taking are matched by a range of risks that require careful management.

Credit risk is paramount, but liquidity risk is also critical. Customers placing money on deposit require access to it at relatively short notice, while banks lend those deposits over much longer periods. This maturity transformation means banks must always maintain sufficient liquidity to meet customer demand.

Where confidence is eroded, the result can be a bank run with catastrophic consequences. Consequently, stress testing and contingency planning for extreme situations are central components of risk management.

Other risk factors include:

• Interest-rate risk: adverse movements in interest rates.
• Operational risk: losses arising from failed or inadequate processes, people, systems and external events.
• Conduct risk: the risk that a firm’s actions lead to unfair customer outcomes.
• Cyber risk and financial crime: ever-present threats in a digital banking environment.

Investors are often wary of payments companies becoming lenders, particularly when they attempt to scale at rates perceived to be excessive or risky. This was evident when buy-now-pay-later operator Klarna was punished by the market following the announcement of rapid lending growth.

This is not to suggest that lending growth is inherently negative. However, rapid expansion can signal weakening underwriting standards and future credit impairments. It may also require additional capital and funding, both of which can be difficult to secure.

This highlights the market’s different attitude towards banks and technology companies. Investors may tolerate higher growth and volatility in technology businesses but once those same companies cross into traditional banking, expectations tend to change. Banks are generally expected to deliver stable, predictable earnings and avoid unwelcome surprises.

In short, investors judge these institutions not only on customer growth, app downloads and payment volumes, but also on metrics such as return on equity, cost of risk, capital ratios, and liquidity. Loan growth must always be viewed in the context of loan quality. Net interest margin and loan impairment charges are also critical measures of performance.

For all the excitement surrounding digital banking and the success of app-driven offerings in attracting customers, particularly younger customers, the fortunes of fintechs that have reached the IPO stage have been mixed.

Revolut’s acquisition of banking licenses in Australia and the UK brings an additional layer of trust, not just among retail depositors but also with regulators in other jurisdictions where it is seeking licenses, something that should support future international expansion.

A banking license does more than permit deposit taking. It indicates prudential soundness, regulatory approval, maturity of governance, and financial resilience.

This means that customers view licensed banks differently from payments firms. This has a direct effect on a bank’s ability to gather deposits, sell mortgages, develop business banking and wealth management.

In terms of competition with incumbent banks, Revolut and its peers undoubtedly possess certain advantages such as a lower cost base, superior technology, customer engagement, international reach, and the ability to innovate faster. Against that, traditional banks have huge deposit bases, substantial branch networks and decades of credit experience.

The acquisition of banking licenses in the UK, Australia, and France should therefore be viewed not as the culmination of the fintech journey into banking, but as the beginning of a much more demanding phase.

Winning customers through innovative payments services demonstrated technological capability: but that is a much less onerous task than building a profitable, resilient lending institution across multiple jurisdictions.

Intuition Know-How has a number of tutorials relevant to the content of this article:

• Fintech – An Introduction
• Digital Banking – An Introduction
• Open Banking & Open Finance
• Payments – An introduction
• Payments Methods
• Payments Cards
• Retail Banking – Customer Service
• Retail Banking – Customer Onboarding
• Retail Banking – Customer Acquisition
• Retail Banking – Customer Retention
• Retail Banking – Customer Experience
• Retail Credit Risk – An Introduction
• Retail Banking – Risk Management
• Banking Regulation – An Introduction