Anthony Sharett of Pathward on how to do banking-as-a-service right

Thanks, Peter. Thanks for having me. It's great to be here.

Yes, I am. I've been in the banking industry for pretty close to 20 years. I did start out as a bank regulator, as it were, and quickly moved into advising financial services companies, banks and credit unions and fintechs, both around litigation and regulatory compliance. And then quickly migrated to positions inside of financial services companies. I felt like I wanted to be closer to the strategy and the strategic decisions that were being made to serve customers. And now I'm at, grateful to be here at Pathward Financial, and I'll be celebrating my five-year anniversary later this summer.

What we like to say is, and we don't just say it but I'm proud of the fact that we embody it, we are a purpose-driven organization. Our purpose is powering financial inclusion for all. Look, we recognize that there are those that are out there that are either unbanked, underbanked, or frankly just underserved. We know there's millions of Americans that do not have access to financial services. So what we do at Pathward is we try to fill that gap, fill a void, by providing products and services to those that need it most, through partnerships, many fintechs who we can work with together to help them.

Well, 2022 was a pretty important year for us. We have our roots in community banking. The old MetaBank was founded in 1954, and we had branches just like any other community bank in America would have. And over the years, through our people, our process, and some technologies, we evolved. And we felt like because of that evolution, through our partnerships with fintechs, because of the unique products and services that we are providing, particularly in the payment space, Peter, we felt like having one unified brand and one identity was important. Secondarily, we were a conglomerate of different companies that we had acquired over the years. Whether that was on our banking as a service side, we also have a commercial finance portfolio and we have a tax business. And a lot of those entities were acquired, and while we tried to integrate them into one enterprise approach, we found that difficult under the old MetaBank brand. So we recognized that having one unified brand with a name that matched our brand identity, we're happy that we came to the name of Pathward, which is essentially a combination of the words path and forward. And we're excited about the opportunity to partner and have an opportunity to be able to capitalize a bit on transferring our intellectual property and our brand to Beige Key LLC, which most people by now know was formerly Facebook.

Despite some of the things that are happening regulatorily in the BaaS space, we remain here at Pathward bullish and excited about what's on the horizon. Now, we can't ignore the fact that many BaaS banks are facing regulatory challenges, primarily in a couple of areas. Number one, third-party risk oversight is certainly an area of opportunity, particularly for those burgeoning BaaS banks. Look, five years ago, I think I could have counted the number of BaaS banks that were truly BaaS banks here in the United States from fingers and toes. That's no longer the case. We're seeing a proliferation of smaller community banks and credit unions and other financial services companies attempting to get into the BaaS space. But I think what many financial institutions, particularly those that are new to the market, are finding out is that despite the fact that technology is important, and so is talent and having a good product to offer to consumers, having a third-party risk oversight, having the right governance, and having the right risk framework in place to protect consumers is really important, but it's also very hard to do right.

Well, you know, look, one of the things that we've seen is, Peter, you saw a bunch of what I would call middleware companies entering this space. And what they have attempted to do is provide a technology or a platform that would connect financial services companies, banks, with other FCHs that are providing a go-to-market solution for customers. The challenge with that is, number one, some of these fintechs and middleware companies did not necessarily understand the requirements around risk and compliance in order to operate responsibly. Number two, some of these companies that were looking to partner with some of these middleware companies, these banks did not necessarily have the framework necessary to safely and soundly go to market. And then third, the technology element of this, while on the surface may appear to be innovative and be the right solution, is very difficult to operationalize and bring it to life in a way where you can grow and scale it. And so what has happened is, as the federal regulators were understanding there was some growth in this area, certainly because of their oversight, they wanted to make sure that these go-to-market strategies were deployed in a safe and sound manner. And what we've seen is a couple of things. Despite the fact you may have a good go-to-market strategy or maybe even find a gap in the market that's helping consumers, without the right process in place, and I think maybe even more importantly without the right culture around risk and compliance, it's very difficult to do that in a short period of time. Look, for Pathward, it took us years to understand the framework that needed to be in place to not only ensure that we've got a good product that helps consumers, but also to ensure that we have the right partners so that we can help them grow and scale in a safe and responsible manner.

Look, I'm not sure if it's dead. One of the reasons that we really like to work with fintechs and those that are innovative and creative is because of the principles, the owners, the founders, those entrepreneurs. They have a burning desire to get it right. And many of them are so bullish and committed to innovation that I'm not going to sit here and say that no one's going to figure it out. But what I am saying is, we've taken some time here. I went to Money 2020 three or four years ago, and there were a proliferation of these middleware companies that were really convincing around the fact that they had a right to win, they found a gap in the market, and that they were going to be able to scale it and grow this. Fast forward four or five years later, we've seen some challenges. Despite that, I do think there are going to be some middleware companies that are going to continue to try to figure this out. But what I am seeing is, look, companies like Pathward and others that have been taking an incremental, left foot, right foot approach to technology, to co-creation, to innovation, I think we're starting to see many of us turn the corner as it relates to that and really partner with fintechs to find solutions together, as opposed to it being sort of a plug-and-play approach.

Absolutely. We are fortunate because of our risk and compliance framework, because of our ability to co-create with our partners, which frankly, Peter, is a newer capability for us that we're very excited about, using a design thinking approach and other innovation strategies. We have several fintech partners that we're proud of, and I'll highlight a few. Most people have probably heard of H&R Block. We are their sponsor bank, and it's tax season right now. I believe yesterday was tax day, so timely to talk about them. But certainly we're proud of the fact that we are a sponsor bank of theirs, and they've got several products and capabilities that are there to provide a more comprehensive approach to banking their consumers. We're proud of the Spruce card product that they have, which provides debit and banking services. Many of the things that they do are at no fees to consumers. So those that come into H&R Block that may want a more complete banking relationship, the Spruce card allows them to do that, and we're proud of our bank sponsorship behind that. That's one example. Another company that I'll highlight in partnership is Clair, around the earned wage access space. Clair a couple of years ago was named the fintech of the year. They had lots of options around who they wanted to partner with, and we're excited and proud of the fact that they decided to partner with us. So Clair allows frontline workers to earn their wages in a more efficient and streamlined manner. So certainly that is providing a service to those that need it, and we are proud to partner with them as well. Another one is Propel. Propel is a Canadian company, not even headquartered here in the United States, but they're providing a secured credit product allowing consumers to build their credit. So not only are we providing access to cash and money to those that need it, but this is turning into a progression to allow consumers to build their credit so that they can become banked if they would like and sort of earn their way to a more comprehensive banking relationship. So these are just three that I would highlight where we're proud of these partnerships. And ultimately, people ask, well, how did you choose these partners? If you've got a pretty robust pipeline, how do you choose the partners that you work with? It ultimately comes back to people. And we are proud and happy that not only are many of the principles and the executives and the team members that work for these fintechs great at what they do, but they do so with a purpose that is aligned with Pathward's.

It is that, that's right. It used to be that a fintech or a partner would come to Pathward and need, if it's on the banking as a service or payment side, they would want a bank that they trusted, because that's really what we provide to many of our fintechs. We want to be that trusted platform that helps them grow and scale. They would come to us and say, we have a product that we believe is meeting a gap in the market and that gives them and us a right to win. And so what we would do is try to then onboard this partner with this new solution in what was typically a customized way. What we found is that created friction for a couple of reasons. Number one, we had to many times fit a square peg in a round hole with how we onboarded and how we launched the product. Number two, there may or may not have been alignment on how to grow the scale of the solution for consumers that needed it. And then three, if there was a change that needed to be made, it was done so in a very customized and what sometimes could have been a disjointed way. So now what we do is at the very front end, using design thinking approaches and also through our product and solutions team, from the outset we have these teams meet together, most of the time on site, many times for multiple days in a row, where we can sort of sit down, brainstorm, whiteboard around what are the customer needs that we're trying to meet, what are some of the technology implications around launching this product, number three, what are the risk and compliance capabilities and things that we need to be thinking about, and then number four, peering around the corner, what gives us collectively the right to win. What we have found is, number one, that has reduced our onboarding and launch time with our partners. Two, we've been able to think about risk and compliance complexities more upfront instead of being reactive to those. And three, what we have found is from a revenue and profitability perspective, it's been easier for us to grow and scale these products and solutions for customers. So for us, this is now instead of becoming sort of ad hoc, this is becoming a repeatable process for us, and we're very excited about that.

I can. Number one, most robust and trusted risk and compliance frameworks for BaaS banks starts with the bank's culture. I think a lot of times people will think that it starts with a technology, a platform, or an enhanced process, but it actually starts with culture. We're proud of the fact that here at Pathward, we believe that we have an appropriate risk appetite, which leads to an appropriate risk framework, but most importantly, we take risk and compliance seriously. Our employees understand that it's a regulatory or a business moat for us and a business opportunity for us. We understand that it is actually up to us to ensure that consumers are protected through our partners. So for us, it starts with culture. Now number two, certainly enhanced processes are in place, both embedded within our business and through our second line risk and compliance teams. And so we're proud of the fact that our business leaders don't just say, well, this is a risk or compliance team's problem, or this is opportunity. We're all working on this together. And so we have risk and compliance professionals that are both embedded in the business and that also sit outside the business. And then number three, we are always looking at enhanced technologies that can not only help us prevent things like fraud at a greater prevalence, but also things around using technology for risk reporting and also to help us be a bit more predictive around things like fraud and things that can upend a good risk and compliance framework. The last thing I'll touch upon is our people. We are fortunate to have a group of professionals that, all the way from folks that are maybe right out of college, those that are more junior in their careers, to very senior and seasoned risk and compliance professionals, because we understand it's good to have a mix. We have folks that have been working in this space for the last 20 or 30 years, but we also have folks that are earlier in their career who are doing a lot of research around enhanced technologies and processes that are now being tested in the financial services space.

You know, Peter, what we try to do is it's a balance. Because on the one hand, as a bank partner, the last thing that we want to do is stifle creativity, stifle co-creation, stifle our fintechs who have a deep entrepreneurial spirit. We don't want to stifle that. And so, as opposed to, and yes, we certainly have partnered with fintechs that really did not have a robust risk and compliance framework or did not have a deep understanding of what's necessary in order for us to grow and scale together. As opposed to saying, you're not ready for this right now, or come back to us in three years when you have this established, what we try to do is help them grow through our experience, through leveraging some of our know-how, by showing them and educating them on our policies, our procedures, educating them on the landscape around this from a bank regulation perspective. So there's quite a bit of education that happens before we were to say, hey, you know, you're probably not ready for this right now, particularly with a bank like Pathward. We try to educate them first and bring them along with us around this before we were to say to come back to us in a few years. So have there been cases where we've worked with a fintech and determined that the timing wasn't right? Sure, that's happened. But before we do that, particularly if we believe in their product, their solution, their capabilities, we'll try to work with them before we make a decision about whether the timing's right or not.

Yes, we are. We're fortunate by the fact that we have a pretty full pipeline right now, as you can imagine. But having said that, we have a growth strategy ourselves here at Pathward. So understanding that our pipeline is pretty full right now, we absolutely are open for business as it relates to working with fintechs. And really what we're looking for is, number one, are we purpose-aligned? Do they have a product, a solution, or a capability that aligns with Pathward and who we are and the customers that we want to serve? Number two, have they found or do they have a solution that's unique? Is it a gap in the market where others may not be playing? That's pretty important to us. And number three, is there a way to reach more than just a few consumers? Is this something that through our trusted platform here at Pathward we can help them grow in scale? So these are some of the criteria that we use to evaluate new fintech partners. But we absolutely are taking on new partnerships through the lens that I just described.

Number one, the first thing that I tell them is they need to be educated and have an understanding of what the regulatory landscape is today, which is much different than it was a few years ago. And so if I'm a startup fintech that may not have a framework that's in place to allow for a bank partnership, we try to educate them on what it would take in order to do that right. So number one, just because a startup may not have a complete framework that is going to be easy to onboard and implement instantaneously does not mean that a bank like us at Pathward does not want to talk to them. There are lots of ways to get from A to Z. We can provide some consultative services to help them do that. Perhaps they could partner with a like-minded or like-missioned or another fintech that may be more mature as it relates to a risk and compliance framework, so it could be a partnership or a joint venture type of opportunity. Number three, it could be something that we want to take a look at. Is there an opportunity that may enhance a capability through a build by our partner relationship? And so I never decline calls when there's a small fintech that maybe just raised a few million dollars in capital but has a great idea. I always take that call. I always talk to them because what we have found is, despite the fact they may not be as mature on the risk and compliance side, it does not mean that there's not an opportunity for us to partner.

The way I think about innovation is in really three ways. You have your core innovation, and that is if you're trying to make a good process or within your business better. Adjacent is sort of, hey, this is innovation that is maybe adjacent to something that's happening, but through a few tweaks here and there we can make something go from good to great. And then there's transformational innovation, which is something net new in the market that we haven't seen before. From my chair, Peter, what I'm seeing is I'm seeing a little less what I would call transformational innovation, and I'm seeing fintechs and banks partner around either core or adjacent innovation. I think some of these concepts that were out there a few years ago that people argued were going to change the entire landscape of the way that customers were going to be banked, I'm not seeing as much of that. I mean, frankly, three or four years ago here at Pathward, we were talking about, look, our fintechs and we saw a lot of literature around this and scholarship and articles, our bank's going to be put out of business by fintechs. We're not hearing that so much anymore. Rather, what we're seeing is we're seeing banks and fintechs partner around what I would call core innovation. Perhaps it's making a risk and compliance framework a bit more efficient. We're seeing adjacent innovation. Perhaps there's an earned wage access product out there that we can make a little bit better. That's what we're seeing, and those frankly are the opportunities that we at Pathward are excited about.

We have a national bank charter through the OCC, so it's the same charter that some of the largest banks in America have. We do not have branches. So three or four years ago, we sold the community bank to another institution because we decided to make a pivot away from a community bank to primarily focusing on the businesses that we have today, which is primarily we are a BaaS bank, but obviously we have other sub-businesses that support that, which is our tax business where we provide refund transfer and refund advances for thousands of independent tax preparers across the country. And we're very proud of our consumer lending and commercial finance business, where in our commercial finance business in particular, we are providing loans to small and midsize businesses, which absolutely aligns with our purpose of enabling financial inclusion for all.

I think a couple of things. Number one, I think you're finding with the middleware partnerships being uncertain, which we talked about a bit earlier, I think you're seeing a lot of banks, particularly BaaS banks, evaluate what technology BaaS banks may need to enable the relationships that fintechs want and need to grow and scale. And so I think as we consider technology enablement and our ability to help fintechs grow and scale, I think you're going to see BaaS banks consider what is that right, so that's number one. AI is out there. For us, this is something that we're monitoring right now. How can we think about the use of AI as it relates to helping our risk and compliance framework become a bit more predictive? We are not anywhere close to necessarily understanding how all of that's going to work, and certainly I think our bank regulators are thinking about this as well. We don't want to get too far ahead of how they're thinking about AI and the use of that, but we have to be smart about it and think about how AI can be used here at Pathward in a responsible and ethical way. And so I think other banks are going to be thinking about that as well. And then I think third is, and for us we never really forget about the customer. What is it that customers are looking for? And I think right now, I think some banks have gotten away from that because of the regulatory environment that we're in. It's easy to now make a pivot away from customer consumer needs and only be thinking about risk and compliance. For us, it's a both/and approach. We have to be thinking both about the customer and their needs and how do we get more access to dollars and cash and money to people that need it that can't go open up a traditional checking or savings account with a regional or large bank. That's a real problem here in the United States. And so how can we continue to help folks address that? How do we get dollars to small and midsize businesses that need it that may not be able to go get traditional financing for an SBA loan or a USDA loan or working capital? How can we help facilitate that? That's still really important, and it's important to do so in a way, particularly if you're going to be using partnerships to do so, in a safe and responsible manner. So I think this both/and approach and trying to thread that needle is something that BaaS banks are going to be thinking about not only today but tomorrow.

We do, we do. And Peter, really love your work, love the podcast, and it's an honor to be here. Thanks for having me today.