Exploring the Strength and Stability of Regional Banks vs Systemically Important Banks

With all the events that have occurred in the banking sector over the past eight weeks, we’ve received a ton of questions from founders surrounding the relative strength and stability of the overall system. Founders are wondering how safe their deposits are, and how the underlying banks that Fintechs are built on affect the relative safety of their deposits. In this guide, we break down regional banks and systemically important banks to answer the questions above—dive in!

An overview of community banks

The Federal Reserve defines community banks, as financial institutions with less than $10 billion in assets under management. They typically only have operations within a set geographic area and offer fewer services than their larger counterparts. That said, roughly 60% of the personal loans and 80% of the agricultural loans issued in the US each year are made by community banks. These community banks usually provide better rates, sizing and payback terms on the loans which is why they are an attractive option to individuals, farmers and small business owners. As of 2021, there were just under 4500 community banks in the US, down from 7,442 in 2008.

An overview of regional banks

The Federal Reserve defines regional banks, as financial institutions with $10 billion to $100 billion in assets under management. They typically offer more branches compared to community banks, while maintaining similar fee structures, which makes them attractive to more mature businesses. They may also provide specialized services for segments of the population, such as venture debt for startups who recently raised equity capital, and personal loans to founders or venture capitalists whose wealth is tied up in the equity of a startup or a fund. As of 2021, there were just under 150 regional banks in the US, down from 200 in 2008.

An overview of systemically important banks

The Federal Reserve defines systemically important banks, as financial institutions with over $100 billion in assets under management. They offer the widest range of financial services: everything from basic banking, e.g. checking and savings accounts and treasury services, e.g. money market funds, ETFs, T-Bills, to investment banking, private wealth management and more. Systemically important banks are subject to more regulations than their community or regional counterparts, as their failure would they pose a serious risk to the economy. There are only 11 banks in the US and 30 banks in the world currently considered “systemically important”, yet they control over 70% of the assets in the banking sector, up from just 42% in 2003.

Why banks are classified differently

Following the financial meltdown of ‘08-09, regulators began scrutinizing banks for their role in the collapse of the economy. They noted lacking risk management protocols and poor decision-making as contributing factors to the crisis. Less than two years later, they established new legislation known as the Dodd-Frank Act, which established the Financial Stability Oversight Council (FSOC) and gave them the ability to label banks and other financial institutions. The goal of the bill was simple: prevent another financial crisis, by requiring banks to undergo periodic risk assessments and stress tests, and maintain a certain amount of reserves on hand. These new legislative actions only applied to banks that met certain levels of assets specified by the FSOC, hence the need for labels.

Originally, financial institutions with more than $50B in assets under management were labeled as systemically important, that changed in 2018 when Former President Donald Trump signed into law a new threshold of $100 billion and later $250 billion, less than 18 months later. The changes in the classifications were meant to loosen restrictions on banks to encourage expansion and greater market share diversification. While the classification is still set at $250B, most refer to the $100B number, since that’s the threshold at which the Federal Reserve can place greater restrictions. These restrictions enacted by the Fed, are influenced by recommendations from the BCBS.

The Basel Committee on Banking Supervision (BCBS) and Basel I, Basel II, and Basel III

According to its website, the BCBS is the “primary global standard setter for the prudential regulation of banks”. The BCBS replaced the Bretton Woods system and was formed to address the problems presented by the globalization of financial and banking markets. The organization is comprised of members from central banks and individual bank supervisors from around the world. The BCBS recommends regulations that banks should be subject to: e.g. Basel I, II and III.

• Basel I - provided methods for assessing banks' credit risk based on risk-weighted assets and suggested minimum capital requirements to keep banks solvent during financial crises.
• Basel II -  expanded the rules for minimum capital requirements, provided a framework for regulatory supervision and established new requirements for the capital adequacy of banks.
• Basel III - further expanded prior regulations, requiring banks to maintain certain leverage ratios and keep certain levels of reserve capital on hand.

How bank deposits are protected: FDIC insurance vs SIPC insurance

Deposits stored with chartered banks are protected by FDIC or SIPC insurance.

• FDIC - The FDIC is a government agency, funded by member banks, that protects deposits held in U.S. banks and savings associations in the event of a bank failure (default). FDIC insurance covers deposits up to $250,000 per depositor, per insured bank, for each account ownership category. 
• SIPC - The SIPC is a private institution that is funded by member brokerages. SIPC insurance covers up to $500,000 for each depositor at a failed SIPC-member brokerage firm, including a maximum of $250,000 for cash claims. It does not cover losses in principal value due to market fluctuations.

To increase the amount of protection, startups leverage cash sweeps to spread their deposits across an interconnected network of charted banks. By doing so, they can park cash at multiple institutions and take advantage of the full $250k FDIC limit per bank. Typically most banks don’t offer cash sweeps, that’s where Fintechs come in.

Fintechs, partner banks and BaaS

Fintechs are not banks, instead, they partner with them. Fintechs leverage the infrastructure and services of licensed banks known as “partner banks” to provide financial services to their customers. These financial services are powered through APIs provided by a “banking-as-a-service” provider.

Here’s an illustrative example of how you can think about the relationship between Fintechs, partner banks, and BaaS providers. 

• Fintechs - Act like the Lyft or Uber app, that connects riders with drivers.
• BaaS - Acts like the cell phones that the Lyft or Uber app runs on.
• Partner Bank - Acts like the driver that picks up the rider.
• Depositor - The rider, which books transportation through the app.

Since Fintechs do not have physical branches or the associated overhead, they have a much lower cost to serve customers. This results in low-to-no-cost banking products and services. Also, because Fintechs don’t hold deposits on their balance sheets or earn the direct EFFR, they’re incentivized to work with multiple partner banks which results in higher FDIC coverage for their customers.

A dichotomy of partner banks

As mentioned above, Fintechs partner with and leverage the infrastructure of other banks to offer digital banking, payment, and lending services to their customers. The underlying bank partner used varies from Fintech to Fintech, and thus so do the accounts, services, and pricing Fintechs offer.

Like the foundation of a house, if an underlying bank partner is weak, the whole thing can crumble—that’s why it matters so much who Fintechs partner with. Thankfully, most Fintechs chose partners that maintain adequate reserves and are in a position of financial strength. Today, all Fintechs have chosen regional banks, as they pass through more economics compared to large banks, while providing sufficient support and the same level of FDIC coverage. 

The regional banks Fintechs are built on and partner with

Here are some of the most common regional banks in the US that Fintechs partner with: 

• Axos Bank
• Bancorp Bank, N.A.
• Blue Ridge Bank
• CBW Bank
• CFSB
• Choice Financial Group
• Comenity
• Emigrant
• Evolve Bank and Trust
• First Century Bank
• Hatch
• Live Oak Bank
• MetaBank
• Middlesex Federal
• Stride Bank
• TAB Bank
• Veridian Credit Union

The systemically important banks in the US

According to the Financial Stability Board, the list of systemically important banks in the US includes J.P. Morgan Chase, Bank of America, Citigroup, HSBC, Barclays, Goldman Sachs, Bank of New York Mellon, Morgan Stanley, Santander, State Street, Wells Fargo.

Our take on regional vs systemically important banks

Regional banks and systemically important banks both serve an important role in the stability of the banking system. Regional banks are the backbone of the economy, together with the community banks, they service roughly 60% of the nation’s small business loans. The systemically important, or “too big to fail” banks, control the majority of the assets in the banking sector. While Fintechs partner with exclusively regional banks today, we suspect that may change in the near future—especially since nearly 70% of deposit outflows went to the systematically important, or “too big to fail banks” following the regional banking collapse.