Webinar: Demystifying Banking — Everything The Big Banks Keep Secret
If you're like most of the founders we talk to these days, you've recently realized that banks put their own interests ahead of their depositors. They intentionally overcomplicate just about everything they do—they use jargon, they minimize all their disclosures and they advertise yield rates that founders never actually receive.
Rather than sitting on the sidelines, we decided to do something about it. In this webinar we co-hosted with Fondo, we break down how banks work and how they make money. We then delve into the role of fintech neobanks and how they’re disrupting the industry. In the final minutes, we share the shocking truths the big banks don’t want you to know and provide tips for safeguarding more of your cash and getting the most from your bank partner.
Give it a listen and let us know your thoughts! If you have questions or if you’d like to take advantage of the Fondo-only discounts, visit this page or email Basile at bsenesi[at]arc.tech.
Webinar Recording
Transcript:
Hey it's David Phillips, CEO at Fondo, we're an all-in-one accounting platform for startups, and today we are joined by Basile Senesi, the Chief Revenue Officer at Arc. Basile has been a FinTech leader for over a decade. He previously scaled Fundbox from an idea to $1.5B valuation, and today he's a founder, an investor, an advisor to FinTech startups.
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Arc is the full-service finance platform for SaaS companies. They're a YC Winter 21 company, and Arc empowers startups with a better cash management experience where they can safely manage payments, store deposits, get access to funding and earn yield all in one place. So he's really an expert in all the things we're gonna talk about today.
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Fondos is also a happy customer of Arc. And yeah, today Basile is gonna break down how banks work, and how they make money, and then we'll delve into the role of FinTech neobanks and how they're disrupting the industry. At the end, Basile is gonna share some of the truths about big banks that they don't want you to know about. And provide some tips for safeguarding more of your cash and getting the most out of your banking partner.
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So with that, I will pass it on to Basile. Thanks. Thanks again, Basile.
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Thanks David I appreciate the intro. And I'm super excited to, chat for those of you who are hanging out with us before we got started.
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Not quite sure what this says about me, but this is the stuff I love talking through. I have a quick question before we get started. Just show hands. Raise your hand if you've ever heard of a cash sweep before.
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Okay. Now raise your hand if you had heard of a cash sweep before March, 2023.
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One theme that has been really clear is, banking is normally this thing we don't think a lot about. It works, it's not necessarily doing much for us. It does what it's supposed to. It's in the background and it's only in times of crisis that we start really paying attention.
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We've lived through a few bank-related crises in the past, but nothing quite like the one that we all experienced. Back in, in March and April. And it's just been a lot of focus and attention and curiosity around what these terms mean, how these banks work, and ultimately how to kinda navigate the choppy waters that we're dealing with as a result.
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Shameless promotion, but as David mentioned Arc is the number one digital bank. We took home about 7% of SVB's deposits in March, a meaningful portion of FRB as well. And the bottom line is a lot of people looking for safety following the regional bank crisis came to Arc for that.
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We'll get into how we've built the platform and why I think it, it reflects some of the things that I've just talked through. But the reality is we're focused on becoming the number one bank for startups, purpose-built for founders at an early in this stage. Our marketing team loves doing some shameless promotions here, so we'll just cover it real quick.
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But we've got 40 people from some of the very best in both FinTech and banking. Our team is ex-brex, ex-SVB, ex-bolt, but also credit suisse and some of the other big players. We serve about a thousand customers, a little more than a thousand today. We have raised quite a bit of money with our latest round being last summer, led by left lane and with friends like Nfx in the mix.
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And we're deploying that cash to build what is ultimately the number one digital bank.
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So what is a bank? Bank is really three things. When you work with a bank, you want a place to put money, a vault of some sort. You want. Access to capital should you need it. The option to do loans, borrow, et cetera, whether credit cards or structured debt, or mortgages.
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And then ultimately for that money that you're not needing to keep in liquid cash, you wanna make sure it's working for you. Asset management, wealth management, all that good stuff. That's really the crux. But the reality is there's a lot more nuance under the hood. Banks are highly regulated.
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And that regulation has led to the evolution of very different kinds of flavors of banking. Some banks specialize in some sectors and ultimately don't support other kinds of use cases very well, and banks have a lot of call-it-hoop jumping that they need to put you through with respect to meeting their regulatory requirements.
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Banking is complex, banking is tough, but if you simplify it, if you. The proverbial ocean. It's really holding your money somewhere, giving you money back in the form of loans, and helping you manage your cash so that it's optimized with that in mind, right?
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There are really two very broad cuts. This is oversimplifying but bear with me.
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On the one hand, you have your traditional offline bank, and on the other hand, your FinTech your neobank put Chase on the left-hand side, put arc bra, mercury on the right-hand side. The single biggest difference between the two. Is that fintechs most of the time are not federally registered banks.
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Whereas, chase and Wells Fargo and Citi have what's called a bank charter. A legal document allows them to hold onto customer deposits. And, to be effectively federally registered as a banking entity, fintechs don't do that. For context, when I was at Funbox, we noodled with the idea of putting down a bank charter.
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Really depends on the situation, but consider several millions, tens of millions of dollars to go through the process and attorney's fees, expenses, fees, et cetera. And a couple of years, anywhere from five to 12 years to actually get your charter approved through them. There's a limited number of charters issued.
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And so it's a very competitive process, which means right, that opening a new bank tomorrow was not necessarily easy. Not to mention very expensive and probably most importantly, incredibly restrictive in what you can and cannot do. There's a good reason for a lot of that restriction, but the bottom line is it's very hard to do on the flip side com of having or not having a banking charter.
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Fintechs don't hold your money on their balance sheet. Instead, they partner with banks that do that. Chase keeps your money on its balance sheet. So does Wells Fargo nc. When you work with a traditional offline bank, a federally registered bank, their balance sheet reflects your actual cash held in deposit accounts, and that's different from what fintechs do.
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Finally, traditional banks earn actual direct deposit revenue, direct lending revenue interest. And charge fees to their customers. Whereas fintechs split that revenue in the form of pass through with the bank partners that they work with. We at Arc work with a number of different bank partners like BNY Mellon.
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Brex works with column. Mercury, works with Choice Financial and evolv. Under the hood, these bank partners are the ones that the money is being stored with. Those banks are the ones earning the money from those activities. And those banks are then passing a portion of those earnings onto the FinTech partners that they work with.
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So Arc’s revenue is not actual direct deposit revenue. It's a percentage of the deposit revenue of our banking partners. Whereas those same banking partners, if they're not working with the FinTech, keep 100% of those earnings. Some key differences to highlight the fact that fintechs are a lot more nimble can work with a lot more different bank partners.
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And ultimately have a slightly different revenue mix. And how they think about economics than do traditional banks.
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So how do banks actually make money? We just talked about the three ways in which a bank can choose to manage and hold cash when you decide to open an account and deposit a couple hundred thousand dollars in the bank.
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Or a million cuz it's after your series A and you're flush with cash. You're gonna put it into a variety of different deposit accounts. The bank can do a few things with that money.
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Traditionally, they've primarily let that money out in good economic times. When banks believe that credit risk is low and the returns to have on credit are really attractive, they take their borrower's deposits and they use it as a pool for lending.
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They're interest on then. It's been historically one of the number one tax cows for many banks. The thing about lending, of course, Is that lending is risky. It's one thing to find people who want the money. It's another to get paid back and you need to make sure that you're coming out ahead on your loan programs.
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Banks charge commensurate with what they perceive as risk. And they wanna make sure that ultimately they're not upside down and getting defaults that outpace their bank earnings on average. By the way, for a bank to recoup one loss loan, it takes about 13 new loans to be originated.
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Interest revenue from about 13 loans on average to cover the one lost principal plus interest loan that defaults. So they think about this very differently in tougher times. And right now, candidly, from a bank's perspective, these are tougher times. They're not necessarily as aggressive in their credit appetite, and so they're making capital less and less available.
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At the same time, banks can invest the deposits into what they view as safe assets. There are a whole bunch of restrictions, rules, and regulations on what banks can and cannot invest in. Frankly, the SVB Saga and the FRB saga in direct follow-up to that was a great highlight of this bottom bucket of banks deciding to invest in what they perceive as safe securities that ultimately aren't so safe.
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When the time pulled up. Generally they're buying government bonds. They're buying government securities, they're buying very low interest type fixed maturity assets. And that's great. It shores up their balance sheet, it earns them a little bit of money, but ultimately it's less of a cash cow in good markets than lending.
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The third bucket, which is one that has gotten a lot of attention now, but typically is very unattractive. Instead of lending or buying stuff with it, they can literally just park the money at the Federalist and through a program called the Secure Overnight Federal rate. They can earn some benefit from the Federal Reserve for keeping the money there.
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SOFR as it's called, is a program that literally pays banks for holding onto customer cash and it at the Fed without getting into the macroeconomics of it. The reason that the Fed wants to do that is sometimes the Fed wants to pull money out of the system, and they encourage banks to move money out of the system and into the Fed by paying them meaningful interest on it.
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So you tie all that back together to what's going on today. The Fed is trying to fight inflation. One of the biggest tools the Fed has to do that is to raise what we continually call interest rates. But actually that's code for saying that they're making banks fatter when banks choose to keep money at the Fed instead of deploying it in the form of loans or buying securities with it.
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A year and some change ago, and we'll go over this in just a second. So r earned nothing today that looks very different. Banks have thought about this mix shift of where they keep money in a very different way over the past 12 months, historically have. Whereas lending has typically been the, primary driver of bank revenue that's changed meaningfully in the last 12 months where deposits held at the Fed are earning outsized returns for these companies.
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And to highlight that, if you look at a little more than 12 months, about 18 months here, where federal interest rates were and by comparison where SOFA was and ultimately what that meant for bank earnings both Gross and Ann Net. Can see that the story has changed massively over time. Left access is percentage, so percentage of r a p I paid out percentage of bank yields there and et cetera.
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The three lines represent the gross of what the banker earns. So basically the sofa rate over time. The light blue line is what they pay out to customers in the form of interest on deposit holdings. And the green line is effectively the difference between the two. It's the net earnings of the bank.
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Of course this is an oversimplification. There's other kind of like pools in this, but if you oversimplify that trend that you can really see is sure banks have gotten very handsomely rewarded for keeping more and more cash at Ted. And customers have also seen their average interest increase on, banking products across the US banking kind of sector.
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But the reality is, so has grown much faster, and by extension, banking, deposit revenue has grown much faster than the payout that customers are getting for parking money there. I think this light blue, this, sorry. Light blue line. The average customer yield payout represents a blended average across the major US bank.
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So think Citibank, Wells Fargo, chase, et cetera. Today you're earning sub 2% on deposits held at Chase if you're holding it into a savings account that is yield bearing, whereas Chase is earning four and some change percent on those same deposits. The slope to those two shows you right, that while we feel like we're already more, the reality is the banks are really making it ahead.
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Now knowing this means that you can start to rate shop in a way that closes the gap between those two numbers and really puts more and more money back in your pocket. And fintechs candidly, have been a lot more aggressive in pulling this blue line way up than traditional banks have been. We'll talk about that in a second, but the gif of it here is there's more money to be made, but it's not necessarily falling equally between how much banks are being rewarded and how much their depositors are ultimately taking home.
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If you think about where the macro is going and if you think about federal interest rate as a tool for combating inflation, The more inflation we want to curb, the more we'll continue raising interest rates. The more we continue to do that, the more we'll encourage banks to pull money out of lending and move money into deposits instead.
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You can make your own opinion as to what you think will happen in the next 12 months, but the trend seems to continue in the direction of, while things will slow down, there will continue to be more interest rate hikes, at least in the next few months even if they're smaller and smaller. So there'll be continued potential to earn more.
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While at the same time accessing financing will continue to be tougher and tougher as these rates rise and banks have less incentive. By the way, jump through this. If any of you have any questions or you wanna stop me, go right ahead. Now the flip side of this, when you think about managing cash, it's really about three things.
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Yes. How much am I earning on that cash? We just covered a portion of how that works. The other two though are how liquid is my cash? Like, how, if I want to access it tomorrow, can I, and then the last component, which we all became very evidently aware of in the last couple of months is how safe is my.
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The FDIC and SIPC programs are effectively making brokerage insurance programs that pay out in the event of those banks or brokerages going belly up. So every federally chartered bank generally participates in the FDIC program. They pay a percentage of their deposit revenue into the insurance pool every year.
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And if any of those banks go belly up, then that pool of cash is used to pay out depositors that lost money in those banks. The standard FDIC coverage today sits at $250,000. It was $125,000, a few decades ago. It was introduced decades and decades before that. For a long time the banking system operated without any FDIC coverage.
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There was bank runs as a regular habit. The FDIC program allowed banks to feel more comfortable keeping less cash on their balance sheet. Feeling less exposed in the event of people wanting to blow up their money and facing a bank run because they knew they had a backstop in the form of the FDIC.Should that ever come to pass.
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The problem is that the coverage amount of the FDIC makes sense for some depositors, but not all. As a consumer, having 250 K gosh is great. Like you have plenty of money in the bank. If you have that, you should probably think about diversifying your assets a little bit if your bank fails.
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You are likely going to get recovery of your $250K or less that you lost cause it's all insured. But if you're a Series A startup who just raised 5 million, 10 million if the bank that's holding that money say goes belly up and deposits don't get made whole, then you've basically lost everything north of 250 K.
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So there's been a lot of attention. On how companies can drive insurance in excess of that 250 K number. There's also a policy discussion around raising that number, making two 50 equal to 500. There's a lot of chatter, but the bottom line today that doesn't exist today, only 250K is insured, and the rule applies in a very unique way.
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Each entity at any given bank that participates in this program is insured up to this amount. If you go back to the model a couple of slides ago, two fintechs who work with the same partner bank, if you happen to have money in those two fintechs that are sitting on the balance sheet of the same bank, they are not each insured 250K.
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Each depositor is insured for 250K. So knowing where your money is under the hood is really important. Here's a common example we see. I. So without getting into the mechanics too much yet of the cash sweep program, if you have money that is participating in a cash sweep program, which basically means the money is sitting in FDIC and chunks at various banks so that you have larger overall FDIC coverage.
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If you happen to also have a commercial relationship with one of the banks in that suite program and have money there, let's say Chase you're not insured twice. If I put money in, say cash suite program, Let's say a million dollars and four chunks of 250K each are being allocated to different banks that participate in the Suite program.
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And I also have a quarter million with Chase separately, cuz you know, they're my backup bank. I'm not insured twice. It was, knowing who's participating is incredibly important to knowing whether all of your funds were protected or not. The reality is F D C insurance is only a way of insurance cash.
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There are a bunch of different ways, which is why we think about the waterfall here. Keep a portion of your cash, 250 ish K in a single account. You have access to it. It's liquid, it's easy. Keep the rest into cash suite products. With Arc for example, we have a cash suite product that ensures you have an additional $5 million beyond your checking savings balance.
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We also pay out the meaningful yield on that. And then in addition to the 5 million, we find that our customers continue to want insurance. The next best thing is SIPC Insurance means instead of keeping it in a bank, keep it in a brokerage with its own brokerage, insurance and coverage, et cetera.
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And then finally, for all the rest, what's widely is the safest asset to invest money into today. With some big asterisks given the debt ceiling negotiations is the US Treasury bill. The US Treasury bill is effectively an IOU to the US government. While you give money to the US government and you're holding a T-Bills, you're effectively being promised by the US government that you'll be repaid when that bill matures.
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This waterfall is how we see startups with a lot of cash, typically protecting their deposits. They are allocated across all these different buckets. That's great in theory, in practice. You can do this if you're a Series C company with a strategic finance team of three. Doing this as a solo founder who's also running, the accounting and books and banking relationships for a company.
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It's a lot of mind-sharing. It's a lot of time. And the benefit of fintechs and frankly the philosophy for arc, unlike that of a traditional bank, because we're not a bank, but we partner with them, we're able to have a single product that has a lot of bank diversification under the hood that allows you to easily manage out of a single place.
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This level of complexity and abstraction. That's really the future I think, of what we're seeing in banking today. The average customer we work with has 250 K with Chase, has a whole bunch of the rest of their cash in some FDIC-insured cash sweep, and has the rest in US government, treasury bills, and money market funds.
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This is the common waterfall.
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We talked about cash sweep, so I'll skip this here. But the way that you should think about a cash sweep is if a bank has a cash sweep product. It basically means that when you put money into this product, they keep the first two 50 and then they take the rest of your money and allocated it into 250 K chunks to FDIC-insured institutions.
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The highlight here, know which banks are on attribute products and make sure that there is no overlap with who you have banking on the side. Oftentimes you can request that your funds be excluded from specific member banks at these particular institutions so that you're not double dipping. That's a seldom-known, but like very useful fact that we find a lot of founders get pretty soaked when they find out because there's a lot of overlap in these capture products.
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BAAS or banking as a service is a very simple way to say middleman. Our friend Austin, who pulled this deck together. Has a great analogy.
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Fintechs are the lift app. Banking as a service is the iPhone, and the partner bank is the actual driver in car, right? Banking as a service is the middle layer between banks and the fintechs. Opening bank accounts issuing cards, all that stuff requires a lot of work. If I'm a traditional regional bank, And I want to make it easy for people to open accounts remotely with me.
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It's a lot of engineering horsepower I need, I might not know how to do that. Quick history lesson for you guys that I think makes this very interesting. In the wake of the 2008 financial crisis there was a lot of regulation passed. To try to tighten controls on banks taking advantage of customers and consumers.
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One of those rules, the Durbin amendment tapped the interchange that large banks could charge customers on debit card and credit card fees. They carved out some exception for that, that allowed small regional banks to not be subject to that cap, which all of a sudden created a gap in the market where small banks could charge more.
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On card swipes that Chase and JP and city, et cetera could, and it opened what we know today as the entire FinTech making as a service layer, the evolves of the world, the choice for Publix of the world, et cetera, all of a sudden overnight had a new revenue opportunity that didn't exist before that they could go after.
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And what did they do? They didn't have the scale to go and widely commercialize their products, so they partnered with startups, they lent out their charters, as we talked about before. FinTech would bring the depositors. These regional banks would provide the actual service and one to one. These banks would create long integration chains with each one of these FinTech players.
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Over time, middlemen came in and said, look, we're gonna handle the banking partnership side. We'll find the FinTech, we'll create rails and APIs that make it really easy for anyone. That, wants to have a banking product under the hood, that is what banking as a service is. We use Strip some companies use unit Treasury.
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Prime is obviously another common layer. What is unique about all these, and the thing that you guys should all know because of that evolution, regional banks have been the primary bank partners that these banking as a service partners work with. If you use a BAS provider, you don't choose who your partner bank is.
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They do that. They negotiate those bank partnerships. You work with the banking as a service provider, and they'll just open accounts wherever they have partners. That's changing. In the wake of everything that's happened, regional banks are becoming an increasingly. Scary thing for a lot of founders who want too big to fail, and we're seeing the evolution of banking as a service moving in the direction of partnering with two big to fail banks who historically not participated in these types of programs because the economics were less interesting given some of this this historical stuff that's happened.
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I realize we're coming up on time. So with that in mind, there are a few things I want you all to remember. You can rate shop and there's a lot of opportunity to run a lot more than the headline yield amount. Whatever SOFR is, you should be able to get close to that number.
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We're very competitive, so are other fintechs, but the headline is, traditional banks tend to really under reward depositors given the headroom they have.
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Make sure that when you are ensuring your cash, It's sitting in the right kinds of insurance buckets based on your total cash position and minimize overlap in particular in cash suite products to make sure you're not double dipping. And then finally with this move towards too big to fail to be the safer thing that investors are asking their Port-co to follow.
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There is an increasing opportunity in the market to work with FI techs that partner with two big to fail banks as opposed to regional banks. Hint, hint, we do that. Mellon is the 13th largest US financial institution. We also have relationships with companies like Evolv who represent the smaller regional bank side of things.
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Too big to fail is we believe that the direction of the future for banking as a service and FinTech in general, and that's the bank partners that we keep bringing under the hood on a regular basis. And with that in mind, we're at the half hour mark. I'll go ahead and pause there. If anyone has any questions, happy to answer them now.
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We're obviously happy to follow up afterwards as well.
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Awesome. Awesome. I just wanna say thanks again. That was incredibly helpful and eye-opening. Thanks everybody for joining us. We'll send up a follow-up email. You'll have Basile access to Basil's email address. I think, one of my favorite things about working with Arc is just how accessible they are and having a dedicated relationship manager.
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So if you are looking to diversify your banking stack, Definitely encourage you to check out Arc and feel free to email Basile or myself if you have any banking questions or tax and accounting questions. We'd love to, to support you.
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Thanks to everyone for coming. Awesome. Appreciate it all.
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Thank you so much. Bye-bye.