SoFi: Revolutionizing Finance for the Digital Generation
By: Alex Nani
The Ivey Business Review is a student publication conceived, designed and managed by Honors Business Administration students at the Ivey Business School.
Long gone are the days of bank branches, where customers would cash in cheques, make cash deposits, and apply for loans in person. SoFi, the member-centric, one-stop shop for financial services, has taken advantage of the technical aptitude of Millennials and the emerging Generation Z market to become a leading cloud-native digital banking platform. Founded in 2011 by four Stanford MBA students, SoFi’s digital native app empowers its members to save, spend, invest, and protect their money while generating interest income for the company.
In addition to lending, SoFi provides checking and savings accounts, credit cards, and a brokerage platform. By continuously developing best-in-class products, SoFi builds reliability between members and its platform, making customers more likely to consider SoFi when they need an additional product—a process labelled the “Financial Services Productivity Loop.” Furthermore, SoFi has built a social area within its digital native application, the member feed, that delivers users' personalized daily financial tasks and content.
With ~9.4 million members and $73 billion of funded loans across 40 products, SoFi has positioned itself as the leading full-service bank for highly educated, digitally savvy consumers. By engaging members through their journey to financial independence, SoFi has captured 60 percent of the student loan refinancing market.
Riding High, But Can It Stay Steady?
SoFi’s ability to draw in consumers with an innovative solution has been key to its latest quarterly success, driving stock price gains by 57 percent year-to-date. Furthermore, recent interest rate cuts have improved the macroeconomic outlook and raised guidance on consumer lending growth.
Despite SoFi’s success, sell-side equity analysts at firms including JP Morgan remain particularly concerned over its direct lending segment's inherent macroeconomic and political risk. Historically, uncertainty surrounding interest rates, student debt forgiveness, and the creditworthiness of borrowers have hurt lending profit contribution, which has grown by 8 percent in Q2 2024 compared to the same quarter in the previous year., This contrasts the bank’s financial services segment, which reported profits of $100 million in Q3 2024 while just breaking even in the same quarter a year prior.
SoFi’s lending segment made up 64 percent of net revenue year-to-date (YTD), and, as a result, its stock price potentially fails to reflect the momentum in its financial services business. Despite reaching record revenues, customer growth, and breaking even for the first time in 2023, the stock price of $16 is well off its all-time high of $25 in Q3 2021. Further growth from its lending segment will be met with intense competition from traditional commercial banks that benefit from economies of scale, offering lower rates on consumer loans. And threats like interest rate hikes could adversely impact valuation overnight, presenting numerous challenges. These factors contribute to SoFi’s stock price volatility—a metric associated with business risk concerning the stock market—as demonstrated by its five-year beta of 1.71. SoFi must diversify its earnings into segments with less balance sheet risk to become a more robust business, specifically, its unexploited technology platform.
SoFi’s Secret Weapon: Can Galileo Blast Off?
SoFi’s technology platform operates under its subsidiary Galileo and provides Application Programming Interface (API) solutions and cloud-native digital core banking platforms for various institutions. A core banking system is a series of back-end servers that manage operations so that front-end account transactions and other actions are seamless for customers. Although this segment has seen success with notable partnerships like Samsung Money by SoFi, growth has been stagnant. Technology Platform profit contribution only grew 2 percent in Q3 2024 compared to Q3 2023, lagging behind its other segments. There is room to grow, and SoFi’s leading digital banking platform, along with its expertise in fintech, presents the bank with a unique opportunity to expand its domestic reach. In particular, the adoption of digital banking has become a deciding factor for consumers. However, rather than applying its digital banking platform to acquire more customers directly, SoFi should look to sell its banking platform solutions to regional banks.
Stuck in the Past, Chasing the Future
Regional banks are defined as lending institutions with $10 billion to $100 billion in domestic assets under management (AUM) in the United States., They rely on physical branches and thus operate within distinct regions, significantly dampening their addressable market. Maintaining a banking system is costly, with the largest regional banks spending billions annually on software and technology. Much of this expenditure is allocated to maintaining outdated systems rather than investing in innovative solutions. The result is aging software and hardware portfolios, slower adoption of emerging and more effective technology, and continued use of manual, paper-based processes.
Several constraints hinder regional banks from adopting cutting-edge technology. Firstly, they operate in less profitable business segments such as small-business loans and subprime consumer lending. This constrains IT spending, limiting the ratio of growth versus maintenance technology expenditures. This results in the increasing reliance on obsolete systems, slower adoption of disruptive technology, and the continued use of manual processes. For instance, apps like Citizens Bank Mobile Banking lack features such as loan applications, requiring customers to visit branches. Additionally, regional banks struggle to attract top IT talent due to lower compensation packages and their locations outside geographical hubs typically concentrating IT talent. Lastly, the pandemic has increased and maintained a pressing need for digital banking, and as remote work remains widespread, modernized offerings are needed to serve the distributed workforce.
Banks Stuck in the Stone Age and SoFi’s Chance to Cash In
On the front end, regional banks have not kept up with the demand for digital products, which could lead to further losses of their mere 13.3 percent of consumer banking market share. And on the back end, their continued reliance on outdated systems will further suppress operating margins—a two-pronged attack on their business model. Unsurprisingly, revenues for these regional players have remained flat over the past 10 years, resting at a CAGR of around 1.1 percent. As a proven disruptor, SoFi is well-positioned to offer struggling regional banks an innovative SaaS solution through their technology platform, creating a massive top-line opportunity. Truist, the largest regional bank, saw its commercial banking non-interest expenses increase by $483 million in 2023, reportedly driven by higher technology expenses. In the same year, software expenses reached $929 million. Regions Bank tells a similar story, with $412 million allocated to equipment (hardware) and software expenses in 2023, representing a 5.1 percent increase over the previous year. With 127 regional banks in the United States valued at over $1 billion who face similar cost structures, even capturing only a few percentage points of technology expenditures represents a multi-billion-dollar opportunity.
Cloud Banking: Turning Tech Woes into Wows
For regional banks, cloud services have the potential to yield massive benefits with ready-to-use products that improve customer acquisition, cost management, and time to market. Outsourced technology development can help banks focus on sales and operations, allowing for quicker deployment of revenue-generating products. Additionally, cloud services reduce the need to manage IT infrastructure, optimize operating costs, and reduce capital expenditures. Advantageously, SoFi already has the infrastructure to support IT migrations with its Galileo APIs and core banking platform.
The benefits of digitization are not just theoretical. When the Spaniard bank BBVA partnered with Accenture and AWS to develop a new digital sales model, BBVA realized 117 percent growth in new customers over five years and posted a record profit of €8.02 billion in 2023. Using facial recognition and text analytics to verify account applicants via mobile apps, BBVA reduced the client onboarding process from several days to just minutes. The new sales model has a massive positive cost-to-income ratio of 41.7%, which is the best among European banks. This comes amidst a wave of broader cloud service adoption at larger regional banks, like Flagstar, which partnered with Oracle to streamline their routine financial processes. Flagstar could standardize reporting and optimize cost structures by migrating to Oracle's cloud banking platform. The overall performance of the bank’s financial planning processes increased four-fold, allowing for more efficient and automated workflows. When regional banks digitize, their cloud platforms become an asset to consumers and widen the competitive moat, capturing market share from their direct competitors—that is, other regional banks without a cloud-native platform.
Bridging Generations and Banking Gaps with Tech
The banking software market is fragmented across FinTech firms, established financial institutions, and traditional software providers, which creates a meaningful opportunity for SoFi’s entry and consolidation. It is worth noting that industry-standard applications on Oracle, Microsoft, and Amazon Web Services typically serve as the starting point for a significant portion of large banking transformation projects due to their extensive data centers and ability to offer infrastructure-as-a-service at a lower cost than smaller players. However, as the most prominent digital lender in the world, SoFi provides a unique value proposition; SoFi is the true expert in digital banking and possesses specialized, redistributable software in the online banking and lending vertical. Given its acute expertise in the sector, success in competitive markets, and cutting-edge commitment to research and innovation, SoFi should position itself as a leading core banking software suite for regional banks. They better understand the competitive strategies needed to win, which constitutes an advantage over pure software vendors and opens the door to providing consultancy and integrated software services—advising regional banks on their digital growth, all while implementing the SoFi stack. Furthermore, regional banks target a consumer base different from that of SoFi. Their customers are 50 percent Baby Boomers (aged 52–70) and Gen Xers (aged 37–51), which represent two demographics that SoFi does not currently target with its digital lending segment. Additionally, the regulatory environment ensures that the banking industry will remain highly competitive through policies like the Bank Merger Act. SoFi will always face intense competition in its lending segment, making it challenging to target a broader audience outside its typical demographic of educated young professionals. Selling their technology platform service to regional banks enables the capitalization of a demographic that SoFi will never be able to target themselves feasibly.
The Roadmap to Reinvent Regional Banking
Banks and their core banking systems have been sluggish in adopting new development paradigms, leading to their rapid disruption by firms specializing in financial technology. Modern consumers demand practical, seamless solutions, and by embracing cloud-native digital banking platforms, regional banks can establish a differentiating competitive advantage. In the next 20 years, it will be challenging to envision a world where regional banks depend on physical branches. Digital transformation will be paramount to their success, with mobile apps and a highly efficient back end becoming essential core competencies that will distinguish industry leaders. For SoFi, this presents a lucrative growth prospect and a strategic solution. The Galileo platform already boasts a robust foundation, including a dedicated software development team and an experienced sales team. By shifting its marketing and product focus to the regional banking sector, SoFi is well-positioned to capture this growing market. Enterprise software inherently generates stickier, recurring revenue streams and promises higher margins. Elevated profitability at higher retention rates will be accretive for shareholders as investors will value incremental increases in the technology platform segment’s earnings at a higher multiple than the lending segment’s. Under the leadership of CEO Anthony Noto, the former COO of Twitter, an all-star lineup board of directors featuring private equity executives and Silicon Valley icons, and SoFi’s commitment to technological innovation, SoFi undoubtedly possesses the expertise to become a leader in financial services.
