Payment-processing company Square (NYSE: SQ) plans to apply to form an industrial bank that will offer services to small businesses, including lending and deposit accounts. The small-business lending market in the United States is estimated to be worth $186 billion, and if Square is able to capture a significant share, its profits could get a major boost.
Square's banking plans
Square plans to submit an application in Utah to form a banking unit, which would be called Square Financial Services, Inc. The newly formed bank would offer loans and deposit accounts to small businesses, and Square plans to capitalize the bank with $56 million in cash.
The bank would be formed as an "industrial loan company," also known as an industrial bank, as opposed to a traditional bank holding company. Square engages in several nonbanking activities, which traditional bank holding companies are not allowed to do. For example, one of Square's core business activities is selling hardware payment terminals to merchants.
The logical next step for Square Capital
To be clear, Square isn't exactly new to the arena of small-business lending. It already operates a lending division, Square Capital, which has been in operation since 2014 and has made more than $1.8 billion in loans, with an average size of just $6,000.
However, Square Capital has offered loans through a partnership with another institution, Utah-based Celtic Bank. The operation has been growing at a breathtaking rate recently. During the second quarter , Square Capital's loan volume was 68% higher than it was a year ago. If granted, the banking license will allow Square to issue loans on its own, without a partner.
According to the current leader of Square Capital, who will also chair Square Financial Services, Jacqueline Reses, "As we scale, it's becoming increasingly important that we have direct relationships with regulators." Also, with such a high level of growth, it's not surprising that Square wants to keep the entire lending operation within its own company.
The next chapter in an impressive growth story?
Square's business has grown impressively in recent years. In the past year alone, Square's gross payment volume has grown 32% and revenue is up by 26%. The company is also having success in getting businesses on the larger end of the small-business spectrum to adopt its payment solutions.
And there could be much more room to grow: Square estimates its payment-processing opportunity at $3 trillion annually, just from U.S. small to medium-sized businesses. This is roughly 50 times the company's current annualized payment volume.
Recently launched initiatives such as the Square Installments consumer financing program and the Square Cash card have also gained considerable traction. And the company's international expansion is still in the early stages.
Between its payment-processing business and the rest of its ecosystem, Square believes there's $64 billion in annual U.S. revenue potential, and six to seven times this amount when international market opportunities are included.
In a nutshell, taking its Square Capital lending platform and transitioning this area of the business into a wholly owned banking operation is a promising next step that could help Square's business-lending arm achieve its potential.
10 stocks we like better than Square
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor , has tripled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Square wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of September 5, 2017