According to a 2019 PWC survey, 42% of banks engaged in joint partnerships with fintech companies, a figure that more than doubles to 94% of financial services companies expressing confidence that fintechs would help grow their company’s revenue over the coming years.
These numbers demonstrate the rapid adoption of bank fintech partnerships in the financial services industry over the last few years.
While banks frequently viewed fintechs as a threat in the early days, many of them today are finding that fintech firms can actually help them flourish. For fintechs, partnering with banks represents a promising opportunity to build mutually beneficial cooperation, expand the geographical presence, and mitigate the compliance burden.
Why should Fintechs and Banks Partner?
The fintech industry has brought ever greater competitive challenges and disruption for banks, particularly community banks. Fintechs often offer better services when it comes to online banking services. At the same time, community banks have relationship experience and compliance know-how that can bring benefits in partnership with fintechs that are building innovative financial solutions.
In our digital economy, customer expectations have risen. Banks of all sizes across the globe must constantly focus on updating their processes and shifting their customer acquisition and retention strategies from expanding their branch system to creating technically sophisticated services such as mobile banking.
Community Bank Fintech Partnerships
In this context, it should come as no surprise that regulatory bodies have shown more interest in the role that innovation can play in the financial sector. In turn, they closely consider compliance and due diligence requirements in bank fintech partnerships.
This interest culminated in new guidelines jointly released in August 2021 by the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency (collectively the “agencies”), intended to help community banks conduct due diligence on fintech companies.
While the Guide is specifically addressed to “community banks”— defined as banks with $10 billion or less in consolidated assets supervised by one of the Agencies — the Agencies note that the fundamental concepts of the Guide may be useful for banks of varying sizes.
The Guide also applies to other types of third-party relationships as a source of due diligence best practices and as a preview of potential areas of future regulatory focus.
Overall, the guidelines provide a structured approach to due diligence for community banks. They offer especially useful guidance for banks with minimal prior experience partnering with fintechs. Moreover, fintech companies may also find the guidance useful in preparing for discussions with potential bank partners.
Due Diligence Focus Areas
The Guide sets out six critical areas of due diligence focus:
- Business experience and qualifications: Operational history, experience, legal and regulatory actions, and strategic plans.
- Financial condition: Financial analysis of the fintech’s ability to remain as a viable business operation and market considerations.
- Information security: InfoSec framework including documented and enforced data security controls, incident response, breach notification processes, and information systems programs and design.
- Legal and regulatory compliance: Organizational documents, licenses, registrations, legal permissibility of activities and products, regulatory compliance policies, marketing channels, and consumer complaints.
- Operational resilience: Business continuity planning, business resilience and incident response, and service level agreements.
- Risk management and controls: Effectiveness of risk policies, procedures, process, training, reporting, and general ability to align with the bank’s risk appetite, appropriate laws, and regulations.
These guidelines reflect the recognition that banks can benefit meaningfully by partnering with fintech companies in any number of operational areas and product types.
Such areas can include:
- digital and mobile payments and deposits
- customer interface and experience technology
- provision of money management and wealth management
- expedited credit underwriting and loan origination processes
- data breach and identity protection tools.
In turn, fintech companies can benefit greatly from the substantial pre-existing customer bases, market presence, and reputation of banks of all sizes.
Bank Fintech Partnership Models
Bank fintech partnerships fall into one or more categories based on the scope of the relationship between the two parties. The least direct relationship is a referral partnership. In this model, banks refer customers to a preferred fintech to supplement features the bank does not offer.
In more direct relationships, the fintech acts as a technology provider to deliver specific functions, specifically as a vendor. Similarly, a bank can choose to offer a fintech’s capabilities under a “white label” or “private label.” Such labeling typically involves customizing the fintech product to remain invisible to the bank’s customers.
More recently, “hybrid” models have also become common in the industry, such as direct investment or acquisition, outsourcing services, or allowing the fintech to work with the bank to offer services such as lending and account issuance.
In each case, these partnerships create mutual responsibilities for ongoing operations, including compliance. It is important for both partners to carry out careful due diligence to ensure the right fit and ability to deliver.
Factors Driving Greater Bank - Fintech Collaboration
Five factors are driving further industry change and creating even greater need for bank fintech partnerships.
The rapid adoption of consumer technology like smartphones and smartwatches has created vastly different customer needs over the past few years. And, as the adoption rate for these devices increases, the need for immediate, one-to-one access to financial services has increased as well.
As a result, banks and credit unions should look to fintech as a means to provide more services, much like the industry has done in the past.
A radical digital transformation took place across industries during the COVID-19 pandemic, as the shift to remote work created more opportunities to develop new products. This pivot uncovered challenges and pain points that likely would not have been assessed and resolved if not for the pandemic.
In fact, 88% of middle-market businesses, including banks, implemented new technologies within the last year.
Evolution of Community Banks
At a time when four biggest commercial banks in the U.S. control 36% of the industry (2018), digitization is also what will enable community banks to remain independent.
For example, embracing technology provides an opportunity to improve decision-making by reducing the amount of time it takes to approve a loan while mitigating risk. Technology can help community banks process more loans, thereby increasing revenues while also reducing the time and cost of processing paperwork.
How far is this collaboration trend going? PwC sees 82% of current financial service providers increasing partnerships within the next five years.
Competition between banks and new entrants may give way to direct collaboration across the fintech ecosystem, which should enable both parties to profit. Potential opportunities span from product design and development by the start-ups to distribution and infrastructure capabilities by banks.
With this backdrop, it is fair to predict that in the coming years, the U.S. government will continue to mature its regulatory approach, and indeed the OCC is already taking steps related to fintech. In a statement before the Federal Reserve Bank of Philadelphia’s Fifth Annual Fintech Conference in November 2021, Acting Comptroller Michael J. Hsu discussed modernizing the financial regulatory perimeter.
Hsu said: “Modernizing the bank regulatory perimeter cannot be accomplished by simply defining the activities that constitute ‘doing banking,’ but will also likely require determining what is acceptable in a bank-fintech relationship.” It is likely that with regulators thinking more and more about bank fintech partnerships, the U.S. will follow existing trends elsewhere in the world.
Conclusion: Staying Ahead of Evolving Regulation Impacting the Future Model of Bank Fintech Partnerships
Given the continuous evolution of the financial technology landscape, a bank’s access to and understanding of fintech will play a vital part in its ability to effectively meet the needs of its customer base. With appropriate risk management and compliance guardrails, fintech partnerships present a notable opportunity for community banks to strengthen existing operations, particularly when the partnership serves the unique strategic objectives of both parties.
What is certain is that bank fintech partnerships will continue to be a driver of innovation in the coming years as both sides strive to grow and engage their customer base to drive more revenue.
As we remain in a fast-moving space where guidance from industry and regulatory experts continue to inform and mold the business model, InnReg is well-positioned to provide support. If you have questions about your compliance requirements and preparation while regulation is still developing, we’re here to support you with practical guidance on compliance and risk considerations related to bank fintech partnerships. As an outsourced compliance provider, we can help you with:
- KYC, AML, and Customer Due Diligence,
- Suspicious Activity Reporting,
- Fraud prevention,
- Red flag programs,
- Information security and data protection,
- Marketing and advertising compliance,
- Compliance governance and risk assessment, and
- Staff compliance and training.