As fintechs broaden their product sets and partner more closely with banks, the once-clear line where fintech ends and banking begins is increasingly muddled, raising questions about customer privacy, data security, compliance and other issues. Banks partnering with fintechs must evolve their compliance and third-party management processes to successfully manage the relationship, says Tom Grundy, senior director for U.S. advisory services at Wolters Kluwer in Minneapolis. Fintech partnerships offer many advantages, including a culture of innovation, speed to market, absence of legacy systems and technology expertise, Grundy says.
However, these otherwise positive attributes can also present significant challenges, given that new technologies and marketing strategies can generate a large amount of business very quickly.
Banks that enter into fintech partnerships on Day One need to be ready to run, and run fast, on legal,” he says. “If you enter a contract unprepared, playing catch-up may result in significant regulatory issues. Having the right project managers and compliance subject-matter resources in place internally should be part of the overall initial plan for building a successful fintech partnership.”
When considering whether to partner with fintechs to offer products or services, banks need to examine whether the relationship fits into the bank’s business strategy and whether the activity can be conducted in a compliant manner, says Greyson Tuck, a banking consultant, attorney and board member of Gerrish Smith Tuck PC in Memphis, Tennessee.
“The more banks allow third parties to access their core processing systems, the more opportunity there is for exposure to a cyber event,” Tuck says. “Banks need to be concerned with legal and technological security issues and follow appropriate policies and procedures to protect against breaches or similar cybersecurity events.”
Regulators expect banks to exert “clearly communicated governance” over the fintech partner’s management of customer relationships, Grundy says.
At a minimum, this means tracking all marketing relationships that essentially act as a fourth party to the partner bank; proactive approval of all outgoing marketing and consumer communications content; monthly reporting of key performance and risk metrics; clear agreement on processes for managing and responding to consumer complaints; and ongoing, scheduled monitoring and testing of transactions.
Regulators are also keeping an eye out for fintechs that are trying to take shortcuts, says Brian S. Korn, partner and head of financial services transactions, fintech and blockchain at Manatt, Phelps & Phillips LLP in New York. “They are watching for companies that are taking a different interpretation of rules and licensing laws than their peers. And the No. 1 driver of regulatory activity is always customer complaints.”
There has been a marked increase in the number of fintechs that are looking to acquire community bank charters, but that is not an easy path because regulators scrutinize the fintech to assure that it can run the bank in a safe, sound and compliant manner.
“A lot of fintech executives aren’t seasoned bankers, so they definitely have a steep learning curve when it comes to banking regulations,” he says. “Before applying for regulatory approval of any bank acquisition, they need to have an adequate compliance team in place.”
Regulators are particularly concerned about fintechs complying with Know Your Customer rules when establishing new accounts, Tuck says. When acquiring a bank charter to obtain deposits, fintechs will need to pay close attention to the flow of cash within the accounts—how much money is coming in and out, and what accountholders are doing with that cash.
“Fintechs’ whole espoused competitive advantage has been that they have much less red tape, so they can be more nimble to do business with,” he says. “So if they acquire a bank charter, the challenge becomes how to maintain that competitive advantage.”
Katie Kuehner-Hebert is a BAI Banking Strategies contributing writer.
Discover how fintechs are an increasingly valuable resource for banks in the BAI Executive Report, “Banks and fintechs are on the partnership track.”