Shana Hennigan is the Chief Business Officer of Raisin US, a unique turnkey digital solution that allows banks and credit unions to expand their reach and source funds from depositors nationwide, with KYC, AML, marketing and customer service included. With over 20 years of experience in the financial services, Hennigan previously served in senior roles at Bank of America Merrill Lynch, Promontory Interfinancial Network and Safened.
Digital Transformation Challenge for Smaller Banks: Getting Fintech Partnerships Right
Fintech partnerships can be profitable for banks but only when entered into cautiously and in compliance with regulatory standards.
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An interagency group of regulators earlier this year issued a joint statement to address banks partnering with fintechs.
The industry is becoming more digital-focused despite concerns that an increased scrutiny may make some banks fearful of working with financial technology companies. Recent data shows that the number of Americans using online banking tools jumped from around 53% in 2019 to over 66% in 2023. Meanwhile, the costs of developing the infrastructure to partake in this digital transformation remain high, disproportionately impacting smaller banks.
Despite increased regulatory oversight, building partnerships with fintech solutions can offer smaller banks a way to innovate and compete. Importantly though, these partnerships must be built strategically with an eye on controlling risks.
Due Diligence and Ongoing Monitoring
The expansion of fintech has been explosive. McKinsey & Co. recently estimated that fintech growth will outpace banking industry growth by a factor of three in this decade.
But massive growth doesn’t necessarily mean smooth sailing for banking partners.
For banks, it is important to build out strong risk management policies, with due diligence being a priority. The regulators’ statement cautions that risk assessment can become more difficult as a bank fragments operations with third parties. Banks should work with potential partners to outline processes and protocols for review, including complaint and information security policies, business continuity plans and service organization control reports.
Due diligence should be an ongoing process built into the relationship with periodic follow-ups to ensure that the partner’s protocols meet or exceed a bank’s guidelines and that they are on top of an ever-evolving regulatory landscape.
Accurate Recordkeeping, Access and Reconciliation
When a bank is not the system of record for deposits sourced through fintech partnerships, the regulators highlight that it is imperative for that bank to understand recordkeeping functions, including who is responsible, who is performing reconciliation and how customer funds would be returned in a worst-case scenario.
The first step here is for all key parties to use proper due diligence with the recordkeeping function and understand how reconciliation is being performed and validated for for the benefit of (FBO) accounts. Regulated entities like banks or broker-dealers undergo examinations and are held to strict regulatory standards. A well-structured FBO account held by a regulated entity, with well thought-out reconciliation processes and procedures, can provide comfort that customer funds are accounted for in case of a partner’s failure.
Dovetailing with these procedures, banks should also look to partners for plans in case of failure, including the process by which customer funds would be returned. This helps ensure that in such a scenario the process is as smooth as possible, further fulfilling recommendations set forth in the joint statement.
Strong Risk Management Policies
One of the major concerns noted in the joint statement was that a lack of third-party oversight could impact a bank’s compliance with consumer protection laws and regulations. Having partners that can live up to the benchmarks established by these protections can help reduce that risk.
Banks should ensure that partners are communicating the information typically provided under the Truth in Savings Act and Regulation DD, and that, per Regulation E, annual error resolution notices are issued and that complaints are resolved in a timely manner.
By following these steps, banks can feel confident that customers will be served in adherence to these regulations and laws while maintaining their own compliance.
Understanding What Fintech Can Offer
Because smaller banks face unique challenges, including disproportionately higher compliance and cybersecurity costs, financial technologies can bring a lot of benefits without added overhead. Thanks to fintech, it’s now easier than ever for smaller banks to compete.
For example, building out the infrastructure to market and service new digital depositors may not be cost effective for smaller banks, but finding a fintech service with experience in the space can be a lifeline, enabling these institutions to reach customers through modern channels.
The benefits can go beyond smaller banks accessing innovation and efficiency without associated overhead. For consumers using these fintech platforms, there is an unparalleled level of safety and peace of mind that regulated institutions can offer.
These relationships can not only help smaller banks get ahead but stay ahead. And, when approached with strong risk management policies, can follow the guidance laid forth by the Federal Reserve, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency.