Banking as a service can bring in more revenue, deposits and customers for community banks. But it can also increase compliance burdens and potential risk.
Banking as a service, or BaaS, is an indirect banking relationship where a financial institution provides the back-end servicing for a company that intermediates with retail customers. Today, most of these relationships occur online – the third party brings in customer deposits, payments transactions and loans in exchange for fees associated with the arrangement. In turn, the bank houses the relationship, facilitates the transactions, and takes the lead on compliance and oversight.
“Banks are outsourcing significant compliance duties to the third party, and they’re taking on risks that are new and different from their direct business because they are providing their banking services indirectly,” says James Stevens, a partner and co-leader of Troutman Pepper’s financial services industry group.
Banking as a service isn’t new, although technology has made it easier for institutions to build out this business line. Sioux Falls, South Dakota-based Pathward N.A., a subsidiary of $6.7 billion Pathward Financial, has been in this space for about two decades. The bank sees its legal and regulatory compliance management system as a “core strength” fueling its innovation with partners, says Lauren Brecht, senior vice president and managing counsel of credit and tax solutions at the bank.
That’s because institutions interested in offering a BaaS business line must walk a fine line of responsible innovation and robust third-party risk management. Executives should understand that they can’t outsource their oversight responsibilities. That’s why it’s so important that banks create robust, “top-down” third-party vendor risk management policies and procedures that specifically address BaaS concerns, Stevens says. He also recommends that banks invest in personnel and systems that can handle the oversight and compliance functions “way in advance” of any partnerships.
“Banks are always going to be the ones left holding the bag, from a regulatory and compliance standpoint,” Stevens says. “It’s incumbent upon them to not only do due diligence and establish a good contractual relationship with their partner, but to also have the capability to manage and oversee it over time to manage those risks.”
To download the report, sponsored by Troutman Pepper, click here.
The Banking as a Service Insights report was originally published in the second quarter 2023 issue of Bank Director magazine.