Let’s start with an assumption that CEOs and directors at community banks across the country are, by now, very aware of the fintech industry. As a result, many management teams and boards are currently developing strategies to address the opportunities and challenges posed by this burgeoning field. There are some basic decisions to be made regarding these relatively new companies, which seem to be popping up daily, one sleek website after another. These decisions include whether to:
- Buy a fintech company
- Build a fintech platform
- Partner with a fintech company
This is certainly the easiest option, although possibly chosen at a bank’s peril. If we consider the words of Amazon CEO Jeff Bezos and one of the preeminent disrupter-in-chiefs, we see why: “What really matters is, companies that don’t continue to experiment, companies that don’t embrace failure, they eventually get in a desperate position where the only thing they can do is a Hail Mary bet at the very end of their corporate existence.” In addition, some of the country’s largest banks have very affirmatively chosen NOT to ignore fintech, and their heavy investments (in the case of JPMorgan Chase & Co., to the tune of $600 million) in emerging fintech solutions will likely lead to significant competitive advantages in the future.
This is a good option, although clearly also an expensive one. Purchases often run into the tens of millions of dollars, so while this is a good solution for banks with the capability of paying those sorts of purchase prices, it is beyond the means of most small institutions.
Another good option for banks committed to supporting the banking industry’s shift toward better technology is to build it from the ground up. Once again, this is typically not cheap—one community bank that established an innovation lab planned to spend over $10 million implementing its initiative.
There are three main types of partnerships. The first would be a straight referral relationship, in which a bank sends loans it cannot approve to a nonbank lender, with all respective functions and branding kept separate and distinct. This tends to result in a poor customer experience, with low volumes. The next is a software platform relationship, where a bank leases an application and/or underwriting system from a nonbank lender. In this type of arrangement, the bank must define all credit parameters and process all applications. The third type of partnership is an integrated approach, where the bank and nonbank partner jointly allocate the various steps in a lending process to one partner or the other. While challenging to design and implement, this type of partnership typically results in better outcomes for banks and their customers.
The integrated approach has emerged as the desired choice for many banks currently collaborating with fintech companies. For example, BancAlliance, a network of over 200 community banks, has established partnerships with various fintech companies that typically follow the integrated approach.
Once a bank has decided to move forward with a partner, there are a number of important items to consider. The first, of course, is partner selection—there are now hundreds of fintech lenders, and it is important to evaluate strategic alignment, reputation, compliance and counterparty strength when choosing a partner. Negotiation is next, where services, economics, compliance, reporting and customer protection must be addressed. Banks must engage in a robust vendor management process, both initially and on an ongoing basis. After implementation, there is typically significant ongoing monitoring and management.
For community banks in particular, collaborative partnerships can offer a compelling avenue. Ignoring fintech altogether seems risky, and most community banks are not able to buy or build fintech platforms on their own. Direct partnerships with fintech lenders can require significant upfront investments of time and money in connection with vendor selection and due diligence. A collaborative approach can share due diligence costs among a number of banks and can allow the banks collectively to negotiate more favorable terms. The collaborative approach also allows information-sharing among banks, which often enhances program management. Recent reports by federal banking agencies seem to support collaborative approaches in this space, and community banks interested in partnering with fintech companies may be well served by exploring the various collaborative arrangements currently available.