The First Considerations in a Bank-Fintech Partnership

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A version of this article was originally published on April 3, 2023, as part of a special report called “Finding Fintechs.”

USAA Federal Savings Bank was among the first banks, if not the first bank, to launch mobile deposit capture to its customer base in 2009, long before such technology was widespread.

In the years since, $111 billion USAA has invested heavily in its mobile banking app, enabling its customers to complete a range of banking transactions, open new accounts, chat with a virtual assistant, apply for a loan or start an insurance claim. The San Antonio bank earns consistently high marks among its peers for its mobile and digital banking offerings, often topping far larger brands like JPMorgan Chase & Co. in customer satisfaction ratings.

Moreover, USAA has done this in an almost entirely digital environment. Because its core customer base — deployed military members and their families — tends to move frequently, the bank has barely any branches, and has poured significant resources into its digital offerings and customer service capabilities. Its core market is a small one, but keeping their specific needs at the center of its strategy has worked to USAA’s benefit, says Ron Shevlin, managing director and chief research officer at Cornerstone Advisors. He likens USAA’s strategy to a bull’s-eye, with deployed military members in the center, and retired service members and their family comprising the outer rings.

“They designed everything about their business as if they were serving the active deployed military member,” Shevlin says. “The reality is that by serving the bull’s-eye, they’re able to attract and serve the outer rings.”

That’s why Shevlin cites USAA as an example of what it means for a bank to have a strong digital strategy. When it comes to financial technology, a successful strategy begins before thinking about specific technologies or even using the word “technology,” Shevlin and others say.

Instead, banks can start by thinking about their core audience and how they can differentiate their organization in the marketplace, and using those principles as a guiding North Star. In turn, that can help communications between chief technology officers and the rest of the bank’s leadership, as well as decisions around staffing and prioritization of different problems.

A little over a third of bankers who participated in Bank Director’s 2022 Technology Survey expressed concerns that their bank was unable to identify specific technologies that would help achieve its strategic goals. A quarter also said they were concerned about an inability to identify specific companies or resources needed to achieve those goals.

“Rather than thinking of technology as a pillar or a piece of your strategy, you should come up with those strategic objectives. And then technology is a ribbon that goes throughout those strategies,” says John Behringer, a financial institutions leader and risk consulting partner at RSM US LLP.

Community banks may lack the talent they need to set up successful technology partnerships. Many community bankers also wear multiple hats, so they may not be able to focus on partnerships. Another crucial conversation to have around this time is how much staff the bank can dedicate to the success of this project. Under-resourcing these projects from the beginning can complicate the rest of the work — like due diligence, implementation and continued oversight — leading to underwhelming and unsatisfactory results for the institution. And banks that don’t have enough staff to manage these projects may need to bring in external consultants, which adds costs.

Shevlin recommends banks cultivate their internal competency for digital partnership collaborations throughout the bank — not just among finance and IT employees. A bank that wants to grow through fintech partnerships will need a number of experts in-house that can find, negotiate, bid, deploy, scale and monitor these new vendor relationships.

Ultimately, it’s the senior leadership team that develops a technology strategy in consultation with outside experts and internal ones, and with approval of the board of directors.

The chief technology or chief information officer is often responsible for managing and developing the bank’s technological resources, among their other duties. When it comes to larger strategic goals, this responsibility will likely include advocating for the bank’s technology needs before the board and other senior leadership. To do so successfully, that person needs to be able to tie those particular needs back to the bank’s core vision for what it wants to achieve, Behringer says.

For example, a chief executive or director may feel the bank has enough IT staff, not necessarily realizing that those employees are largely handling help desk tickets and other basic maintenance, not working on big-picture strategic needs. When communicating with the rest of the bank’s leadership, senior technology officers might emphasize the need for in-house staff working on initiatives that move the needle on strategy, while discussing the possibility of outsourcing or automating the more rote tasks needed to keep the lights on, Behringer says.
“Come back to, ‘What’s our vision? What do we view as kind of core to who we are?’” he says. “That’s where I think the CEO can do a better job. A lot of times with management, technology is an afterthought.”

Technology executives should also be mindful not to get too deep into the weeds and keep tech discussions focused on how they tie to broader business objectives.

“A CIO or CTO, even just talking to the executive team, has to translate the tech speak into business operational impact and dollars and cents: ‘What’s this going to cost us, and what’s this going to do,’ without going into mind-numbing levels of detail about the technology,” Shevlin says.

When considering broader staffing needs required to put strategic tech initiatives into play, it may be useful for banks to segment staff into those dedicated to running the bank and those dedicated to growing the bank, while improving efficiency and profitability. One centralized group should take responsibility for integration into the bank’s core, while another should have ownership for the results of fintech partnerships, Shevlin says.

Banking as a service and embedded finance are another story entirely, and banks that are getting into those areas should ideally have entire departments or business units dedicated to that. “You really have to understand that’s not your garden-variety fintech partnership,” Shevlin says. “That’s a whole new set of products and services.”

It’s also a good idea for bankers to make sure they’re fully utilizing the technology they already have, says Enrico Camerinelli, a strategic advisor at Aite-Novarica Group. The more technology a bank introduces, the more robust its backend systems need to be to handle that, he says.

“Banks need to leverage, as much as possible, the existing investments they have,” he says. “Technology is not necessarily always innovation in the sense of always building new things on top of old stuff.”

Legacy technology written in older programming languages doesn’t necessarily need to be scrapped as long as the bank is able to still maintain that infrastructure. In many cases, the
issue is not so much with older programming languages as it is with a lack of internal expertise about the language or tech in question.

“It’s not necessarily the software per se, but it’s the fact that it’s at risk of being unmanaged,” Camerinelli says. “That is the risk.”

Bankers can work on a broader strategy by mapping out whether a particular item on the to-do list is internal or external facing, or if it relates to a credit opportunity, mobile banking, the retail bank, a back-office function or some other function. Initiatives aimed at creating efficiencies within the organization can be just as meaningful as those intended to boost revenue or customer acquisition.

It may also help for bankers to think about setting measurable goals, within reasonable timeframes, as part of that strategic road map. For customer-facing technologies, tangible metrics could include adding more customers, growing market share or increasing the number of customers using digital banking or the bank’s mobile app.

“There should definitely be a growth target, from both the perspective of the percentage of customers that are in that bull’s-eye plus the percentage of revenue that is being generated by that segment,” Shevlin says. He adds that executives should be realistic in setting those goals, though, saying, “It’s never going to be 100%.”

Breaking larger projects into smaller chunks or tasks can also help keep teams motivated and on track when tackling strategic initiatives, says Laura Merling, chief transformation and operations officer at $26 billion Arvest Bank Group in Bentonville, Arkansas.

“You’re not shortcutting something, but you’re saying, what can be done in small chunks to show progress,” Merling said in an August 2022 conversion with Bank Director. “A lot of times in a bank, something might be a very long project that’s going to take 18 months to roll out. I don’t ever want a big aha at the end. What I want to see is incremental progress, which means figure out what you can roll out in 30 days, 60 days, 90 days, so that you have consistent progress. And then you measure it.”

Tech initiatives that serve an internal function can still be linked to some measurable outcome, but Behringer says that doesn’t necessarily have to be head count or expense reductions. Instead, bankers might look at improving the average time it takes to clear a particular task and once that’s accomplished, think about how they can deploy those fulltime employees more smartly. “I don’t like to just focus on cost-cutting,” he says.

Bank Secrecy Act and Anti-Money Laundering Act compliance may be one example of a function where a bank can digitize some part of the process and create internal efficiencies. Behringer describes one client that previously took about four hours to close out a suspicious activity report investigation because the BSA analyst needed to spend about three of those hours pulling data from various places. The firm built a bot that could automatically pull that relevant data for the analyst and was ultimately able to make that person’s job less mundane and repetitive. After making that change, a BSA analyst can now close out about eight alerts in a work day instead of two.

“That employee’s job satisfaction just went through the roof because they’re doing what they like to do, versus doing administrative tasks,” he says.

Bank Director Managing Editor Kiah Lau Haslett contributed to this report.

Insights Report: The Secret to Success in Banking as a Service

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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.

In Pursuit of Deposits, Think Outside the Box

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The script flipped.

During parts of the coronavirus pandemic, banks were so flooded with deposits that some bankers were happy when a portion of them fled. Now, at a time when the Federal Reserve has raised interest rates at the fastest pace since the 1980s, banks are battling for deposits to the point where some bankers are proactively calling customers, imploring them to stay.

The industry’s hot pursuit of deposits won’t stop soon, either. According to the What’s Going On In Banking 2023 study by Cornerstone Advisors, banks seeking to grow deposits among their retail base of customers more than doubled, from 21% in 2022 to 51% in 2023. Moreover, banks wanting small business deposits jumped to 72% in 2023, from 41% in 2022. The ability to bring in deposits is influencing senior executives’ bonuses.

In the quest for deposits, it’s likely time for banks to go beyond offering a sign-up bonus or higher savings rates. Here are three other ideas to consider.

1. Provide Banking as a Service
When banks “rent” their charter to nonbank financial services companies to serve a specific consumer group, they are providing banking as a service, or BaaS. While not the norm, the fintech-bank partnership has become more popular. Of the roughly 300 financial institutions surveyed for the Cornerstone report, 13% said they are considering the possibility of launching BaaS services.

The allure of the partnership is its ability to grow noninterest income and deposits in new markets. Adding to the appeal: According to the Cornerstone report, the return on assets and equity for BaaS banks exceeds the industry averages for all banks.

What to watch: This isn’t a strategy for all banks, of course. It comes with risk and attention from regulators. According to a recent Restive Ventures report, “[r]egulators are posing hard questions about consumer data and are seeking to understand where risk actually lies in the three-way relationships among fintechs, BaaS providers, and the actual regulated bank.”

2. Recruit Fintech Talent
While the unemployment rate remains low, banks are still struggling to recruit talent. But with tech companies eliminating thousands of positions, there are strong candidates for your bank to hire.

Hop on LinkedIn, where numerous fintech companies are sharing lists of recent employee layoffs. Seek out people who could develop your next product or service invention and send them a message.

Also, widen your network and mingle at new events. In so doing, you may discover someone with a skill set that’s different from others already working at your institution. For example, of there’s a reception celebrating female talent at an industry event, attend it regardless of your gender.

What to watch: If recruiting an entrepreneur, there’s a good chance the person is creative. In working within more rigid environments like a bank, they’ll need an outlet to discover ideas to try. Offer them a budget to take classes they wish to pursue.

3. Reevaluate How People Join Your Bank Online
The way someone becomes a bank customer online has long been cumbersome. The application often still requires too much manual entry of would-be customers, causing them to abandon the chore.

It’s high time to invest in a system that simplifies the process of signing up for an account online, while still complying with know your customer rules. The good news: In 2023, more than one in four banks expect to select a new or replacement commercial digital account opening app, according to the Cornerstone report; 21% of banks plan to do the same thing for their consumer account opening app.

What to watch: Go beyond making the application form easier to fill out on a phone and address the other hassles interfering with why someone doesn’t switch. For example, U.S. Bancorp partnered with Atomic, a company that offers payroll connectivity services, to roll out a feature that lets new account holders switch their direct deposit information in minutes, removing a barrier of why someone might drop their account.

Your bank needs to think outside of the box to secure more business at a time when deposit competition is fierce. As Curt Queyrouze, president of Seattle-based Coastal Community Bank, said in the report: “I think we’re spending too much energy trying to protect the status quo instead of embracing innovation. The slow tide of customer preference will soon turn into a tidal wave and it will be too late to catch up. These transformations take years.”

What to Consider as Regulators Scrutinize Bank-Fintech Partnerships

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Fintech partnerships, specifically banking as service arrangements, are changing the risk profile at community banks and require heightened risk management from executives and the board.

Banking as a service has evolved from the niche domain of certain community banks to a business line facilitated by software. The growth of the industry, and its concentration among small banks, has attracted the attention of the Office of the Comptroller of the Currency, and its Acting Comptroller Michael Hsu. Experts say that community banks should respond by increasing their due diligence and strengthening their risk management oversight, practices and processes ahead of potentially more scrutiny from regulators.

“The growth of the fintech industry, of [banking as a service] and of big tech forays into payments and lending is changing banking, and its risk profile, in profound ways,” Hsu said in prepared remarks at a conference hosted by The Clearing House and the Bank Policy Institute in New York City in September. 

Banking as a service leverages an institution’s charter so a nonbank partner can offer banking products or services to customers. It creates a series of layers: A bank services a fintech, who offers products to a business or individual. And increasingly, the connection between the fintech and the bank is facilitated, partially or completely, by software that is in the middle of the fintech and bank relationship, called middleware. 

One company that makes such an operating system is Treasury Prime, where Sheetal Parikh works as associate general counsel and vice president of compliance solutions. 

“We’ve learned how to become more efficient; we have a lot of these banks with antiquated technology systems and cores that can’t necessarily get fintech companies or customers to market as quickly as maybe they could,” says Parikh.  

While software and operating systems can make the onboarding and connections easier between the parties, it doesn’t ease the regulatory burden on banks when it comes to vendor due diligence and customer protections. A bank can delegate different aspects and tasks within risk management and fraud detection and prevention, but it can’t outsource the responsibility.

“The banks that do it [banking as a service] well have constant engagement with their fintechs,” says Meg Tahyar, co-head of Davis Polk’s financial institutions practice and a member of its fintech team. “You need someone at the end to hold the bag – and that’s always the bank. So the bank always needs to have visibility and awareness functions.” 

Even with middleware, running a rigorously managed, risk-based BaaS program in a safe and sound manner is “operationally challenging” and “a gritty process,” says Clayton Mitchell, Crowe LLP’s managing principal of fintech. The challenge for banks adding this business line is having a “disciplined disruption” approach: approaching these partnerships in an incremental, disciplined way while preparing to bolster the bank’s risk management capabilities.

This can be a big ask for community institutions — and Hsu pointed out that banking as a service partnerships are concentrated among small banks; in his speech, he mentioned an internal OCC analysis that found “least 10 OCC-regulated banks that have BaaS partnerships with nearly 50 fintechs.” The found similar stats at banks regulated by the Federal Reserve and FDIC; most of the banks with multiple BaaS partnerships have less than $10 billion in assets, with a fifth having less than $1 billion.

Tahyar says she doesn’t believe Hsu is “anti-banking as a service” and he seems to understand that community banks need these partnerships to innovate and grow. But he has a “sense of concern and urgency” between fintech partnerships today and parallels he sees with the 2007 financial crisis and Great Recession, when increasing complexity and a shadow banking system helped create a crisis.  

“He understands what’s happening in the digital world, but he’s ringing a bell, saying ‘Let’s not walk into this blindly,’” she says. “It’s quite clear that [the OCC] is going to be doing a deep dive in examinations on fintech partnerships.”

To start addressing these vulnerabilities and prepare for heightened regulatory scrutiny, banks interested in BaaS partnerships should make sure the bank’s compliance teams are aligned with its teams pushing for innovation or growth. That means alignment with risk appetite, the approach to risk and compliance and the level of engagement with fintech partners, says Parikh at Treasury Prime. The bank should also think about how it will manage data governance and IT control issues when it comes to information generated from the partnership. And in discussions with prospective partners, bank executives should discuss the roles and responsibilities of the parties, how the partnership will monitor fraud or other potential criminal activity, how the two will handle customer complaints. The two should make contingency plans if the fintech shuts down. Parikh says that the bank doesn’t have to perform the compliance functions itself — especially in customer-facing functions.  But the bank needs strong oversight processes. 

OCC-regulated banks engaged in fintech partnerships should expect more questions from the regulator. Hsu said the agency is beginning to divide and classify different arrangements into cohorts based on their risk profiles and attributes. Fintech partnerships can come in a variety of shapes and forms; grouping them will help examiners have a clearer focus on the risks these arrangements create and the related expectations to manage it.

What is clear is that regulators believe banking as a service, and fintech partnerships more broadly, will have a large impact on the banking industry — both in its transformation and its potential risk. Hsu’s speech and the agency’s adjustments indicate that regulatory expectations are formalizing and increasing. 

“There is still very much a silver lining to this space,” says Parikh. “It’s not going anywhere. Risk isn’t all bad, but you have to understand it and have controls in place.”

Unlocking Banking as a Service for Business Customers

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Banking as a service, or BaaS, has become one of the most important strategic imperatives for chief executives across all industries, including banking, technology, manufacturing and retail.

Retail and business customers want integrated experiences in their daily lives, including seamlessly embedded financial experiences into everyday experiences. Paying for a rideshare from an app, financing home improvements when accepting a contractor quote, funding supplier invoices via an accounting package and offering cash management services to fintechs — these are just some examples of how BaaS enables any business to develop new and exciting propositions to customers, with the relevant financial services embedded into the process. The market for embedded finance is expected to reach $7 trillion by 2030, according to the Next-Gen Commercial Banking Tracker, a PYMNTS and FISPAN collaboration. Banks that act fast and secure priority customer context will experience the greatest upside.

Both banks and potential BaaS distributors, such as technology companies, should be looking for ways to capitalize on BaaS opportunities for small and medium-sized enterprises and businesses (SMEs). According to research from Accenture, 25% of all SME banking revenue is projected to shift to embedded channels by 2025. SME customers are looking for integrated financial experiences within relevant points of context.

SMEs need a more convenient, transparent method to apply for a loan, given that business owners are often discouraged from exploring financing opportunities. In 2021, 35% of SMEs in the United States needed financing but did not apply for a loan according to the 2022 Report on Employer Firms Based on the Small Business Credit Survey. According to the Fed, SMEs shied away from traditional lending due to the difficult application process, long waits for credit decisions, high interest rates and unfavorable repayment terms, and instead used personal funds, cut staff, reduced hours, and downsized operations.

And while there is unmet demand from SMEs, there is also excess supply. Over the last few years, the loan-to-deposit ratio at U.S. banks fell from 80% to 63%, the Federal Reserve wrote in August 2021. Banks need loan growth to drive profits. Embedding financial services for SME lending is not only important for retaining and growing customer relationships, but also critical to growing and diversifying loan portfolios. The time for banks to act is now, given the current inflection point: BaaS for SMEs is projected to see four-times growth compared to retail and corporate BaaS, according to Finastra’s Banking as a Service: Global Outlook 2022 report.

How to Succeed in Banking as a Service for SMEs
There are three key steps that any institution must take to succeed in BaaS: Understand what use cases will deliver the most value to their customers, select monetization models that deliver capabilities and enable profits and be clear on what is required to take a BaaS solution to market, including partnerships that accelerate delivery.

BaaS providers and distributors should focus on the right use case in their market. Banks and technology companies can drive customer value by embedding loan and credit offers on business management platforms. Customers will benefit from the increased convenience, better terms and shorter application times because the digitized process automates data entry. Banks can acquire customers outside their traditional footprint and reduce both operational costs and risks by accessing financial data. And technology companies can gain a competitive advantage by adding new features valued by their customers.

To enable the right use case, both distributors and providers must also select the right partners — those with the best capabilities that drive value to their customers. For example, a recent collaboration between Finastra and Microsoft allows businesses that use Microsoft Dynamics to access financing offers on the platform.

Banks will also want to focus on white labeling front‑to-back customer journeys and securing access to a marketplace. In BaaS, a marketplace model increases competition and benefits for all providers. Providers should focus on sector‑specific products and services, enhancing data and analytics to enable better risk decisions and specialized digital solutions.

But one thing is clear: Going forward, embedded finance will be a significant opportunity for banks that embrace it.

Five Fintech Solutions Every Bank Should Have

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If Money 20/20 was any indication, it seems like banks are finally ready to really embrace fintech. Small and medium-sized banks have realized that their technology budgets can be used for things other than building and managing technology in-house to keep up with large financial institutions with big budgets and neobanks with brand new tech stacks. A tech stack is the combination of technologies a company uses to build and run an application or project, and typically consists of programming languages, frameworks, a database, front-end tools, back-end tools and applications connected via APIs.

For banks starting to explore fintech partnerships, we’ve compiled a list of the top five fintech solutions every bank should have in its tech stack today.

1. Account Opening Platform
New customer acquisition is one of the most important components of a successful financial institution. An online account opening platform powers an omnichannel interface to onboard new customers quickly and seamlessly. A good account opening platform should also provide a customizable user interface, increased account conversion rates and detailed reporting.

2. Identity Decisioning Platform
An identity decisioning platform, or IDP, automates identity and risk decisions across the lifecycle of your customer. IDPs power smart decisions that can reduce risk for your business while providing a frictionless customer experience for identity verification and onboarding, ongoing transaction monitoring and credit underwriting.

IDPs are the decision engine behind the account opening platform that helps banks determine whether to accept or reject an applicant. It continues to monitor that client’s account activity and powers underwriting decisions. Your IDP should connect to multiple data sources through application programming interfaces, or APIs, allowing you to add and change data sources as needed. By bringing all of your identity and risk decisions into one platform, you’ll see a holistic view of your customers and automate more decisions.

3. Open Banking Platform
Your customers expect to be able to access their financial data across various apps. Open banking platforms make it easy for banks to securely share data with third-party businesses through an API that allows customers to connect their banking data. Open banking platforms are the key component connecting your bank to popular apps like peer-to-peer payments, financial management and cryptocurrency investments.

4. BaaS Platform
You’ve probably noticed the trend of non-bank businesses beginning to offer financial products. This trend is powered through BaaS, or banking as a service, platforms. BaaS platforms enable a third-party business to integrate digital banking or payment services directly into their products by connecting them with a bank. This model allows non-financial institutions the ability to offer a financial product without getting a banking license. Unlike open banking platforms, which share the financial data within a bank account to a third-party business, BaaS platforms transfer the complete banking services into a third-party business’s product.

5. Know Your Transaction Solution
If your bank is starting to think about how to approach cryptocurrency and digital assets, one of the first things you’ll need is a Know Your Transaction, or KYT, provider to complement your Know Your Customer (KYC) procedures. KYT solutions help you remain compliant with anti-money laundering laws when monitoring crypto transactions. A KYT solution allows banks to track crypto funds and ensure they are not coming from mixers (a service that mixes streams of cryptocurrency to improve anonymity and make it more difficult to trace), foreign exchanges or blacklisted addresses.

Fintech companies can provide a lot of value to banks. Many of them are built to plug into your existing infrastructure and be up and running in weeks. They can help banks be more agile and adapt to new customer needs faster, save banks money on engineering resources and bring focused expertise to their category. Alloy also has resources available to help banks select fintech partners and build out their tech stacks.

New Accounting Guidance Seeks to Clarify Three Big Questions

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The Office of the Chief Accountant has provided new insight into three of the biggest questions posed in recent months by banks and financial institutions. Publishing in the 2021 edition of its annual Bank Accounting Advisory Series (BAAS) OCC Bulletin 2021-37, the chief accountants office shared guidance covering:

  • Loans held for sale (Subtopic 2E)
  • Employee stock options (Subtopic 8C)
  • Grants received by banks (Subtopic 11E)

The three are among the Accounting Standards Updates (ASU) issued by the Financial Accounting Standards Board prior to March 31, 2021. The annual bulletin addresses the topics that are most relevant to national banks and federal savings associations, and it promotes consistent application of accounting standards and regulatory reporting among OCC-supervised banks. Below is an overview of the three key items in the latest accounting bulletin update:

Loans held for sale (Subtopic 2E, Question 4)
If a bank has adopted Accounting Standards Codification (ASC) Topic 326 and decides to sell a loan that was originally marked as held for investment (HFI) whose fair value has declined because of negative trends in credit quality, the bank should apply a two-step process to account for the transaction. First, it should apply a regulatory charge-off, in accordance with the interagency guidance on held for sale. Second, after the write-down, the bank should apply the guidance for HFI to HFS transfers in ASC 310 or ASC 948.

Employee stock options (Subtopic 8C, Question 2)
A bank may participate in and sponsor an employee stock ownership plan (ESOP) solely for the benefit of bank employees. When the related ESOP trust borrows funds from the related holding company and is considered an internally leveraged ESOP, the loan is generally not required to be recorded at the subsidiary bank level under ASC 718-40. It is permitted if, based on the judgment of management or the external auditor, it is needed to accurately report the subsidiary bank’s financial condition in the call report or the subsidiary bank’s audited financial statements, both of which are presented on a bank-only level.

Grants received by banks (Subtopic 11E, Questions 1-2)
For regulatory reporting purposes, banks should account for any non-governmental grants received in accordance with ASC 958-605. While Topic 958 applies specifically to nonprofit entities, the guidance on accounting for contributions received (such as grants) applies to all entities. Banks that receive governmental grant proceeds, such as grants from the Community Development Financial Institution fund, should apply ASC 958-605 by analogy for call report purposes. The recipient bank should first determine if there are any donor-imposed conditions; revenue is recognized for grants without conditions when it is received.

When donor-imposed conditions exist, revenue is recognized when those conditions have been substantially met. In this situation, the grant should be recognized as deferred revenue with a related receivable, cash or other contributed asset recognized. For call report purposes, grant revenue should be included in Schedule RI, “Other Non-Interest Income;” if thresholds are met, it should be disclosed on Schedule RI-E, “Explanations.” Unearned grant revenue should be included in Schedule RC-G, “Other Liabilities.”

Additionally, the 2021 Bank Accounting Advisory Series includes Appendix A, “Newly Issued Accounting Standards.” The appendix describes new accounting standards applicable to this edition of the BAAS and the first call report for which calendar year-end institutions must adopt the ASUs.

Fintech Acquisitions Are Rare Among Banks; Here’s One Exception

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Few banks seem interested in purchasing financial technology firms. Just five such deals were announced this year as of July 14, based on a list of acquisitions compiled by Piper Sandler & Co. for Bank Director, using data from S&P Global Market Intelligence. Six of these deals were announced in 2020. Bank Director’s 2021 Bank M&A Survey found that a paltry 11% of respondents — primarily representing banks above $1 billion in assets — said their bank was likely to purchase a technology company in 2021.

Piper Sandler Managing Director Chris Donat believes banks are more interested in the tools and the solutions — more easily obtained through vendor relationships and collaborations — than in owning these companies outright.

Our list of recent fintech acquisitions by banks finds that as a group, big banks are the most active acquirers. But one small bank has been exceptionally active in this space: $2.7 billion MVB Financial Corp., based in ​​Fairmont, West Virginia. Working with fintechs has become a core element of the bank’s strategy.

MVB’s strategic shift dates back to 2016, when CEO Larry Mazza and CFO Don Robinson were trying to come up with a strategy to generate deposits to fuel the bank’s loan growth. They were inspired, says Robinson, by companies outside the banking sector that were housing deposits in loyalty programs and digital apps.

Examples include Starbucks Corp. and DraftKings, a sports betting app that reported $288 million in “cash reserved for users” — essentially deposits — in its 2020 annual report. Meanwhile, Starbucks recorded $1.6 billion in “stored value card liability” as of June 27; these funds are tied to the coffee purveyor’s prepaid cards, which customers can purchase and replenish online or in stores. Neither of these companies aim to be a bank, but they do draw dollars that their customers can use to buy coffee or gamble online — money that isn’t going to their primary bank account.

To better understand this evolving landscape, Robinson and Mazza reallocated marketing dollars to invest in fintech companies, viewing it as research and development. They took an active role in their investments, sitting on their boards. “We had a day-to-day involvement, kind of front row seat to their interactions,” says Robinson.

Today, the bank provides banking-as-a-service (BaaS) to fintech clients such as the personal finance company Credit Karma, which was itself acquired by Intuit last year. (Other BaaS banks include Coastal Financial Corp., NBKC Bank and Celtic Bank Corp.) The business has led to a huge increase in deposits. Fintech deposits totaled $533 million at the end of 2020, an increase of $382 million (255%) over the previous year — accounting for more than a quarter of MVB’s $1.98 billion in total deposits. Most of the fintech deposits ($358 million) come from the gaming industry. MVB’s return on average equity has more than doubled in the last two years, to 16.7% in 2020. Its return on average assets was 1.7%, up from 0.7% in 2018.

MVB has specific requirements for investing in fintech companies. There needs to be a market for the solution, which must solve problems faced by the industry or the bank’s clients. The management team should have a proven track record and resources for growing and scaling the company. And MVB wants to see what it can bring to the table. “We’re looking at that strategic partnership,” says Robinson. “How can we work with this [company]?”

The approach has resulted in a diverse array of acquisitions and investments, including Invest Forward, which offers a digital savings account; Paladin, focused on fraud prevention; and Trabian Technology, a software developer.

In a release explaining the rationale behind the Trabian acquisition, Mazza noted that the company adds “a new revenue stream and profit center and technological expertise that will benefit MVB and all of our stakeholders.”

Acquisitions that extend MVB further into areas like software development and fraud protection help the bank turn cost centers into profit centers, explains Robinson. “Trabian does work for, not only MVB, but it also does work for third parties,” he says. “As we look at the fintech world, one of the key pieces for us was looking at, how do you bring that expertise in house?”

The bank launched MVB Edge Ventures in June to oversee its technology investments and tackle two challenges that would vex any bank considering putting its capital into a fintech: valuation and culture.

To address valuations, MVB does its homework. “These are not public companies, right? So there’s a lot of diligence we have to do to make sure we understand the overall market,” says Robinson. “[We] try to stay away from pre-revenue companies, and we don’t invest in concepts.”

And the new venture arm addresses the cultural piece, along with regular communication with Robinson and Mazza.

“We have a team [that] work[s] together on a regular basis [to] integrate the companies and provide that platform,” says Robinson. He and Mazza regularly communicate with their portfolio fintechs, and Robinson says they have a lot to learn from one another. “They’re sharing the challenges and pitfalls they’re seeing,” he says, “and also the opportunities.”

Of course, MVB is not the only bank looking to fintech acquisitions to fuel growth. Earlier this month, Fifth Third Bancorp closed its acquisition of Provide. The digital platform offers deposit accounts, insurance coverage and financing to healthcare providers, originating $300 million in loans in the first half of 2021, according to Fifth Third’s July 21 earnings call.

“Our focus is on nonbank transactions that enhance our product and service capabilities,” Fifth Third CEO Greg Carmichael said on the call. “Provide would be a great example of that.” Fifth Third started investing in the company in 2018, and began funding loans through the platform around two years later. Provide will continue to operate as a subsidiary of the Cincinnati-based regional bank, which expects the platform to generate around $400 million in originations in the second half of 2021 and $1 billion in 2022.

2020-2021 (YTD) Fintech Acquisitions by Banks

Acquiring Bank Name Ticker Fintech Target Announcement Deal Value ($M)
Fifth Third Bancorp FITB Provide 6/22/2021 Undisclosed
Axos Financial AX E*TRADE Advisor Services 4/20/2021 $55
MVB Financial Corp. MVBF Trabian Technology 4/16/2021 Undisclosed
Bank of America Corp. BAC Axia Technologies 4/1/2021 Undisclosed
PNC Financial Services Group PNC Tempus Technologies 1/27/2021 Undisclosed
Alliance Data Systems Corp. (Comenity Bank) ADS Lon Operations 10/28/2020 $450
CRB Group (Cross River Bank) n/a Synthetic P2P Holdings Corp. (d/b/a PeerIQ) 8/21/2020 Undisclosed
American Express Co. AXP Kabbage 8/17/2020 Undisclosed
MVB Financial Corp. MVBF Invest Forward 8/7/2020 $1
MVB Financial Corp. MVBF Paladin 4/17/2020 Undisclosed
Bank of Montreal BMO Clearpool Group 1/22/2020 $147

Source: Piper Sandler & Co. using data from S&P Global Market Intelligence.

The Unbankey Bank: Coastal Financial’s Evolution

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Coastal Financial Corp., a $2 billion community banking company in Everett, Washington, was a typical community bank seven years ago. It wasn’t looking to launch a banking-as-a-service (BaaS) division, where the bank would lend out its charter, payment rails and other bank exclusive products and services to third parties.

But that is exactly what the bank did.

When asked if he knew anything about BaaS prior to 2015 — the launch year of Coastal’s BaaS program — CEO Eric Sprink confessed, “Nope — we stumbled into it.”

In 2015, Sprink met Arkadi Kuhlmann, former CEO of ING Direct USA and ING Direct Canada, who was looking for a bank partner to offer banking services on the back end for his financial technology company, Zenbanx. The fintech offered deposit accounts, international currencies and money transfers.

This was the first time Sprink had heard anything about BaaS. He was interested, the board was interested, the executive team of Coastal was interested; so, the bank started an almost 15-month process of engaging investment bankers and consultants, speaking with regulators and preparing to enter into this new line of business.

But then, Coastal lost the bid to do business with Zenbanx to the personal finance giant SoFi Technologies, which later bought the fintech. Six months later, SoFi announced it was shutting down all Zenbanx accounts.

Instead of opting for resignation, Sprink — with the blessing of his board — continued to chase down new technology leads and partners. In the words of one of Sprink’s board members: “‘We’ve got to find out more about this … start running.’”

And Sprink hasn’t stopped running since. Along the way, Coastal recruited multiple new board members — one about every 18 months, and four in total — who have helped build Coastal’s BaaS strategy from the ground up. Sprink explains the process as being, “evolutionary, not revolutionary … We’ve intentionally looked really hard for expertise that we’re lacking in the evolution of our BaaS group.”

That expertise, in part, is coming from its newest members: Stephan Klee; venture capitalist veteran and current CFO of Portage Ventures; Sadhana Akella-Mishra, chief risk officer at alternative core provider Finxact; Rilla Delorier, a former innovation executive at Umpqua Bank and PNC Bank; and Pamela Unger, a former tax manager at PwC, who brings understanding of direct venture capital accounting and oversight.

Coastal is dedicated to partnering with fintechs that are not only unwavering in their mission, but that are compatible with Coastal’s core values: stay flexible, embrace great thinking and be “unbankey,” as Sprink says. In what he describes as their “emotional gating criteria,” the bank sits down — or Zooms in, post-March 2020 — with these fintechs. They want to better understand the business, review their performance and investors, and, most importantly, find out what they want to accomplish. The key is to find partners that will reach and embolden specific communities through financial products and services tailored to their needs.

“We try real hard upfront to make sure we’re picking the ones that best fit us and that have the most likelihood of success,’’ he says. “With limited resources, you really have to stick to your gating criteria and believe in what you’re trying to accomplish.”

The whole process, from initial discussion to commercial launching, takes upwards of one year to 18 months. As of July, Coastal was working with 24 fintechs, half of them actively offering banking products and services through Coastal.

It takes a lot of effort to get to that stage. Out of the more than 1,100 fintechs vetted, only about 2% became fintech partners.

And in regard to the 12 active fintech partners, Coastal just recently crested the $1 million in revenue mark. Coastal’s BaaS revenue for the quarter ending June of 2021 was $1.4 million, a 50.2% increase from the prior quarter. Included in Coastal’s overall BaaS revenue, the bank reported $110,000 in interchange income for the quarter ending in June, up from $35,000 in the prior quarter. The bank isn’t tracking profitability of the division yet, but plans to break it out next year for analysts and investors.

In a 2020 survey, venture capitalist firm Andreessen Horowitz found that out of those surveyed, half of the BaaS banks were seeing above-industry average rates on their return on assets and equity, calculated from 2017 to 2019. The firm says that these returns are two to three times the average industry rate.

When Bank Director magazine launched a study to determine the top 10 fastest growing U.S. banks in 2020, it found that two of the banks listed are BaaS providers: NBKC Bank, with $1.2 billion in assets, placed at the top of the list, while $4.7 billion Celtic Bank ranked fifth.

A BaaS division could lead a bank to new revenue and deposit sources, growth and access to new customer segments, but it does not have the sole capability to turn a bank profitable. It takes good timing, patience and a healthy bank with curious leaders — a combination that Coastal seems to flourish on.

The bank’s second quarter 2021 investor presentation also reports that 73% of Coastal’s fintech partners are headed by a diverse CEO, those who identify as a minority or female. Eighty-eight percent have a diverse co-founder. Partners include Greenwood, Cheese, Fair, Aspiration and Ellevest, some of which reach underserved communities or offer mission-based banking practices.

“At the end of the day, we’re still a community bank, and we’re trying to give that [community banking] experience to others [who] haven’t had it yet,” Sprink says. “And we’re using partners to deliver it.”

Getting Faster, Simpler, Cheaper and More Secure

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In June 2020, Coastal Financial Corp. began onboarding financial technology clients to ramp up its banking as a service (BaaS) business.

The $1.8 billion community banking company in Everett, Washington, would lend its bank charter, compliance program and payment rails to nonbanks for a fee. Nine out of 10 of those clients are unregulated by any financial regulator; one out of 10 might be a regulated entity such as a broker-dealer. This arrangement means the bank must monitor its nonbank customers for compliance with anti-money laundering, foreign sanctions and Bank Secrecy Act (BSA) laws.

Andrew Stines, the chief risk officer of Coastal Financial, and his staff of BSA experts keep track of a fluctuating amount of flagged transactions per month, about 3,000 to 4,000, on everything from ACH and loan payments to debit and credit card transactions. It’s a lot. From the bank regulators’ point of view, “I’m the one who really owns that risk,” Stines says.

The company previously had manually pulled flagged transactions for further investigation  with Excel spreadsheets. But that didn’t work anymore, given the workload. So Coastal turned to Hummingbird, the winner of Bank Director’s 2021 Best of FinXTech Award for compliance & risk.

Hummingbird automatically pulls flagged transactions from the bank’s core, Neocova, and automates compliance reporting. It sends suspicious activity reports (SARs) to regulators after Coastal Financial conducts investigations. Hummingbird also creates an auditable trail of each case.

The bank is not alone in trying to ramp up its fraud and compliance monitoring and reporting using new software. Financial institutions are under increasing pressure to update their fraud technologies with machine learning, robotic process automation and other tools to combat increasingly sophisticated criminals and higher use of digital services, according to a February 2021 report from the research firm Celent.

Celent Head of Risk Neil Katkov projects that North American financial institutions — which are the greatest targets for global fraud — will spend $3.1 billion on fraud technology in 2021, or 16.1% more than the year before. Spending on fraud operations will amount to another $4.55 billion, he wrote.

The marketplace for fraud and compliance software has become crowded, which benefits banks, says Kevin Tweddle, the senior executive vice president for community bank solutions at the Independent Community Bankers of America.

“People ask me what’s a fintech,” he says. “It makes [banking] faster, simpler, cheaper and more secure.” An especially active group right now are cybersecurity companies, all vying to monitor threats for financial institutions and to help with compliance and reporting requirements.

Finalists in the compliance and risk category for the Best of FinXTech Awards included IT compliance company Adlumin, which uses machine learning to detect threats, malfunctions and operations failures in real time, and the cybersecurity provider DefenseStorm, which is a cybersecurity compliance platform built for banks and credit unions. For more on how Bank Director chose winners, click here.

But Hummingbird was clearly a stand-out for Coastal Financial. The software program was cost competitive, although Stines declines to name the price. Using the software clearly pays for itself, he says. But he admits the company might not need Hummingbird if not for its BaaS business, which adds to the company’s reporting requirements. Stines estimates he’d have to hire four to five additional full-time employees without it.

The drawback is that Hummingbird’s software doesn’t include every tool the banking company needs. But there’s a roadmap to adding functionality, and Hummingbird sticks to its promised dates, Stines says. The real selling factor was the user interface and the fact that Hummingbird seems eager to make changes as needed, and understands Coastal Financial’s technology clients. “They are more forward-thinking and more in tune with digital and fintech services than traditional players in the space,” he says.

This may just be the beginning. For Tweddle, banks and credit unions are enjoying an early to middle development period for fintech. “There’s a lot more interesting things to come,” he says.