5 Considerations When Vetting Fintech Partnerships

Fintech collaborations are an increasingly critical component of a bank’s strategy.

So much so that Bank Director launched FinXTech, committed to bridging the gap between financial institutions and financial technology companies. Identifying and establishing the right partner enables banks to remain competitive among peers and non-bank competitors by allowing them to access modern and scalable solutions. With over 10,000 fintechs operating in the U.S. alone, finding and vetting the right solution can seem like an arduous task for banks.

The most successful partnerships are prioritized at the board and executive level. Ideally, each partnership has an owner — one that is senior enough to make decisions that dictate the direction of the partnership. With prioritization and owners in place, banks can consider fintech companies at all stages of maturity as potential partners. While early-stage companies inherently carry more risk, the trade-off often comes in the form of enhanced customization or pricing discounts. These earlier-stage partnerships may require the bank to be more involved during the implementation, compliance or regulatory processes, compared to working with a more-mature company.

There is no one-size-fits-all approach, and it’s important for banks to evaluate potential partners based on their own strategic plan and risk tolerance. When conducting diligence on fintechs of any stage or category, banks should place emphasis on the following aspects of a potential partner:

1. Analyze Business Health. This starts with understanding the fintech’s ability to scale while remaining in viable financial conditions. Banks should evaluate financial statements, internal key performance indicator reports, and information on sources of funding, including major investors.

Banks should also research the company’s competitive environment, strength of its client base and potential expansion plans. This information can help determine the fintech’s capability to sustain operations and satisfy any financial commitments, allowing for a long-term, prosperous partnership. This analysis is even more important in the current economic environment, where fresh capital may be harder to come by.

2. Determine Legal and Compliance. Banks need to assess a fintech’s compliance policies to determine if their partner will be able to comply with the bank’s own legal and regulatory standards. Executives should include quarterly and annual reports, litigation or enforcement action records, and other relevant public materials, such as patents or licenses, in this evaluation.

Banks may also want to consider reviewing the fintech’s relationship with other financial institutions, as well as the firm’s risk management controls and regulatory compliance processes in areas relevant to the operations. This can give bank executives greater insight into the fintech’s familiarity with the regulatory environment and ability to comply with important laws and regulations.

3. Evaluate Data Security. Banks must understand a fintech’s information and security framework and procedures, including how the company plans to leverage customer or other potentially sensitive, proprietary information.

Executives should review the fintech’s policies and procedures, information security control assessments, incident management and response policies, and information security and privacy awareness training materials. In addition, external reports, such as SOC 2 audits, can be key documents to aid in the assessment. This due diligence can help banks understand the fintech’s approach to data security, while upholding the regulator’s expectations.

4. Ask for References. When considering a potential fintech partnership, executives should consult with multiple references. References can provide the bank with insight into the company’s history, conflict resolution, strengths and weakness, renewal plans and more, allowing for a deeper understanding of the fintech’s past and current relationships. If possible, choose the reference you speak with, rather than allowing the fintech to choose.

5. Ensure Cultural Alignment. The fintech’s culture plays an important role in a partnership, which is why on-site visits to see the operations and team in action can help executives with their assessment. Have conversations with the founders about their goals and speak with other members of the team to get a better idea of who you will be working with. Partners should be confident in the people and technology — both will create a mutually successful and meaningful relationship.

Despite the best intentions, not all partnerships are successful. Common mistakes include lack of ownership and strategy, project fatigue, risk aversion and unreasonable expectations. Too often, banks are looking for a silver bullet, but meaningful outcomes take time. Setting expectations and continuing to re-evaluate the success and performance of these partnerships frequently will ensure that both parties are achieving optimal results.

Once banks establish partnerships, they must also nurture the relationship. Again, this is best accomplished by having a dedicated partner owner who is responsible for meeting objectives. As someone who analyzes hundreds of fintechs to determine quality, viability and partner value, I am encouraged by the vast number of technology solutions available to financial institutions today. Keeping a focused, analytical approach to partnering with fintechs will put your bank well on its way to implementing innovative new technology for all stakeholders.

Modernizing Your Retail Banking Business

The Covid-19 pandemic accelerated the decline of traffic in most banks’ retail branches, leading many organizations to reexamine the cost of their branch services and the ultimate viability of their branch-based services. Bank boards and executive teams must address the changing operating risks in today’s retail banking environment and assess the potential strategic risks of both action and inaction.

Speculation about the impending death of branch banking is nothing new: industry observers have debated the topic for years. As customers have become more comfortable with online banking, banks experienced a sizeable drop in in-person transactions. Regulatory changes, social trends and the growth of fintech alternatives exacerbated this development, leading many banks to cut back or centralize various branch-based activities. Between June 2010 and year-end 2020, branch offices have decreased by more than 16,000, or 16.7%, according to a Crowe analysis of report from the Federal Deposit Insurance Corp.

The pandemic also introduced important new challenges. Many banks had already shifted the focus in their branches, but greater consumer acceptance of remote and self-service options clouded the role of the branch even further. At the same time, pandemic relief programs produced a wave of liquidity, which hid or delayed the recognition of fundamental challenges many bankers expect to face: finding new ways to continue growing their core deposits at an acceptable cost.

So far, banks’ responses to these challenges have varied. Some banks — both large and small — have accelerated their branch closure plans. Others have notified regulators that they do not plan to reopen branches shuttered during lockdowns. But some banks actually are adding new offices as they reconfigure their retail banking strategies. What is the underlying strategic thinking when it comes to brick and mortar locations?

Developing and Executing an Effective Strategy

There is no one-size-fits-all approach, of course. Closing a majority of branches and becoming a digital-only organization is simply not appropriate for most banks. Nevertheless, many aspects of the physical model require innovation. Directors and executive teams can take several steps to successfully modernize their retail banking strategies.

  • Rethink branch cost and performance metrics. Banks use a variety of tools to attract deposits, sell products and build relationships, which means conventional performance metrics such as accounts or transactions per employee, cost per transaction or teller transaction times often are inadequate measurements.

A branch’s contribution also includes the visibility it provides as a billboard for the bank, access to and support for the specialized products and services it can deliver and the role it plays in establishing a community presence. Management teams need to develop tools to determine and measure the value of such contributions to the bank and its product lines, as well as their associated costs. Branches are long-term investments that require longer-term planning strategies and tactics.

  • Identify customer expectations. One factor contributing to the decline in foot traffic is what customers experience when they visit a branch. Although branch greeters can establish a welcoming atmosphere, such encounters often succeed only in a nice greeting — not necessarily in service.

Because customers can perform most banking business online, banks must ascertain why customers are visiting the branch — and then focus on meeting those needs. Ultimately, customers must leave the branch feeling fulfilled, having accomplished a transaction or task that would have been more difficult outside the branch.

  • Execute a coordinated digital strategy. Having a digital strategy means more than updating the bank’s website, streamlining its mobile banking interface or even partnering with a fintech to offer new digital products. Such catch-up activities might be necessary, but they no longer set a bank apart in today’s digital landscape or improve profitability and growth.

Beyond technology, banks should consider how their digital strategy and brand identity align and how that identity ties back to customers’ expectations. Traditionally, banks’ brand identities were linked to a specific geographic location or niche audiences, but brand identity also can reflect other communities or affinity groups or a particular service or product at which the bank is especially adept. This identity should be projected consistently throughout the customer experience, both digitally and in person.

Although most banks should not abandon their branches altogether, many will need to reevaluate their market approaches, compare opportunities for improved earnings performance and consider reimagining their value proposition for in-person services. Strategies will vary from one organization to the next, but those that succeed will share certain critical attributes — including a willingness to question conventional thinking and redeploy resources without hesitation.

Disability and Opportunity in Banking

Keri Cain didn’t set out to become a marijuana banker. But after her muscular dystrophy led her to give up her dream career in apparel merchandising, she moved back to Oklahoma and stumbled into the massive opportunity to support businesses operating in the newly legalized marijuana space with legitimate banking services. She currently serves as Bank Secrecy Act director of special programs at Tulsa, Oklahoma-based Regent Bank, and created the institution’s cannabis banking program. 

Her interest in this sector is informed by her curiosity as well as her disability. She shares with Bank Director her thoughts on including disability in conversations about diversity and inclusion, how banks can make their workplaces more accessible for all employees and how therapeutic cannabis may figure in her future.

This episode, and all past episodes of The Slant Podcast, are available on Bank Director, Spotify and Apple Music.

Focusing on ESG

In this episode of Looking Ahead, Crowe LLP Partner Mandi Simpson talks with Al Dominick about what’s driving greater focus on environmental, social and governance (ESG) issues, and explores some of the fundamentals that boards should understand. She also sheds light on how boards can consider shareholder return and balance long-term ESG strategy with a short-term view on profitability, and provides tips on how boards can better focus on this important issue.

Margin With a Mission

Darrin Williams didn’t become CEO by getting promoted through the management ranks of the banking industry. In fact, as a lawyer, he spent some of this time suing banks and publicly traded companies before later serving in the Arkansas House of Representatives. But his passion for lifting his community through financial education led him to the $2 billion Southern Bancorp in Arkadelphia, Arkansas, one of the largest Community Development Financial Institutions in the country. Williams talks about his early influences and the influx of support for the CDFI industry following the murder of George Floyd. 

Additional episodes of The Slant Podcast are now available on Spotify and Apple Music!

Lessons From the Best Banks

The strategies and areas of excellence found in the best banks identified by Bank Director in its 2022 RankingBanking report, sponsored by Crowe LLP, vary greatly. But all top performers have a few things in common, including a long-term focus on strategic execution. Crowe Partner Kara Baldwin, who leads the firm’s national financial services audit practice, shares her insights on what the best banks have in common, from technology adoption to culture.

  • The Main Driver of Strong Performance
  • Growth Predictions
  • Setting Technological Priorities
  • Building a Strong Culture

Uncover more about the nation’s best banks in the 2022 RankingBanking study, which identified the top performers by asset size based on financial performance; the ranking also considered innovation, growth, leadership and corporate governance.

3 Steps to Planning for Climate Risk

Last year, President Joe Biden’s Executive Order on Climate-Related Financial Risk and the resulting report from the Financial Stability Oversight Council identified climate change as an emerging and increasing threat to U.S. financial stability.

A number of financial regulatory and agency heads have also spoken about climate risk and bank vulnerability.

Now the question is: What should banks be doing about it now? Here are three steps you can take to get started:

1. Conduct a Risk Assessment
Assessing a financial institution’s exposure to climate risk poses an interesting set of challenges. There is the short-term assessment for both internal operations and business exposures: what is happening today, next month or next year. Then there are long-term projections, for which modeling is still being developed.

So where to begin?
Analyzing the potential impacts of physical risk and transition risk begins with the basic question, “What if?” What if extreme weather events continue, how does that impact or alter your operational and investment risks? What if carbon neutral climate regulations take hold and emissions rapidly fall? Widen your scope from credit risk to include market, liquidity and reputational risk, which is taking on new meaning. Bank executives may make reasonable decisions to stabilize their balance sheet, but those decisions could backfire when banks are seen as not supporting their customers in their transition.

Regional and smaller financial institutions will need more granular data to assess the risk in their portfolios, and they may need to assemble local experts who are more familiar with climate change’s impact on local companies.

2. Level Up the Board of Directors
Climate change has long been treated as part of corporate social responsibility rather than a financial risk, but creating a climate risk plan without executive support or effective oversight is a fool’s errand. It’s time to bring it into the boardroom.

Banks should conduct a board-effectiveness review to identify any knowledge gaps that need to be filled. How those gaps are filled depends on each organization, but climate change expertise is needed at some level — whether that be a board member, a member of the C-suite or an external advisor.

The next step is incorporating climate change into the board’s agenda. This may already be in place at larger institutions or ones located in traditionally vulnerable areas. However, recent events have made it clear that climate risk touches everything the financial sector does. Integrating climate risk into board discussions may look different for each financial institution, but it needs to start happening soon.

3. Develop a Climate-Aware Strategy
Once banks approach climate risk as a financial risk instead of simply social responsibility, it’s time to position themselves for the future. Financial institutions are in a unique position when formulating a climate risk management strategy. Not only are they managing their own exposure — they hold a leadership role in the response to carbon neutral policies and regulation.

It can be challenging, but necessary, to develop a data strategy with a holistic view across an organization and portfolio to reveal where the biggest risks and opportunities lie.

Keeping capital flowing toward clients in emission industries or vulnerable areas may seem like a high risk. But disinvestment may be more detrimental for those companies truly engaged in decarbonization activities or transition practices, such as power generation, real estate, manufacturing, automotive and agriculture. These exposures may be offset by financing green initiatives, which have the potential to mitigate transition risk across a portfolio, increase profit and, better yet, stabilize balance sheets as the economy evolves into a carbon neutral world.

Banks Inherited a Wholesale Balance Sheet During the Pandemic. Here’s What to Do.

Bank managements and directors must recognize how cash has changed significantly over the past seven quarters, from the fourth quarter of 2019 to the third quarter of 2021. The median cash-to-earning assets for all publicly traded banks has grown to 10% in recent quarters, up from 4% pre-pandemic. This is a direct impact of the Covid-19 pandemic on deposit flows from government stimulus and the reluctance to deploy cash in a time of historically low interest rates.

The result is a healthy “wholesale” balance sheet that is separate and distinct from banks’ normal operations. This must be factored into growth plans for 2022 and 2023. We think it may take several quarters to properly deploy the excess liquidity. Investors already demand faster loan growth and their tolerance towards low purchases of securities may wane. The pressure to take action on cash is real, and it should be seen as an opportunity and certainly not a curse. We see excess cash as a high-class problem that can be met with a successful response at all banks.

We expect financial institutions will become far more open about their two balance sheet positions in the near future. First, let’s talk about the “normal” operation with stated goals and objectives on growth (e.g. loans, earnings per share and returns on tangible equity). Next, segment the “wholesale” balance sheet, which contains the cash position and any extra liquidity in short-term securities. Using our industry data above (10% cash in earning assets, up from 4% pre-pandemic), a $3 billion community bank has $300 million in cash instead of the usual $120 million it carried two years earlier — this establishes a $180 million wholesale position. Company management should directly communicate how this separate liquidity will be used to enhance earnings and returns in future quarters. Likewise, boards should stay engaged on how this cash gets utilized within their risk tolerance.

Late in the fourth quarter of 2021, certain company acquisitions disclosed the use of excess cash as a key rationale of the deal. An example is Ameris Bancorp, whose executive team stated in its December 2021 purchase of Balboa Capital that the transaction was funded by excess cash. Back in May 2021, Regions Financial (which is neutral-rated by Janney) acquired EnerBank with a home improvement finance strategy that would deploy its liquidity into new loans. Regions has since completed additional M&A deals with the same explanation. Many more small M&A transactions seem likely in 2022 using cash deployment as an underlying theme.

It has been my experience for three decades as an equity analyst that banks miss chances to explain their strategy in a succinct yet powerful manner. Remaining shy under the pretense of conservatism does not generally reward a higher stock valuation. Instead, banks who are direct and loud about their strategy (and then execute) tend to be rewarded with a stronger stock price. Hence, it is a far better idea to express a game plan for cash and a bank’s distinct “wholesale” balance sheet.

The current cash positions (which produced little to no earnings return in prior quarters) are now a superb opportunity to make a difference with investors. We encourage banks to be direct on how they will utilize excess cash and liquidity separate from their existing operations. The Janney Research team estimates banks can generate nearly a 10% boost to EPS by 2023 from managing excess cash alone. This is separate from any benefit from higher interest rates and Federal Reserve policy shifts that may occur.

Outlining a cash strategy in 2022 and 2023 is a critical way to differentiate the bank’s story with investors. Bank executives and directors must take advantage of this opportunity with a direct game plan and communicate it accordingly.

The Emerging Impacts of Covid Stimulus on Bank Balance Sheets

In the middle of 2020, while some consumers were stockpiling essentials like water and hand sanitizer, many businesses were shoring up their cash reserves. Companies across the country were scrambling to build their war chests by cutting back on expenses, drawing from lines of credit and tapping into the Small Business Administration’s massive new Paycheck Protection Program credit facility.

The prevailing wisdom at the time was that the Covid-19 pandemic was going to be a long and painful journey, and that businesses would need cash in order to remain solvent and survive. Though this was true for some firms, 2020 was a year of record growth and profitability for many others. Further, as the SBA began forgiving PPP loans in 2021, many companies experienced a financial windfall. The result for community banks, though, has been a surplus of deposits on their balance sheets that bankers are struggling to deploy.

This issue is exacerbated by a decrease in loan demand. Prior to the pandemic, community banks could generally count on loan growth keeping up with deposit growth; for many banks, deposits were historically the primary bottleneck to their loan production. At the start of 2020, deposit growth began to rapidly outpace loans. By the second quarter of 2021, loan levels were nearly stagnant compared to the same quarter last year.

Another way to think about this dynamic is through the lens of loan-to-deposit (LTD) ratios. The sector historically maintained LTDs in the mid-1980s, but has recently seen a highly unusual dip under 75%.

While these LTDs are reassuring for regulators from a safety and soundness perspective, underpinning the increased liquidity at banks, they also present a challenge. If bankers can’t deploy these deposits into interest-generating loans, what other options exist to offset their cost of funds?

The unfortunate reality for banks is that most of these new deposits came in the form of demand accounts, which require such a high degree of liquidity that they can’t be invested for any meaningful level of yield. And, if these asset and liability challenges weren’t enough, this surge in demand deposits effectively replaced a stalled demand for more desirable timed deposits.

Banks have approached these challenges from both sides of the balance sheet. On the asset side, it is not surprising that banks have been stuck parking an increasing portion of the sector’s investment assets in low-yield interest-bearing bank accounts.

On the liabilities side, community banks that are flush with cash have prudently trimmed their more expensive sources of funds, including reducing Federal Home Loan Banks short-term borrowings by 53%. This also may be partially attributable to the unusual housing market of high prices and low volumes that stemmed from the pandemic.

As the pandemic subsides and SBA origination fees become a thing of the past, shareholders will be looking for interest income to rebound, while regulators keep a close eye on risk profiles at an institutional level. Though it’s too soon to know how this will all shake out, it’s encouraging to remember that we’re largely looking at a profile of conservative community banks. For every Treasury department at a mega bank that is aggressively chasing yield, there are hundreds of community bank CEOs that are strategically addressing these challenges with their boards as rational and responsible fiduciaries.

Visit https://www.otcmarkets.com/market-data/qaravan-bank-data to learn more about how Qaravan can help banks understand their balance sheets relative to peers and benchmarks.

The Topic That’s Missing From Strategic Discussions

As of Oct. 8, 2021, the U.S. experienced 18 weather-related disasters with damages exceeding the $1 billion mark, according to the National Oceanic and Atmospheric Administration (NOAA). These included four hurricanes and tropical storms on the Gulf Coast — the costliest disaster, Hurricane Ida, totaled $64.5 billion, destroying homes and knocking out power in Louisiana before traveling north to cause further damage via flash flooding in New Jersey and New York. Out West, the financial damage caused by wildfires, heat waves and droughts has yet to be tallied but promises to be significant. More than 6.4 million acres burned, homes, vegetation and lives were destroyed, and a hydroelectric power plant outside Sacramento even shut down due to low water levels.

These incidents weren’t unique to 2021. In fact, the frequency of costly natural disasters — exceeding $1 billion, adjusted for inflation — have been ticking up since at least the 1980s.

 

Scientists at the NOAA and elsewhere point to climate change and increased development in vulnerable areas such as coastlines as the cause of these more frequent, costlier disasters, but bank boards aren’t talking about the true risks they pose to their institutions. Bank Director’s 2021 Risk Survey, conducted in January, found just 14% of directors and senior executives reporting that their board discusses the risks associated with climate change at least annually. An informal audience poll at Bank Director’s Bank Audit & Risk Committees Conference in late October confirmed little movement on these discussions, despite attention from industry stakeholders, including regulators and investors that recognize the risks and opportunities presented by climate change.

These include acting Comptroller of the Currency Michael Hsu, who on Nov. 3 announced his agency’s intent to “develop high-level climate risk management supervisory expectations for large banks” above $50 billion in assets along with guidance by the end of the year. He followed that announcement with a speech a few days later that detailed five questions every bank board should ask about climate change. While his comments — and the upcoming guidance — focus on larger institutions, smaller bank boards would benefit from these discussions.

Hsu’s first two questions for boards center on the bank’s loan portfolio: “What is our overall exposure to climate change?” and “Which counterparties, sectors or locales warrant our heightened attention and focus?” Hsu prompts banks to dig into physical risks: the impacts of more frequent severe weather events on the bank’s markets and, by extension, the institution itself. He also asks banks to look at transition risks: reduced demand and changing preferences for products and services in response to climate change. For example, auto manufacturers including General Motors Co. and Ford Motor Co. announced in November that they plan to achieve zero emissions by 2040; those shifts promise broad impacts to the supply chain as well as gas stations across the country due to reduced demand for fuel.

Consider your bank’s geographic footprint and client base: What areas are more susceptible to frequent extreme weather events, including hurricanes, floods, wildfires and droughts? How many of your customers depend on carbon intensive industries, and will their business models be harmed with the shift to clean energy? These are the broad strategic areas where Hsu hopes boards focus their attention.

But the changes required in transitioning to a clean economy will also result in new business models, new products and services, and the founding and growth of companies across the country. It’s the other side to the climate change coin that prompts another question from Hsu: “What can we do to position ourselves to seize opportunities from climate change?

Some large investors agree. In Larry Fink’s 2021 letter to CEOs, the head of BlackRock reaffirmed the value the investment firm places on climate change, noting the opportunities along with the risks. “[W]e believe the climate transition presents a historic investment opportunity,” he wrote in January. “There is no company whose business model won’t be profoundly affected by the transition to a net zero economy – one that emits no more carbon dioxide than it removes from the atmosphere by 2050. … As the transition accelerates, companies with a well-articulated long-term strategy, and a clear plan to address the transition to net zero, will distinguish themselves with their stakeholders.”

Some banks are positioning themselves to be early movers in this space. These include $187 billion Citizens Financial Group, which launched a pilot green deposit program in July 2021 that ties interest-bearing commercial deposits to a sustainable-focused lending portfolio. The challenger bank Aspiration launched a credit card in November that plants two trees with every purchase. And $87 million Climate First Bank opened its doors over the summer, offering residential and commercial solar loans, and financing environmentally-friendly condo upgrades. Climate First is founder and CEO Kenneth LaRoe’s second bank focused on the environment, and he sees a wide range of opportunities. “I call myself a rabid environmentalist — but I’m a rabid capitalist, too,” he told Bank Director magazine earlier this year.

 

Select Green Initiatives Announced in 2021

Source: Bank press releases and other public information

Climate First Bank (St. Petersburg, Florida)
Specialized lending to finance sustainable condo retrofits and residential/commercial solar loans; contributes 1% of revenues to environmental causes.

Citizens Financial Group (Providence, Rhode Island)
Launched pilot green deposit program in July 2021, totaling $85 million as of Sept. 30, 2021.

Aspiration (Marina Del Rey, California)
Fintech introduced Aspiration Zero Credit Card, earning cash back rewards and planting two trees with every purchase.

JPMorgan Chase & Co. (New York)
Designated “Green Economy” team to support $1 trillion, 10 year green financing goal.

Bank of America Corp. (Charlottesville, North Carolina)
Increased sustainable finance target from $300 million to $1.5 trillion by 2030.

Fifth Third Bancorp (Cincinnati, Ohio)
Issued $500 million green bond to fund green building, renewable energy, energy efficiency and clean transportation projects.

 

Boards that don’t address climate change as a risk in the boardroom will likely overlook strategic opportunities. “Banks that are poorly prepared to identify climate risks will be at a competitive disadvantage to their better-prepared peers in seizing those opportunities when they arise,” Hsu said.

Hsu offered two additional questions for bank boards in his speech. “How exposed are we to a carbon tax?”references the price the U.S. government could place on greenhouse gas emissions; however, he also stated that the passage of such a tax in the near future is unlikely. The other, “How vulnerable are our data centers and other critical services to extreme weather?” certainly warrants attention from the board and executive team as part of any bank’s business continuity and disaster recovery planning.

Most management teams won’t be able to answer broader, strategic questions on climate initially, Hsu said, but that shouldn’t keep boards from asking them. “Honest responses should prompt additional questions, rich dialogue, discussions about next steps and management team commitments for action at future board meetings,” Hsu stated. “By this time next year, management teams hopefully should be able to answer these questions with greater accuracy and confidence.”