How Strategic Banks Use Micro-innovation to Fuel New Growth

With digital financial experiences booming and young consumers flocking to app-focused banking, institutions are assessing which of their products and services will prove popular in the future and exploring how to ensure growth continues among a new demographic of consumers.

For the 65 million members of Generation Z in the U.S., “going to the bank” or “writing a check” are quickly becoming tasks from a bygone era. A 2021 survey underlined that 32% of these customers would prefer to do all their banking outside a physical branch, which presents banks with an opportunity for their digital products to take the lead.

If digital banking is the way of the future, why shouldn’t banks drop everything and go all-in? For most banks, that’s not feasible — or economically wise. It’s vital that banks understand the importance of solving problems while adding value for the customer. Former Apple co-founder CEO Steve Jobs explained, “when we created the iTunes music store, we did that because we thought it would be great to be able to buy music electronically, not because we had plans to redefine the music industry.” Solely focusing on innovation isn’t a practical strategy; the aim should be to make small bets that lead to big breakthroughs.

Most banks don’t need to adopt an “innovate or die” mindset toward the future to drive change. Not every bank will launch a groundbreaking app, and not every company can be Apple. Nor should there they be. Instead, leaders can look to micro-innovation: A scalable, stepwise growth model that supports agile technology integration and novel processes without a major overhaul to the bank’s core or existing infrastructure.

Flex and Expand the Core
A traditional full core conversion can take a bank five years or more to complete. The digital world won’t wait that long; it’s important that banks start implementing change now with micro-innovation. Rather than reinventing the essential processes that are working, micro-innovation allows institutions to launch services in a parallel run to test fresh ideas and offer new products. A micro-innovation approach allows core processes and revenue streams to remain intact while your institution welcomes the future.

Our partner, Holyoke, Massachusetts-based PeoplesBank, efficiently launched a compelling financial brand, ZYNLO, operating alongside its traditional offerings. The new digital bank is designed for younger customers and offers features to support financial health with tools like Zyng Roundup, Zyng matching and early access to paychecks. PeoplesBank is looking beyond the traditional realm of innovation and embrace new thinking by partnering with social media influencers to spread brand awareness and increase visibility.

Where to Begin?
The best incremental innovations are those that can be brought to market swiftly at an affordable cost. Consider leveraging your customer data to pluck low-hanging opportunities to serve groups of customers while providing valuable insights to improve their financial journey.

There’s an opportunity to start small by implementing a fresh onboarding experience. New customers are oriented to digital solutions; if it makes sense for your customers, consider building in-app account opening and educational tools to help them seamlessly engage with their financial future from their smartphone.

Get attention by testing out new product types and fine-tuning processes. Automatically rounding up transactions and deposit that change into savings, early access to paychecks with direct deposits, mobile-first initiatives and financial education tools like monthly spending reports are all popular among young consumers.

Ready to go further? By collaborating with a knowledgeable fintech partner, your institution can launch a own digital financial brand and deliver compelling hooks, such as invoice factoring, tax tools, credit builders and financial modeling, that better serve a niche group of individuals with shared financial needs and goals. Niche digital banks market to a wide range of geographically dispersed customers centered around identities (African Americans, LGBTQ), professions (doctors and lawyers), or shared life experiences and passions (individuals who have previously been incarcerated, pet owners, newly married couples).

In a time of economic uncertainty, organizations looking to win the moment should approach the future with a flexible and entrepreneurial mindset. Identify where your institutions wants to be, determine what’s required to get there and take the first steps in parallel to what’s already working. There’s no time like today.

Using Sub Debt To Play Offense

Subordinated debt can be an attractive capital option for many banks. Will Brackett, managing director at Performance Trust Capital Partners, breaks down how bankers can think through their approach to using subordinated debt. He recommends that every financial institution take a hard look at its balance sheet and how it could perform under myriad interest rate scenarios. Those banks with strong track records, and little or no existing subordinated debt, are best positioned to fetch better than market pricing in an issuance. 

Topics include: 

  • Advantages of Subordinated Debt
  • Which Banks Benefit Most 
  • Achieving the Best Pricing 

Becoming a CEO

The chief executive officer is usually the single most important person in any organization, but it’s a job that most individuals grow into over time. The transition is often filled with challenges and difficult learning experiences.

Such was the case for Ira Robbins, the chairman and CEO at Valley National Bancorp, a $54 billion regional bank headquartered in Wayne, New Jersey. The 48-year-old Robbins was just 43 when he succeeded long-time CEO Gerald Lipkin in 2018. Lipkin, on the other hand, was closing in on his 77th birthday when he passed the baton to Robbins after running the bank for 42 years.

Robbins is deeply respectful of Lipkin but shares that one immediate challenge he faced was changing a culture that hadn’t kept pace with the bank’s growth over the years. He said Valley National was a $20 billion bank that operated as if it was still a $5 billion bank. Changing that culture was not easy, and he had to make some very difficult personnel decisions along the way.

Robbins is thoughtful, introspective and candid about his growth into the CEO role at Valley National. His reflections should be of great interest to any banker who hopes to someday become a CEO.

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

CECL Model Validation Benefits Beyond Compliance

The current expected credit loss (CECL) adoption deadline of Jan. 1, 2023 has many financial institutions evaluating various models and assumptions. Many financial institutions haven’t had sufficient time to evaluate their CECL model performance under various stress scenarios that could provide a more forward-looking view, taking the model beyond just a compliance or accounting exercise.

One critical element of CECL adoption is model validation. The process of validating a model is not only an expectation of bank regulators as part of the CECL process — it can also yield advantages for institutions by providing crucial insights into how their credit risk profile would be impacted by uncertain conditions.

In the current economic environment, financial institutions need to thoroughly understand what an economic downturn, no matter how mild or severe, could do to their organization. While these outcomes really depend on what assumptions they are using, modeling out different scenarios using more severe assumptions will help these institutions see how prepared they may or may not be.

Often vendors have hundreds of clients and use general economic assumptions on them. Validation gives management a deeper dive into assumptions specific to their institution, creating an opportunity to assess their relevance to their facts and circumstances. When doing a validation, there are three main pillars: data and assumptions, modeling and stress testing.

Data and assumptions: Using your own clean and correct data is a fundamental part of CECL. Bank-specific data is key, as opposed to using industry data that might not be applicable to your bank. Validation allows for back-testing of what assumptions the bank is using for its specific data in order to confirm that those assumptions are accurate or identify other data fields or sources that may be better applied.

Modeling (black box): When you put data into a model, it does some evaluating and gives you an answer. That evaluation period is often referred to as the “black box.” Data and assumptions go into the model and returns a CECL estimate as the output. These models are becoming more sophisticated and complex, requiring many years of historical data and future economic projections to determine the CECL estimate. As a result of these complexities, we believe that financial institutions should perform a full replication of their CECL model. Leveraging this best practice when conducting a validation will assure the management team and the board that the model the bank has chosen is estimating its CECL estimate accurately and also providing further insight into its credit risk profile. By stripping the model and its assumptions down and rebuilding them, we can uncover potential risks and model limitations that may otherwise be unknown to the user.

Validations should give financial institutions confidence in how their model works and what is happening. Being familiar with the annual validation process for CECL compliance will better prepare an institution to answer all types of questions from regulators, auditors and other parties. Furthermore, it’s a valuable tool for management to be able to predict future information that will help them plan for how their institution will react to stressful situations, while also aiding them in future capital and budgeting discussions.

Stress testing: In the current climate of huge capital market swings, dislocations and interest rate increases, stress testing is vital. No one knows exactly where the economy is going. Once the model has been validated, the next step is for banks to understand how the model will behave in a worst-case scenario. It is important to run a severe stress test to uncover where the institution will be affected by those assumptions most. Management can use the information from this exercise to see the connections between changes and the expected impact to the bank, and how the bank could react. From here, management can gain a clearer picture of how changes in the major assumptions impact its CECL estimate, so there are no surprises in the future.

What to Consider as Regulators Scrutinize Bank-Fintech Partnerships

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.”

Asking the Right Questions About Your Bank’s Tech Spend

Bank Director’s 2022 Technology Survey, sponsored by CDW, finds 81% of bank executives and board members reporting that their technology budget increased compared to 2021, at a median of 11%. Much of this, the survey indicates, ties to the industry’s continued digitization of products and services. That makes technology an important line item within a bank’s budget — one that enables bank leaders to meet strategic goals to serve customers and generate organizational efficiencies.

“These are some of the biggest expenditures the bank is making outside of human capital,” says John Behringer, risk consulting partner at RSM US LLP. The board “should feel comfortable providing effective challenge to those decisions.” Effective challenge references the board’s responsibility to hold management accountable by being engaged, asking incisive questions and getting the information it needs to provide effective oversight for the organization.  

Banks budgeted a median $1 million for technology in 2022, according to the survey; that number ranged from a median $250,000 for smaller banks below $500 million in assets to $25 million for larger banks above $10 billion. While most believe their institution spends enough on technology, relative to strategy, roughly one-third believe they spend too little. How can boards determine that their bank spends an appropriate amount?

Finding an apples to apples comparison to peers can be difficult, says Behringer. Different banks, even among peer groups, may be in different stages of the journey when it comes to digital transformation, and they may have different objectives. He says benchmarking can be a “starting point,” but boards should delve deeper. How much of the budget has been dedicated to maintaining legacy software and systems, versus implementing new solutions? What was technology’s role in meeting and furthering key strategic goals? 

A lot of the budget will go toward “keeping the lights on,” as Behringer puts it. Bank of America Corp. spends roughly $3 billion annually on new technology initiatives, according to statements from Chairman and CEO Brian Moynihan — so roughly 30% of the bank’s $11 billion total spend.

For banks responding to the survey, new technology enhancements that drive efficiencies focus on areas that keep them safe: For all banks, cybersecurity (89%) and security/fraud (62%) were the top two categories. To improve the customer experience, institutions have prioritized payments capabilities (63%), retail account opening (54%), and consumer or mortgage lending (41%).

Benjamin Wallace says one way board members can better understand technology spend is to break down the overall technology cost into a metric that better illustrates its impact, like cost per account. “For every customer that comes on the board, on average, let’s say $3.50, and that includes the software, that includes the compensation … and that can be a really constructive conversation,” says Wallace, the CEO of Summit Technology Group. “Have a common way to talk about technology spend that you can look at year to year that the board member will understand.”

Trevor Dryer, an entrepreneur and investor who joined the board of Olympia, Washington-based Heritage Financial Corp. in November 2021, thinks boards should keep the customer top of mind when discussing technology and strategy. “What’s the customer’s experience with the technology? [W]hen do they want to talk to somebody, versus when do they want to use technology? When they do use technology, how is this process seamless? How does it align with the way the bank’s positioning itself?” If the bank sees itself as offering high-touch, personal service, for example, that should be reflected in the technology.

And the bank’s goals should drive the information that floats back to the boardroom. Dryer says $7.3 billion Heritage Financial has “great dashboards” that provide important business metrics and risk indicators, but the board is working with Chief Technology Officer Bill Glasby to better understand the impact of the bank’s technology. Dryer wants to know, “How are our customers interacting with our technology, and are they liking it or not? What are the friction points?” 

Some other basic information that Behringer recommends that bank leaders ask about before adopting new technology include whether the platform fits with the current infrastructure, and whether the pricing of the technology is appropriate. 

Community banks don’t have Bank of America’s $11 billion technology budget. As institutions increase their technology spend, bank leaders need to align adoption with the bank’s strategic priorities. It’s easy to chase fads, and be swayed to adopt something with more bells and whistles than the organization really needs. That distracts from strategy, says Dryer. “To me, the question [banks] should be asking is, ‘What is the problem that we’re trying to solve for our customers?’” Leadership teams and boards that can’t answer that, he says, should spend more time understanding their customers’ needs before they go further down a particular path. 

The best companies leverage technology to solve a business problem, but too many management teams let the tail wag the dog, says Wallace. “The board can make sure — before anyone signs a check for a technology product — to press on the why and what’s driving that investment.” 

Forty-five percent of respondents worry that their bank relies too heavily on outdated technology. While the board doesn’t manage the day-to-day, directors can ask questions in line with strategic priorities. 

Ask, “’Are we good at patching, or do we have a lot of systems where things aren’t patched because systems are no longer supported?’” says Behringer. Is the bank monitoring key applications? Have important vendors like the core provider announced sunsets, meaning that a product will no longer be supported? What technology is on premises versus hosted in the cloud? “The more that’s on prem[ises], the more likely you’ve got dated technology,” he says.

And it’s possible that banks could manage some expenses down by examining what they’re using and whether those solutions are redundant, a process Behringer calls “application rationalization.” It’s an undertaking that can be particularly important following an acquisition but can be applied just as easily to organic duplication throughout the organization. 

A lack of boardroom expertise may have members struggling to have a constructive conversation around technology. “Community bank boards may not have what we would consider a subject matter expert, from a technology standpoint,” says Behringer, “so they don’t feel qualified to challenge.” 

Heritage Financial increased the technology expertise in its boardroom with the additions of Dryer and Gail Giacobbe, a Microsoft executive, and formed a board-level technology committee. Dryer led Mirador, a digital lending platform, until its acquisition by CUNA Mutual Group in 2018. He also co-founded Carbon Title, a software solution that helps property owners and real estate developers understand their carbon impact. 

Experiences like Dryer’s can bring a different viewpoint to the boardroom. A board-level tech expert can support or challenge the bank’s chief information officer or other executives about how they’re deploying resources, whether staffing is appropriate or offer ideas on where technology could benefit the organization. They can also flag trends that they see inside and outside of banking, or connect bank leaders to experts in specific areas. 

“Sometimes technology can be an afterthought, [but] I think that it’s a really critical part of delivering banking services today,” says Dryer. “With technology, if you haven’t been in it, you can feel like you’re held captive to whatever you’re being told. There’s not a really great way to independently evaluate or call B.S. on something. And so I think that’s a way I’ve been trying to help provide some value to my fellow directors.”  

Less than half of the survey respondents say their board has a member who they’d consider a tech expert. Of the 53% of respondents who say their board doesn’t have a tech expert, just 39% are seeking that expertise. As a substitution for this knowledge, boards could bring in a strategic advisor to sit in as a technologist during meetings, says Wallace. 

On the whole, boards should empower themselves to challenge management on this important expense by continuing their education on technology. As Wallace points out, many boards play a role in loan approvals, even if most directors aren’t experts on credit. “They’re approving credit exposure … but they would never think to be in the weeds in technology like that,” he says. “Technology probably has equal if not greater risk, sometimes, than approving one $50,000 loan to a small business in the community.”

The ways in which banks leverage technology have been featured recently in Bank Director magazine. “Confronting the Labor Shortage” focuses on how M&T Bank Corp. attracts and trains tech talent. “Community Banks Enter the Venture Jungle” examines bank participation in fintech funds; a follow-up piece asks, “Should You Invest in a Venture Fund?”  Some institutions are evaluating blockchain opportunities: “Unlocking Blockchain’s Power” explores how Signature Bank, Customers Bancorp and others are leveraging blockchain-based payments platforms to serve commercial customers; risk and compliance considerations around blockchain are further discussed in the article, “Opportunities — and Questions — Abound With Blockchain.” 

Technology is an important component of a bank’s overall strategy. For more information on enhancing strategic discussions, consider viewing “Building Operational Resiliency in the Midst of Change” and “Board Strategic Leadership,” both part of Bank Director’s Online Training Series.   

Bank Director’s 2022 Technology Survey, sponsored by CDW, surveyed 138 independent directors, chief executive officers, chief operating officers and senior technology executives of U.S. banks below $100 billion in assets to understand how these institutions leverage technology in response to the competitive landscape. Bank Services members have exclusive access to the complete results of the survey, which was conducted in June and July 2022. 

How Technology Fosters Economic Opportunity and Success

Is your bank promoting financial literacy and wellness within the communities you serve?

The answer to that question may be the key to your bank’s future. For many community financial institutions, promoting financial wellness among historically underserved populations is directly linked to fostering resilience for individuals, institutions and communities.

Consider this: 7 million households in the United States didn’t have a bank account in 2019, according to the Federal Deposit Insurance Corp.; and up to 20 million others are underserved by the current financial system. Inequities persist along racial, geographical and urban lines, indicating an opportunity for local institutions to make an impact.

Many have already stepped up. According to the Banking Impact Report, which was conducted by Wakefield Research and commissioned by MANTL, 55% of consumers said that community financial institutions are more adept at providing access to underrepresented communities than neobanks, regional banks or megabanks. In the same study, nearly all executives at community institutions reported providing a loan to a small business owner who had been denied by a larger bank. And 90% said that their institution either implemented or planned to implement a formal program for financial inclusion of underserved groups.

Technology like online account origination can play a critical role in bringing these initiatives to life. Many forward-thinking institutions are actively creating tools and programs to turn access into opportunity — helping even their most vulnerable customers participate more meaningfully in the local economy.

One institution, 115-year-old Midwest BankCentre based in St. Louis, is all-in when it comes to inclusion. The bank partnered with MANTL to launch online deposit origination and provide customers with convenient access to market-leading financial products at competitive rates.

Midwest BankCentre has also committed $200 million to fostering community and economic development through 2025, with a focus on nonprofits, faith-based institutions, community development projects and small businesses for the benefit ofr historically disinvested communities. The bank offers free online financial education to teach customers about money basics, loans and payments, buying a home and paying for college, among others.

Midwest BankCentre executives estimate that $95 out of every $100 deposited locally stays in the St. Louis region; these dollars circulate six times throughout the regional economy.

In a study conducted in partnership with Washington University in St. Louis, researchers found that Midwest Bank Centre’s financial education classes created an additional $7.1 million in accumulated wealth in local communities while providing critical knowledge for household financial stability.

“When you work with a community banker, you are working with a neighbor, friend, or the person sitting next to you at your place of worship,” says Danielle Bateman Girondo, executive vice president of marketing at Midwest BankCentre. “Our customers often become our friends, and there’s a genuine sense of trust and mutual respect. Put simply, it’s difficult to have that type of relationship, flexibility, or vested interest at a big national bank.”

What about first-time entrepreneurs? According to the U.S. Bureau of Labor Statistics, approximately 33% of small businesses fail within 2 years. By year 10, 66.3% have failed.

Helping first-time entrepreneurs benefits everyone. Banks would gather more deposits and make more loans. Communities would flourish as more dollars circulate in the local economy. And individuals with more paths to economic independence would prosper.

For Midwest BankCentre, one part of the solution was to launch a Small Business Academy in March 2021, which provides practical education to help small businesses access capital to grow and scale.

The program was initially launched with 19 small businesses participating in the bank’s partnership with Ameren Corp., the region’s energy utility, with a particular focus on the utility’s diverse suppliers. And 14 small business owners and influencers participated in the bank’s partnership with the Hispanic Chamber of Commerce of Metro St. Louis. Midwest BankCentre teaches small businesses how to “think like a banker” to gain easier access to capital by understanding their financial statements and the key ratios.

Efforts like these might explain why, according to the Banking Impact Report, 69% of Hispanic small business owners and 77% of non-white small business owners believe it’s important that their bank supports underserved communities. Accordingly, non-white small businesses are significantly more likely to open a new account at a community bank or credit union: 70%, compared to 47% of white small businesses.

This can be a clear differentiator for a community bank: a competitive advantage in a crowded marketplace.

For today’s community banks, economic empowerment isn’t a zero-sum game; it’s a force multiplier. With the right strategies in place, it can be a winning proposition for the communities and markets within your institution’s sphere of influence.

The Community Bank Board Guide to Crossing $10 Billion

Community banks that have weathered the economic extremes of the coronavirus pandemic and a rapidly changing interest rate environment may find themselves with another important looming deadline: the $10 billion asset threshold.

In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (often called Dodd-Frank) created a regulatory demarcation for banks above and below $10 billion in assets. In 2018, regulatory reform lessened one of the more-stringent expectations for $10 billion banks, but failed to eliminate many of the other regulatory burdens. Experts that have worked with banks to cross the divide since the law went into effect recommend that institutions around $5 billion begin preparing for the costs and expectations of being a larger bank.

“The list of changes when going from $9.9 billion to $10 billion isn’t long. It’s the significance of those changes that can create challenges if not appropriately planned for,” writes Brandon Koeser, financial services senior analyst with RSM US LLP, in an email. “Banks need to take a thorough look at their entire institution, including people, processes and risk oversight.”

The pandemic may have delayed or complicated the work of banks who are preparing to cross the threshold. Anna Kooi, a partner and national financial services industry leader at Wipfli, says she has clients at banks whose growth accelerated over the last two years and are approaching the $10 billion asset line faster than expected.

Bank Director has assembled a guide for boards that reviews some areas that are impacted by the threshold, along with questions directors can use to kick off conversations around preparation.

Lost Income
The Dodd-Frank Act’s Durbin Amendment capped the interchange fees on debit card transactions that banks above $10 billion can charge; interchange fees are not reduced for banks under $10 billion. The capped fees have cost card issuers nearly $106 billion in interchange revenue since 2012, including an estimated $15.2 billion in 2020, according to an Electronic Payments Association analysis in August 2021 using data from the Federal Reserve.

Banks preparing to cross $10 billion should analyze how big the reduction of debit interchange revenue could be, as well as alternatives to make up for that difference, Kooi says. The interchange cap impacts banks differently depending on the depositor base: commercial banks may not miss the income, while institutions with a larger retail base that use their debit cards may experience a significant hit. Banks that have more time to consider alternatives will be better positioned when the interchange cap goes into effect, she says.

Regulatory Expectations
Banks over $10 billion in assets gain a new regulator with a new round of exams: the Consumer Financial Protection Bureau. While other banking regulators tend to focus on prudential safety and soundness, the CFPB aims to promote “transparency and consumer choice and preventing abusive and deceptive financial practices” among markets for financial services and products, according to the agency’s mission statement. This exam shift means banks may want to reach out to consultants or other external partners that have familiarity with the CFPB to prepare for these exams.

“The focus is going to be more intense in certain areas,” says Adam Maier, partner and co-chair of Stinson’s banking and financial services division. “They’re going to bring in a different regulatory approach that is very unique, and at times, can be difficult.”

Expectations from other regulators may also increase, and increased scrutiny could lead to a higher risk that examiners discover something at a bank that needs to be addressed.

“A guaranteed place of focus from regulators will be over the bank’s risk program,” Koeser writes. “Undertaking an assessment of the risk management function, including the risk program, staffing levels and quality of talent will be key. In a new world above $10 billion, the old mantra of ‘If it isn’t broke, don’t fix it,’ won’t fly.”

While banks don’t have to participate in the annual Dodd Frank Act Stress Test, or DFAST, exercise until they are $100 billion, regulators may want to see evidence that the bank has some way to measure its credit and capital risk exposure.

“What I’ve heard [from] banks is the regulators, the OCC in particular, still want to talk about stress testing, even though [the banks] don’t have to do it,” Maier says. “I would follow the lead of your primary regulator; if they want you to still demonstrate something, you still have to demonstrate it.”

And importantly, the Dodd-Frank Act mandates that bank holding companies above $10 billion have a separate board-level risk committee; this provision was changed to $50 billion in the 2018 financial reforms bill. The committee must have at least one risk management expert who has large-company experience.

Staffing and Systems
Heightened regulatory expectations may require a bank to bring on new talent, whether it’s for the board or the executive team. Some titles Kooi says a bank may want to consider adding include a chief risk officer, chief compliance officer and a chief technology officer — all roles that would figure into a robust enterprise risk management framework. These specialty skill sets may be difficult to recruit locally; Kooi says that many community banks preparing for the threshold retain a recruiter and assemble relocation packages to bring on the right people. Oftentimes, banks seek to poach individuals who have worked at larger institutions and are familiar with the systems, capabilities and expectations the bank will encounter.

Additionally, boards will also want to revisit how a bank monitors its internal operational systems, as well as how those systems communicate with each other. Maier says that banks may need to bulk up their compliance staff, given the addition of the CFPB as a regulator.

M&A Opportunities
A number of banks have chosen to cross $10 billion through a transaction that immediately offsets the lost revenue and higher compliance expenses while adding earnings power and operational efficiency, writes Koeser. M&A should fit within the bank’s strategic and long-term plans, and shouldn’t just be a way to jump over an asset line.

Banks that are thinking about M&A, whether it’s a larger bank acquiring a smaller one or a merger of equals, need to balance a number of priorities: due diligence on appropriate partners and internal preparations for heightened regulatory expectations. They also need to make sure that their prospective target’s internal systems and compliance won’t set them back during integration.

Additionally, these banks may need to do this work earlier than peers that want to cross the threshold organically, without a deal. But the early investments could pay off: An $8 billion institution that is prepared to be an $11 billion bank after a deal may find it easier to secure regulatory approvals or address concerns about operations. The institution would also avoid what Maier calls “a fire drill” of resource allocation and staffing after the acquisition closes.

Questions Boards Should Ask

  • Do we have a strategy that helps us get up to, and sufficiently over, $10 billion? What is our timeline for crossing, based on current growth plans? What would accelerate or slow that timeline?
  • Will the bank need to gain scale to offset regulatory and compliance costs, once it’s over $10 billion?
  • What do we need to do between now and when we cross to be ready?
  • What role could mergers and acquisitions play in crossing $10 billion? Can this bank handle the demands of due diligence for a deal while it prepares to cross $10 billion?
  • Are there any C-level roles the bank should consider adding ahead of crossing? Where will we find that talent?
  • Do we have adequate staffing and training in our compliance areas? Are our current systems, processes, procedures and documentation practices adequate?
  • How often should the board check in with management about preparations to cross?
  • Have we reached out to banks we know that have crossed $10 billion since the Dodd-Frank Act? What can we learn from them?

Article was updated on Nov. 15, 2022, to reflect that $50 billion banks are now mandated to have a board-level risk committee.

The Easiest Way to Launch a Digital Bank

New fintechs are forcing traditional financial institutions to acclimatize to a modern banking environment. Some banks are gearing up to allow these fintechs to hitchhike on their existing bank charters by providing application programming interfaces (APIs) for payments, deposits, compliance and more. Others are launching their own digital brands using their existing licenses.

Either way, the determining factor of the ultimate digital experience for users and consumers is the underlying technology infrastructure. While banks can spawn digital editions from their legacy cores through limited APIs and cobbled-up middleware, the key questions for their future relevance and resilience remain unanswered:

  1. Can traditional banks offer the programmability needed to launch bespoke products and services?
  2. Can they compose products on the fly and offer the speed to market?
  3. Can they remove friction and offer a sleek end-to-end experience?
  4. Can they meet the modern API requirements that developers and fintechs demand from banks?

If the core providers and middleware can’t help, what can banks use to launch a digital bank? The perfect springboard for launching a digital bank may lie in the operating system.

Removing friction at every touchpoint is the overarching theme around most innovation. So when it comes to innovation, why do banks start with the core, which is often the point in their system with the least amount of flexibility and the most friction?

When it comes to launching a digital bank, the perfect place for an institution to start is an operating system that is exclusively designed for composability — that they can build configurable components to create products and services — and the rapid launch of banking products. Built-in engines, or engines that can take care of workflows based on business rules, in the operating system can expedite the launch of financial services products, while APIs and software development kits open up the possibility for custom development and embedded banking.

That means banks can create products designed for the next generation of consumers or for niche communities through the “composability” or “programmability” offered by these operating systems. This can include teen accounts, instant payments for small and medium-sized business customers that can improve their cash flow, foreign exchange for corporate customers with international presence, domestic and international payments to business customers, tailored digital banking experiences; whatever the product, banks can easily compose and create on the fly. What’s more, they also have granular control to customize and control the underlying processes using powerful workflow engines. The operating system also provides access to centralized services like compliance, audit, notifications and reporting that different departments across the bank can access, improving operational efficiency.

Menu-based innovation through operating systems
The rich assortment of microservices apps offered in operating systems can help banks to launch different applications and features like FedNow, RTP and banking as a service(BaaS) on the fly. The process is simple.

The bank fills up a form with basic information and exercises its choice from a menu of microapps compiled for bankers and customers. The menu includes the payment rails and networks the bank needs — ACH, Fedwire, RTP, Swift — along with additional options like foreign exchange, compliance, onboarding and customer experiences like bulk and international payments, to name a few.

The bank submits the form and receives notification that its digital bank has been set up on a modern, scalable and robust cloud infrastructure. The institution also benefits from an array of in-built features like audit, workflows, customer relationship management, administration, dashboards, fees and much more.

Setting up the payment infrastructure for a digital bank can be as easy as ordering a pizza:

  1. Pick from the menu of apps.
  2. Get your new digital brand setup in 10 minutes.
  3. Train employees to use the apps.
  4. Launch banking products to customers.
  5. Onboard fintech partners through For-Benefit-Of Accounts (FBO)/virtual accounts.
  6. Offer APIs to provide banking as a service without the need for middleware.

The pandemic has given new shape and form to financial services; banks need the programmability to play with modular elements offered on powerful operating systems that serve as the bedrock of innovation.