Community Banks to Fintech: We Need You

fintech-2-1-17.pngWhen Terry Earley, the chief financial officer of Yadkin Bank, a $7.5 billion asset bank in Raleigh, North Carolina, gets to work each morning, he sees an online dashboard showing him all the details of the loans in his bank’s pipeline, what is closing and when, and more. “If you don’t know the information, you can’t manage your company,’’ he says.

Upgrading from cumbersome Excel spreadsheets, he can easily see which lenders are pricing loans lower than others, and quickly react in terms of lender training and managing the bank’s loan portfolio. “A lot of times we try to manage [by] anecdote,’’ he says. “But what does the data tell you? The information is key.”

Like a lot of other community banks, Yadkin is increasingly using partnerships with technology companies to improve its operations and better meet customer needs. At Bank Director’s Acquire or Be Acquired Conference in Phoenix, Arizona, which wrapped up yesterday, Earley and other bankers talked about M&A and growth strategies, as well as how they were using technology to improve profitability and efficiency. In Yadkin’s case, the bank signed up with PrecisionLender, a pricing and profitability management platform, when it became a $1 billion bank several years ago. Then, it partnered with technology company nCino, which operates a secure cloud-based operating system, when it became a $4.5 billion bank, to get access to a quicker commercial lending origination platform. [For more on how banks are using the cloud, see Bank Director digital magazine’s Tech Issue story, “Banks Sail Straight Into the Cloud.”]

Even investors are getting excited about the plethora of off-the-shelf software available to help smaller banks become more competitive with larger institutions. Joshua Siegel, CEO of asset manager StoneCastle Partners, said he thinks banks have a lot of room to improve efficiencies with technology and take out back office costs, as well as offer better customer service. The software to do this is becoming increasingly available and affordable to do so. Siegel was happy to see banks as small as $150 million in assets offering online personal financial management tools superior to what regional banks are offering, because the regional banks are sometimes held up trying to develop their own software in-house.

While some financial technology companies are directly competing with banks for small business loans or payments, such as payments provider PayPal or online lender Kabbage, other financial technology companies want to sell their technology to banks.

Instead of only seeing the potential threats, there are reasons for the industry to see financial technology as a tool that can help them compete with bigger banks, which control most of the nation’s deposits. Small banks can use software to speed up their lending operations and the time it takes to open an account, and make the entire experience of doing business with a bank easier and simpler.

Somerset Trust Co. in Somerset, Pennsylvania, is using a fintech company called Bolts Technologies to quickly validate identities and open accounts for new customers. Radius Bank, a $1 billion asset bank in Boston, Massachusetts, is using a variety of partnerships with fintech companies to support its branchless bank, including a robo-advisor software company called Aspiration.

“From a cultural perspective, we look at whether they share our values,’’ said Radius Bank CEO Mike Butler. “It needs to be true partnership. If we’re just in it to try to make money off each other, then it’s not worth it. But if there is a benefit in terms of both of us wanting to create a better customer experience, then you have a great partnership.”

Manage Risk More Effectively

risk-management-1-9-17.pngIn today’s connected, interrelated world of finance, it’s hard for bankers to see all the complex relationships between different groups of customers—perhaps some are subsidiaries of larger firms, guarantors of third-party loans, or investors in the same funds. Whatever their nature, these hidden links can multiply the risk of lending by exposing you to more risk than you’re prepared to assume.

One of the missing links that worsened the 2008 financial crisis was the inability of financial institutions to accurately connect exposures to the responsible entity. In some cases, the same entity was recorded twice in the system under different names. In some cases, the ownership or credit relationship among entities was not defined, and in others, manual data entry errors distorted the entity identity or its hierarchical relationships.

A uniquely defined entity aids in risk management by helping banks know who is carrying risk for them and allows organizations to capture operational efficiencies. In a sense, banks build their entire organizations around entities. For instance, a retail and commercial bank will have separate business divisions that look after different groups. Once these entities are known and structured within their hierarchies and groups, banking organizations apply risk calculations along these hierarchies to get an accurate view of the risk contribution of an entity. Good entity management confers a host of benefits on the bank:

Improved Operational Efficiency
Being able to construct a full view of the entity rather than seeing it from the perspective of a single account could deliver substantial cost reductions by helping banks avoid large scale duplication in the recording and maintaining of customer data. Creating an entity record in the system involves manually inputting entity details such as entity name, country of operations, tax ID number, chief executive and so on. Moreover, this information has to be updated on a regular basis, exposing the records to greater manual errors.

Accurate Risk Aggregation
When aggregating limits for risk appetite calculations, banks need to make sure that the appropriate entities’ data is included in the calculations to avoid misrepresentation, undercounting, or even double-counting. Entity-to-entity and facility-to-entity risk aggregation calculations used to allocate risk to the correct owner depend on this unique entity definition.

Counterparty Risk Management
Collateral and guarantees are risk mitigants that help reduce the credit risk of a particular borrowing transaction with an entity. This is achieved primarily by offering the bank an alternative or secondary source of repayment should the borrowing entity be unable to pay back a loan by itself. Looking at the entire deal structuring process, identifying who owns the collateral and who is providing the guarantee becomes critical for effective risk mitigation.

Entity Risk Grades
Typically, company financial statements are important inputs to the calculation of an entity risk grade, which in turn is used to calculate capital allocation against loans made to entities. Hence, it’s important to ensure that the correct financials for the entity are being used. In larger organizations, entities are linked together in a complex hierarchical relationship with intertwined risk. These situations may mean that the entire group shares common risk, resulting in the risk grade of one entity being distributed to other entities across the hierarchy.

Data Privacy and Security
From a regulatory perspective, banks have to demonstrate the integrity of their data, showing that no unauthorized person has access to the data or an opportunity to change it. In cases of sensitive, restricted deals, banks have to ensure that the access of any employee outside the deal team is prohibited. In other words, banks need a system where they can manage user access to entities along with the actions those users can take on those entities.

Demonstrating Regulatory Compliance
Know-your-customer regulations are in effect in all advanced economies and require that banks identify every customer to satisfy anti-money laundering rules, sanctions, fraud and other financial crime measures. The Basel Committee on Banking Supervision (BCBS) regulations also drive demand for identification. Leverage, liquidity and many other ratios calculated under different Basel regimes assume that the banks have properly identified entities.

Reporting on Transactions
Banks are required to prove that their records are accurate even when the actual borrower may be buried under a complex web of entity relationships and hierarchies. The principles for effective risk data aggregation and risk reporting are set out in BCBS 239, which requires accurate, true and clean data broken down along several dimensions. A unique entity identifier stored within the database makes it possible to query and report at the required level of granularity.

For more on this topic, see our white paper.