Another version of this article was originally published on April 3, 2023, as part of a special report called “Finding Fintechs.”
As part of his job, Clayton Mitchell once bought a list of global financial technology companies from a data provider. It had 7,000 names on it.
“I can’t do anything with this,” says the managing principal in the risk consulting practice of Crowe LLP, who advises banks on partnering with fintech companies. “Figuring out the winners and losers is a bit of a needle in a haystack approach.”
Banks that want to partner with technology companies or buy software from a vendor face the same sort of tsunami of options. On the one hand, fintechs offer real promise for community banks struggling to keep up with bigger institutions, credit unions and other competitors — a chance to cut costs and increase efficiencies, grow deposits and loans, and give customers quicker and easier ways to do business with the bank.
But in the midst of economic uncertainty, banks face real risks in doing business with early-stage fintechs that might consolidate or even go out of business. So how do you choose?
The problems banks face making a digital transformation are legion. In Bank Director’s 2022 Technology Survey, 45% of responding CEOs, directors, chief operating officers and senior technology executives said they worried about reliance on outdated technology. Forty-eight percent worried their bank had an inadequate understanding of the impact of emerging technologies. And 35% believed their bank was unable to identify the solutions it needs.
Historically, small and midsized banks have relied on their core processor to identify and vet companies for them. About half of Mitchell’s customers continue to rely on the bank’s core processor exclusively to find and vet technology companies for them. Cornerstone Advisors’ annual “What’s Going On In Banking” survey of community banks found this year that 55% of respondents didn’t partner with a fintech startup in 2022; 20% had partnered with one fintech; 16% with two and the rest with three or more. But Mitchell thinks the opportunities to go beyond the core are better and more feasible for small and community banks than ever, if the bank follows due diligence. “Sometimes you have to solve problems quicker than the core will get it to you,” he says. “There’s a growing appetite to go outside the core.”
The big three core processors — Fiserv, FIS and Jack Henry & Associates — have started offering newer, cloud-based cores to connect with a greater variety of technology companies, plus there are ways to add additional layers to core systems to connect useful technological tools, using what’s known as application programming interfaces. “There are different layers of technology that you can put in place to relegate the core platform more into the background and let it become less of a focus for your technology stack than it has historically been,” says Neil Hartman, senior partner at the consulting firm West Monroe.
In combination with technological change, leadership among banks is changing, too. The last three years of the pandemic taught banks and their customers that digital transformation was possible and even desirable. “We’re seeing more progressive bank leadership. Younger generations have grown up in digital environments and with the experiences of Amazon and Apple, those technology behemoths, and are starting to think about their technology partnerships a little more aggressively,” Hartman says. He adds that banks are beginning to reckon with the competition coming from the biggest banks in terms of digital services. “That’s trickling down into the regional and community bank space,” he says.
Fintechs, likewise, are adjusting to banks’ sizable regulatory compliance obligations, and they’re maturing, too, says Susan Sabo, the managing principal of the financial institutions group for the professional services firm CliftonLarsonAllen LLP. Many fintechs have upgraded their structure around risk management and controls to ensure they’ll get bank customers. “With the onset of the pandemic, I do think it allowed many fintechs to reset and reinvest, and they did start to build some traction with banks,” Sabo says.
Still, many banks hesitate to use an alternative to the big three core processors or switch the bulk of their lending and deposit gathering capabilities to a fintech, she says. They’re sticking to fintechs that offer what she calls ancillary solutions — treasury management, credit loss modeling and other types of platforms. But even that has been changing, as evidenced by the success of the fintech nCino, which sells a cloud-based operating system and had its initial public offering in 2020. Sabo recommends using proper due diligence to vet fintech companies. It’s also important to consider cybersecurity, data privacy and contractual issues. And last but not least, consider what can go wrong.
One big hurdle for smaller banks is the cost of using third-party solutions. “Nothing about technology is ever cheap,” Sabo says. “Even things as simple as, ‘We need to refresh all of our hardware,’ becomes a massive investment for a [community] bank. And if you’re held to your earnings per share each quarter, or you’re held to your return to your investors each quarter … you may keep putting it off. Many banks are in a situation where they’re anxious about their technology because they haven’t invested along the way.”
Talent is another large obstacle banks face. Small banks, especially those in rural areas, may struggle to find the staff to make the technology a success. Information technology departments often aren’t equipped with strategic decision-making skills to ensure a fintech partner will meet the bank’s big-picture goals.
And banks that want to leverage data analytics to improve their business will have to hire data scientists and data engineers, says Corey Coscioni, director of strategic alliance and business development at West Monroe. “You’re going to need to build some level of internal capabilities,” he says.