Unlocking Banking as a Service for Business Customers

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

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

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

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

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

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

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

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

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

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

Does Your Bank Struggle With Analysis Paralysis?

The challenge facing most community financial institutions is not a lack of data.

Institutions send millions of data points through extensive networks and applications to process, transmit and maintain daily operations. But simply having an abundance of data available does not automatically correlate actionable, valuable insights. Often, this inundation of data is the first obstacle that hinders — rather than helps — bankers make smarter decisions and more optimal choices, leading to analysis paralysis.

What is analysis paralysis? Analysis paralysis is the inability of a firm to effectively monetize data or information in a meaningful way that results in action.

The true value is not in having an abundance of data, but the ability to easily turn this cache into actionable insights that drive an institution’s ability to serve its community, streamline operations and ultimately compete with larger institutions and non-bank competitors.

The first step in combatting analysis paralysis is maintaining a single source of truth under a centralized data strategy. Far too often, different departments within the same bank produce conflicting reports with conflicting results — despite relying on the “same” input and data sources. This is a problem for several reasons; most significantly, it limits a banker’s ability to make critical decisions. Establishing a common data repository and defining the data structure and flow with an agreed-upon lexicon is critical to positioning the bank for future success.

The second step is to increase the trust, reliability, and availability of your data. We are all familiar with the saying “Garbage in, garbage out.” This applies to data. Data that is not normalized and is not agreed-upon from an organizational perspective will create issues. If your institution is not scrubbing collected data to make sure it is complete, accurate and, most importantly, useful, it is wasting valuable company resources.

Generally, bad data is considered data that is inaccurate, incomplete, non-conforming, duplicative or the result of poor data input. But this isn’t the complete picture. For example, data that is aggregated or siloed in a way that makes it inaccessible or unusable is also bad data. Likewise, data that fails to garner any meaning or insight into business practices, or is not available in a timely manner, is bad data.

Increasing the access to and availability of data will help banks unlock its benefits. Hidden data is the same as having no data at all.

The last step is to align the bank’s data strategy with its business strategy. Data strategy corresponds with how bank executives will measure and monitor the success of the institution. Good data strategy, paired with business strategy, translates into strong decision-making. Executives that understand the right data to collect, and anticipate future expectations to access and aggregate data in a meaningful way is paramount to achieving enduring success in this “big data” era. For example, the success of an initiative that takes advantage of artificial intelligence (AI) and predictive capabilities is contingent upon aligning a bank’s data strategy with its business strategy.

When an organization has access to critical consumer information or insights into market tendencies, it is equipped to make decisions that increase revenue, market share and operational efficiencies. Meaningful data that is presented in a timely and easy-to-digest manner and aligns with the company’s strategy and measurables allows executives to react quickly to changes affecting the organization — rather than waiting until the end of the quarter or the next strategic planning meeting before taking action.

At the end of the day, every institution’s data can tell a very unique story. Do you know what story your data tells about the bank? What does the data say about the future? Banks that are paralyzed by data lose the ability to guide their story, becoming much more reactive than proactive. Ultimately, they may miss out on opportunities that propel the bank forward and position it for future success. Eliminating the paralysis from the analysis ensures data is driving the strategy, and enables banks to guide their story in positive direction.

Breaking the Legacy Mindset

For banks, the status quo can often stymie innovation. Even if executives have the desire to try something new, their institution can be incumbered by entrenched legacy systems.

But taking a chance on something new can open up institutions to the possibility of achieving something bigger. The decision to choose a new path is usually very difficult; loyalty and security can feel hard coded in our DNA. But sometimes it comes to the point where you realize that the thing you are doing over and over is never going to produce a different, game-changing outcome.

The adage of “Nobody ever got fired for buying IBM” continues to ring true in many ways in the fintech space. It refers to the idea that making a safe bet never got anyone in trouble; choosing the industry’s standard company, product or service had little repercussions for the executives making the decisions — even if there were newer, cheaper or better options. It was safe, the company was reliable and little happened in the way of bucking the status quo.

The payments industry has a number of parallels from which we can draw. The electronic payment ecosystem is more than 40 years old; while there has been innovation, it has not been at the same pace as the rest of the technology industry. Some bankers may remember “knuckle busters” and the carbon paper of old. Although banking have since shed those physical devices, the core processing behind the electronic payments system largely remains the same.

These legacy systems mean the payments industry traditionally has had extremely high barriers to entry. This is due to a number of factors, including increasing risk and regulatory compliance needs, high capital investments, a technology environment that is difficult to penetrate and complex integration webs between multiple partners. This unique environment increases the stickiness of mature offerings and creates a complex set of products and long-standing relationships that make it difficult for new products or providers to break through.

The industry’s fragmentation is also a blessing and a curse. While fragmentation gives institutions and consumers choices in the market, it hinders new companies from emerging. This makes it challenging for companies to gain traction or disrupt existing solutions with new and creative ways to solve problems and address needs. Breaking into the market is still only step one. Convincing banks that you can simplify their processes and scale your solutions is an ongoing challenge that smaller fintechs must overcome to truly participate — and potentially disrupt — the industry. The combination of these factors fuels a deep resistance to change in the banking industry.

Fintechs aren’t legacy companies — and that is a good thing. Implementations don’t need to take months, they can be done in weeks. Customer service isn’t challenging when communication happens openly and quickly. Enhancements are affordable, and newer platforms offer nimbleness and openness.

In order to succeed, fintechs must find ways to innovate within the gray space. This could look like any number of things: taking advantage of mandates that create new opportunities, stretching systems and capability gaps to explore new norms, or venturing out into entirely uncharted territory. And banks do not have to fit into the same familiar patterns; changing one piece of the puzzle does not always have to be a massive undertaking.

What within your bank’s walls just “works”? What system or processes have been on autopilot that could chart a new path? What external services are your customers using that the bank could bring in-house if executives thought outside the box? Fintech can complement the bank, if you select the right partner that expands your ecosystem. Fintech can change user experiences — simplifying them to deliver a truly different outcome altogether.

Take a chance on fintech. It will be epic.

Recapturing the Data That Creates Valuable Customer Interactions

Before the end of 2021, regulators announced that JPMorgan Chase & Co. had agreed to pay $200 million in fines for “widespread” recordkeeping failures. For years, firm employees used their personal devices and accounts to communicate about business with their customers; the bank did not have records of these exchanges. While $200 million is a large fine by any account, does the settlement capture the true cost of being unsure about where firm data resides?

In 2006, Clive Humby coined the phrased “data is the new oil.” Since then, big tech and fintech companies have invested heavily in making it convenient for consumers to share their needs and wants through any channel, anytime — all while generating and accumulating tremendous data sets makes deep customer segmentation and target-of-one advertising possible.

Historically, banks fostered personal relationships with customers through physical conversations in branches. While these interactions were often triggered by a practical need, the accumulated knowledge bankers’ had about their customers, and their subsequent ability to capitalize on the power of small talk, allowed them to identify unmet customer needs with products and services and drive deeper relationships. Fast forward to the present day: Customer visits to branches have dropped to unprecedented levels as they embrace digital banking as their primary way of managing their finances.

But managing personal finances is different from banking. While most bank interactions revolve around checking balances, depositing checks and paying people and bills, the valuable interactions involve open-ended conversations about the desire to be able to buy a first home, planning for retirement or education, and funding large purchases like cars. These needs have not gone away — but the way consumers want to engage with their institution has completely transformed.

Consumers want to engage their banker through channels that are convenient to them, and this includes mobile messaging, SMS, Facebook messenger and WhatsApp. JPMorgan’s bankers may not have been trying to circumvent securities regulations in engaging with customers on their terms. Failing to meet your customers where they are frustrates both customers and bankers. Failing to embrace these digital channels leads to less valuable data the bank can use.

Banking platforms — like digital, payment and core banking — can capture data that provides insight into consumers’ saving and spending behavior, but fails to capture latent needs. Institutions that make it more convenient for customers to ask their personal banker something than Googling it opens up an entirely new data source. Allowing customers to ask open-ended questions augments transactional insight with unprecedented data on forward-looking needs.

In a recent case study, First National Bank of Omaha identified that 65% of customers expressed interest in exploring new products and services: 15% for credit cards, 12% for home loans, 9% for investments, and 7% for auto loans.

If “data is the new oil,” the real value lies is in the finished product, not the raw state. While data is exciting, the true value is in deriving insights. Analyzing conversational data can provide great insight. And banks can unlock even greater value when they analyze unprocessed conversational data in the context of other customer behavior, like spending patterns, propensity to use other engagement channels and socio-demographic changes.

At present, most of this data is owned and guarded by financial processors and is not readily available for banks to access and analyze. As banks extend their digital engagement model, it is imperative they own and can access their data and insights. And as banks increasingly see the benefits of allowing customers to engage with their banker in the same way they talk to their friends, key considerations should include:

  • Conversation aggregation. Is a customer’s conversation with multiple bankers aggregated to a single thread, avoiding data lost through channel switching?
  • Are conversations across channels retained within a dedicated and secure environment?
  • Can conversations transition from one relationship banker to another, avoiding the downfall of employee attrition?
  • Are suitable tools powered by artificial intelligence and other capabilities in place to ensure a real-time view of trending topics and requests?
  • Data access. Is raw conversational data readily available to the bank?

Engaging customers through digital channels presents an exciting opportunity for banks. No longer will data live within the mind of the banker: rather, insight that are derived from both individual and aggregate analysis can become a key driver for both strategic and tactical decisioning.

The Future-Proof Response to Rising Interest Rates

After years of low interest rates, they are on the rise — potentially increasing at a faster rate than the industry has seen in a decade. What can banks do about it?

This environment is in sharp contrast to the situation financial institutions faced as recently as 2019, when banks faced difficulties in raising core deposits. The pandemic changed all that. Almost overnight, loan applications declined precipitously, and businesses drew down their credit lines. At the same time, state and federal stimulus programs boosted deposit and savings rates, causing a severe whipsaw in loan-to-deposit ratios. The personal savings rate — that is, the household share of unspent personal income — peaked at 34% in April 2020, according to research conducted by the Federal Reserve Bank of Dallas. To put that in context, the peak savings rate in the 50 years preceding the pandemic was 17.7%.

These trends became even more pronounced with each new round of stimulus payments. The Dallas Fed reports that the share of stimulus recipients saving their payments doubled from 12.5% in the first round to 25% in the third round. The rise in consumers using funds to pay down debt was even more drastic, increasing from 14.6% in round one to 52.3% in round three. Meanwhile, as stock prices remained volatile, the relative safety of bank deposits became more attractive for many consumers — boosting community bank deposit rates.

Now, of course, it’s changing all over again.

“Consumer spending is on the rise, and we’ve seen a decrease in federal stimulus. There’s less cash coming into banks than before,” observes MANTL CRO Mike Bosserman. “We also expect to see an increase in lending activities, which means that banks will need more deposits to fund those loans. And with interest rates going up, other asset classes will become more interesting. Rising interest rates also tend to have an inverse impact on the value of stocks, which increases the expected return on those investments. In the next few months, I would expect to see a shift from cash to higher-earning asset classes — and that will significantly impact growth.

These trends are unfolding in a truly unprecedented competitive landscape. Community banks are have a serious technology disadvantage in comparison to money-center banks, challenger banks and fintechs, says Bosserman. The result is that the number of checking accounts opened by community institutions has been declining for years.

Over the past 25 years, money-center banks have increased their market share at the expense of community financial institutions. The top 15 banks control 56.2% of the overall marketshare, up from 40% roughly 25 years ago. And the rise of new players such as fintechs and neobanks has driven competition to never-before-seen levels.

For many community banks, this is an existential threat. Community banks are critical to maintaining competition and equity in the U.S. financial system. But their role is often overlooked in an industry that is constantly evolving and focused on bigger, faster and shinier features. The average American adult prefers to open their accounts digitally. Institutions that lack the tools to power that experience will have a difficult future — regardless of where interest rates are. For institutions that have fallen behind the digital transformation curve, the opportunity cost of not modernizing is now a matter of survival.

The key to survival will be changing how these institutions think about technology investments.

“Technology isn’t a cost center,” insists Christian Ruppe, vice president of digital banking at the $1.2 billion Horicon Bank. “It’s a profit center. As soon as you start thinking of your digital investments like that — as soon as you change that conversation — then investing a little more in better technology makes a ton of sense.”

The right technology in place allows banks to regain their competitive advantage, says Bosserman. Banks can pivot as a response to events in the macro environment, turning on the tap during a liquidity crunch, then turn it down when deposits become a lower priority. The bottom line for community institutions is that in a rapidly changing landscape, technology is key to fostering the resilience that allows them to embrace the future with confidence.

“That kind of agility will be critical to future-proofing your institution,” he says.

The Race to Perform

Last October, I journeyed to Austin, Texas, to watch my first Formula One race. Like many, Netflix’s wildly popular Formula 1: Drive to Survive drew me in. That docuseries dramatically increased the popularity of the sport in the United States, with plenty of drama on track and off. 

Inevitably, the show takes viewers inside a showdown between two cars jostling for points, separated by mere milliseconds. While being out front has its advantages, so too does drafting your competition, waiting for the chance to pull ahead. Indeed, the “push-to-pass” mechanism on a race car provides a temporary jolt of speed, allowing the hunter to quickly become the hunted. Speed, competition and risk-taking is on my mind as we prepare to host Bank Director’s Experience FinXTech event May 5 and 6 in the same city as the Circuit of The Americas.

Much like Formula One brings some of the most ambitious and creative teams together for a race, Experience FinXTech attracts some of the most inspiring minds from the deeply competitive financial services space.

Now in its seventh year, the event connects a hugely influential audience of U.S. bank leaders with technology partners at the forefront of growth and innovation. Today, as banks continue to transition towards virtual or digital strategies, fintechs become partners rather than just competitors in the race to succeed. 

We’ll look not only at fintechs offering efficiencies for banks, but at fintechs offering growth and improved performance as well. As fintech guru Chris Skinner recently noted, “If you only look at technology as a cost reduction process, you never get the market opportunities. If you look at technology as a market opportunity, you get the cost savings naturally as a by-product.”

We’ll consider investor appetites, debate the pros and cons of decentralized finance and share experiences in peer exchanges. 

Throughout, we’ll help participants gauge technology companies at a time when new competitors continue to target financial services.   

Most Formula One races are won on the margins, with dedicated teams working tirelessly to improve performance. So too are the banks that excel — many of them with dedicated teams working with exceptional partners.

Top 5 Fintech Trends, Now and in the Future

A version of this article originally appeared on RSM US LLP’s The Real Economy Blog.

Financial technology, or fintech, is rapidly evolving financial services, creating a new infrastructure and platforms for the industry’s next generation. Much remains to be seen, but here are the top trends we expect to shape fintech this year and beyond:

1. Embedded Finance is Here to Stay
Increasingly, customers are demanding access to products and services that are embedded in one centralized location, pushing companies to provide financial services products through partnerships and white-label programs.

Health care, consumer products, technology companies can embed a loan, a checking account, a line of credit or a payment option into their business model and platform. This means large-scale ecosystem disruption for many players and presents a potential opportunity for companies that offer customized customer experiences. This also means the possibility of offering distinct groups personalized services uniquely tailored to their financial situation.

2. A Super App to Rule All
We also anticipate the rise of “super apps” that pull together many apps with different functions into one ecosystem. For example, WeChat is used in Asia for messaging, payments, restaurant orders, shopping and even booking doctors’ appointments.

The adoption of super apps has been slower in the United States, but finance and payment companies and apps including PayPal Holding’s PayPal and Venmo, Block’s Cash App, Coinbase Global’s cryptocurrency wallet, Robinhood Markets’ trading app, buy now, pay later firms Affirm and Klarna and neobank Chime are building out their functionality. Typical functions of these super apps include payments via QR code, peer-to-peer transfers, debit and checking accounts, direct deposits, stock trading, crypto trading and more.

3. DeFi Gains Further Acceptance
Roughly a third of all the venture capital fintech investments raised in 2021 went to fund blockchain and cryptocurrency projects, according to PitchBook data. This includes $1.9 billion in investments for decentralized finance (known as DeFi) platforms, according to data from The Block. DeFi has the potential not only to disrupt the financial services industry but radically transform it, via the massive structural changes it could bring.

DeFi is an alternative to the current financial system and relies on blockchain technology; it is open and global with no central governing body. Most current DeFi projects use the Ethereum network and various cryptocurrencies. Users can trade, lend, borrow and exchange assets directly with each other over decentralized apps, instead of relying on an intermediary. The net value locked in DeFi protocols, according to The Block, grew from $16 billion in 2020 to $101.4 billion in 2021 in November 2021, demonstrating its potential.

4. Digital Wallets
Digital wallets such as Apple Pay and Google Pay are increasingly popular alternatives to cash and card payments, and we expect this trend to continue. Digital wallets are used for 45% of e-commerce and mobile transactions, according to Bloomberg, but their use accounts for just 26% of physical point-of-sale payments. By 2024, WorldPay expects 33% of in-person payments globally to be made using digital wallets, while the use of cash is expected to fall to 13% from 21% in the next three to four years.

We are starting to see countries like China, Mexico and the United States strongly considering issuing digital currency, which could also drastically reduce the use of cash.

5. Regulators Catching Up to Fintechs
It’s no surprise that regulators have been playing catch up to fintech innovation for a few years now, but 2022 could be the year they make some headway. The Consumer Finance Protection Bureau, noting the rapid growth of “buy now, pay later” adoption, opened an inquiry into five companies late in 2021 and has signaled its intent to regulate the space.

Securities and Exchange Commission Chair Gary Gensler signaled the agency’s intent to regulate cryptocurrencies during an investor advisory committee meeting in 2021. The acting chair of the Federal Deposit Insurance Corp. has similarly prioritized regulating crypto assets in 2022, noting the risks they pose. And this January, the Acting Comptroller of the Currency, Michael Hsu, noted that crypto has gone mainstream and requires a “coordinated and collaborative regulatory approach.”

Other agencies have also begun evaluating the use of technologies like artificial intelligence and machine learning in financial services.

The Takeaway
There are other forces at play shaping the fintech space, including automation, artificial intelligence, growing attention on environmental, social and governance issues, and workforce challenges. But we’ll be watching these five major trends closely as the year continues.

Fintech Transactions

Global fintech investment hit $98 billion in the first half of 2021, promising a return to pre-pandemic levels, according to KPMG. So what can we expect for fintech M&A in 2022? Ritika Butani leads corporate development at the technology platform Toast, which provides payments and other services to the restaurant sector. She leverages her background to provide her expectations for fintech M&A, including cross-border transactions. Butani also shares her perspective on the traits of a great technology acquisition.

Defending Your Bank Against Cybercrime

Fraudsters always look for the path of least resistance.

Recently, the most vulnerable targets have been government funded pandemic relief programs. According to recent research from several academics, 15% of Paycheck Protection Program loans were fraudulent in the 18 months leading to August 2021, totaling $76 billion. And the U.S. Department of Labor reported $87 billion in unemployment benefit scams during that same period.

As Covid-19 relief programs wind down, fraudsters are redirecting their focus from government-backed programs to bank customers and employees. The latter half of 2021 saw an uptick in traditional types of cybercrime: identity fraud, ransomware, social engineering and money laundering. So, what can a bank do to keep itself safe?

Arm employees and customers with knowledge.
Share resources and stories to help employees and customers understand the risk of cybercrime, defend their devices and detect suspicious activity. Employees are the first line of defense; it only takes one breach to compromise an institution. Provide training programs to educate staff about the different types of financial crimes and detection mechanisms. In addition, take steps to heighten customers’ awareness of fraud trends through campaigns and educational programs. For example, it is important that employees and customers know how to verify host files and certificates, determine the difference between  valid and scam websites, store confidential information and private data on their devices and set-up their devices on different network servers to minimize damage in case of an attack.

Build financial crime programs.
Investing in fraud, anti-money laundering and cybersecurity tools without a long-term strategic plan is a futile and expensive proposition. It’s common for organizations to have strategic initiatives for digital delivery channels and customer experience, but lack a financial crimes strategy. Many financial institutions do not realize they need one until it is too late: they suffer a large loss that could have been prevented. Banks should first identify, evaluate and classify assets and risks and then build a program as part of the long-term business strategy rather than a disconnected component. This approach helps to recognize an institution’s vulnerabilities and launch the most effective defensive strategy.

Invest in modern defense technologies.
Encryptions, patching software, firewalls, multi-factor authentication and real-time monitoring systems are all part of the complex, multifaceted defense that mitigates the risk of an attack. There’s not a single solution that can do it all. For instance, early breach detection mechanisms act as a strong defense, sending alerts and implementing backup and recovery programs in the event of an attack. Artificial intelligence and machine learning technologies can go on the offense, analyzing customer behavior, tracking transactions and reporting on deviations from usual behavior in real-time. Adding workflows to automated alerts allows accountholders to be involved with challenging transactions, reducing the risk for errors down the line. The foundation of any security program is continuous monitoring and evaluation of vulnerabilities, defense technologies and risk plans.

Test your incident response plan.
It is vital to test the resiliency of plans with simulated fraud or cybersecurity attacks. Don’t underestimate the chaos that a breach will cause. Everyone at the bank, from directors and the C-suite to the branch managers, must understand and be comfortable with their role in mitigating loss.

Banks spend plenty of resources building sticky customer relationships, but fraud immediately breaks that bond. A research paper by Carnegie Mellon University found that 37% of customers leave their financial institution after experiencing fraud. When a customer account is compromised, the user needs to completely modify the information on that account, including direct deposits and utility payments. The lack of trust in their financial institution, coupled with the need to rebuild their account from scratch, pushes customers to shop for another institution.

As new technologies emerge and the financial services industry becomes increasingly digitalized, the risk of financial fraud also grows. Fraudsters are constantly evolving their strategies to take advantage of new vulnerabilities. To keep safe, banks need a top-down management approach that focuses on education, long-term defense programs, modern technologies and continuous testing. Customers expect a high level of security and fraud protection from their financial institution; if they don’t get it, they will look elsewhere. In order to grow and retain their customer base, banks need to have an upper hand in the war on bank fraud.

The Most Important Aspect of Third-Party Risk Management

Third-party risk management, or TPRM, is a perpetual hot topic in banking and financial services.

Banks are outsourcing and using third parties for a range of products, services and activities as the financial services landscape becomes more digital and distributed. A common refrain among regulators is that “you can outsource the activity, but you can’t outsource the responsibility.” Banks can engage third parties to do what they can’t or don’t want to do, but are still on the hook as if they were providing the product or service directly. This continues to be a common area of focus for examiners and has been identified as an area for potential enforcement actions in the future.

Given the continuing intense focus on third party activities and oversight, one word comes to mind as the most critical component of TPRM compliance: structure. Structure is critical in the development of a TPRM program, including each of its component parts.

Why is it so critical? Structure promotes consistency. Consistency supports compliance. Compliance mitigates risk and liability.

Banks with a consistent approach to TPRM conduct risk assessments more easily, plan for third party engagements, complete comprehensive due diligence, adequately document the relationship in a written agreement and monitor the relationship on an ongoing basis. Consistency, through structure, ultimately promotes compliance.

Structure will become increasingly important in TPRM compliance, given that the Federal Reserve Board, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency issued proposed interagency guidance on TPRM last summer. While the guidance has not been finalized as of this publication, the concepts and substantive components have been in play for some time; indeed, they are based largely on the OCC’s 2013 guidance and FAQs on the topic.

Generally, the proposed guidance contemplates a “framework based on sound risk management principles for banking organizations to consider in developing risk management practices for all stages in the life cycle of third-party relationships.” Like other areas of risk management, this framework should be tailored based on the risks involved and the size and complexity of the banking organization. Fortunately, interagency guidance will enhance the consistency of the regulatory examination of TPRM compliance across banks of all sizes and charter-types.

The proposed guidance outlines the general TPRM “life cycle” and identifies a number of principles for each of the following stages: planning, due diligence and third-party selection, contract negotiation, ongoing monitoring and termination. The first three stages of this TPRM life cycle benefit the most from a structured approach. These three stages have more stated principles and expectations outlined by the banking agencies, which can be broken down effectively through a properly structured TPRM program.

So, when looking at improvements to any TPRM program, I suggest bank executives and boards start with structure. Going forward, they should consider the structure of the overall program, the structure of each of the stages of the life cycle outlined by the banking agencies and the structure of compliance function as it relates to TPRM. An effective strategy includes implementing a tailored structure at each stage. If executives can accomplished that, they can streamline compliance and make it more consistent throughout the program. Structure provides certainty as to internal roles and responsibilities, and promotes a consistent approach to working with third parties.