Why Bank-Fintech Partnerships Are Here to Stay


partnership-8-18-17.png“Silicon Valley is coming,” Jamie Dimon, chief executive officer at J.P. Morgan Chase & Co., famously warned his bank’s shareholders two years ago. Indeed, with the rapid proliferation of fintech companies that are creating cutting-edge products, banks are asking how they can compete with these nimble startups that are reaching unbanked populations, and making routine transactions speedier and more accessible, without the same regulatory burdens shouldered by banks. While we can’t offer a silver bullet, it appears that some banks have concluded that there is considerable wisdom in the adage “if you can’t beat them, join them.”

A bank-fintech partnership is an arrangement in which a fintech company provides marketing, administration, loan servicing or other services to a bank to enable the bank to offer tech-enabled banking products. For example, a fintech company may perform loan origination services, while the bank funds and closes the loans in its own name and later sells loans it does not want to hold in portfolio to purchasers, including the fintech company. Banks have also partnered with fintech companies to provide payments services or mobile deposits. While some partnerships offer products under the fintech company’s brand, in other cases the fintech company quietly operates in the background. Some banks enter into more limited relationships with fintech companies, for example, by purchasing loans or making equity investments.

Many banks have realized advantages of bank-fintech partnerships, including access to assets and customers. Since most community banks serve discreet markets, even a relatively simple loan purchase arrangement can unlock new customer relationships and diversify geographic concentrations of credit. Further, a fintech partnership can help a bank serve its legacy customers, for instance, by enabling the bank to offer small dollar loans to commercial customers that the bank might not otherwise be able to efficiently originate on its own.

Of course, fintech companies derive significant benefits from these partnerships as well. For Fintech companies, having a bank partner eliminates barriers of market entry. With the bank as the “true lender” or money transmitter, the fintech company spares the time and expense of obtaining state licenses. Bank partners can lend uniformly on a nationwide basis and are not subject to many of the different loan term limitations that state licensed lenders are. Of course, banks must comply with their own set of lending regulations.

Though potentially beneficial, banks must be mindful of the risks that partnerships present. Banks are expected to oversee their fintech partners in a manner commensurate with the risk, as they would any service provider, following detailed regulatory guidance on oversight of third-party relationships. In June 2017, the Office of the Comptroller of the Currency (OCC) issued a bulletin communicating enhanced expectations for oversight of third parties, including, specifically, fintech companies.

Banks must perform initial and ongoing due diligence on any fintech partner to ensure that it has the requisite expertise, resources and systems. The partnership agreement should hold the fintech company accountable for noncompliance, and enable the bank to terminate the relationship without penalty in the case of any legal violation. The parties should agree to strict information security and confidentiality standards. Banks should reserve the right to conduct audits and access records necessary to maintain oversight. Adequate oversight is essential because liability for violations or errors made by the fintech company may ultimately rest with the bank.

Banks seeking to partner with lending platforms must also structure the relationship to address true lender concerns and consider how they will sell loans or receivables on the secondary market, including to the fintech company. Unless an arrangement is properly structured, a court or a regulator may conclude that the bank was not the true lender and that the interest exceeds applicable usury limits. Similarly, as a result of a ruling by the U.S. Court of Appeals for the Second Circuit in Madden v. Midland Funding, if interest on a bank loan exceeds the rate permitted by applicable law for non-bank lenders, a non-bank purchaser may not be able to enforce the loan even if it was valid when made by the bank. Banks might address this risk by selling participation interests instead.

While competition from fintech companies may seem daunting, the proliferation of bank-Fintech partnerships suggests that banks fill a critical niche in the fintech industry. Moreover, even though some fintech companies have sought to become banks themselves and the OCC has proposed offering a special purpose bank charter to fintech companies, given the high regulatory hurdles of operating as a bank and the obstacles the OCC has encountered in advancing its proposal, it appears that bank-fintech partnerships are here to stay.

Use Good/Better/Best for Checking Success


checking-accounts-10-28-16.pngShop for a new car, a cell phone plan, a cable TV package or a major appliance these days and you’ll find one consistent and very successful product strategy–Good/Better/Best (GBB).

GBB is a three-tiered strategy conceptually defined as follows:

  1. Good: A basic level of value for price sensitive customers. Good offers a minimal amount of added value to differentiate yourself from your competitors and/or to marginally satisfy comparison shoppers. For example, coach class airline tickets would fit in this category.
  2. Better: An in-between level of value for customers who appreciate some level of value and are willing to pay a certain price to receive it, because they are still a bit price sensitive. The amount of value added above Good depends on the product type and marketplace, but the incremental level of value must be noticeable. For example, business class airline tickets would be better than coach but not as expensive as first class.
  3. Best: An advanced level of value for those customers who are actively looking for maximum added value. Price sensitivity is not a priority. The amount of value added above Better has to be all that is economically possible to add and still maintain acceptable profit margins or strategic goals. First class airline tickets would be a Best option when flying.

Every successful GBB design works when the product offerings build on each other. Your Good product is fundamental. Better is Good plus more. Best is Better plus more. GBB provides choices by comparison, easily showing how the price changes when different features are added or subtracted. As a result, buyers will be content that they decided to buy only as much as they needed. The power behind GBB is simplicity and familiarity.

While buyers appreciate choice, too many choices are counterproductive. The paradox of choice theory holds that too many options discourages rather than encourages buyers to buy. Why? Because it increases the effort that goes into making a buying decision. So buyers decide not to decide and don’t buy your product. Or if they do buy, the effort to make the decision often diminishes from the enjoyment derived from the product. In short, buyers do not respond well to choice overload and GBB keeps it simple. It’s very familiar to think in terms of three when buying things. Popular use of GBB product design by retailers for commonly purchased items has conditioned the typical buyer to be at ease with this product design.

GBB simplicity also works well for the sellers of the product. There are only three options to understand and communicate to a buyer. Plus, sellers feel credible as GBB appeals to a wider market, providing something for everyone without requiring everyone to just buy the premium option.

So how does this all relate to your consumer checking line-up strategy? Actually, it’s very natural, because you can align your GBB checking products with the three types of checking account buyers:

  1. A fee averse buyer wants free checking if it’s available or the cheapest account you offer.
  2. A value buyer is most focused on account benefits and is willing to pay for the account if there’s a perceived fair exchange of value.
  3. An interest buyer demands some yield on their deposits and also expects to be rewarded for being a productive or loyal customer.

In addition, nearly all three checking products under a GBB structure generate enough average annual revenue to cover the annual costs to service a typical checking account relationship, except for totally free checking.

Here’s how that breaks down, along with the comparative average annual revenue from each GBB checking product type and typical distribution of these accounts in a checking portfolio:

Product Strategy Buyer Type Checking Product Type Average Annual Revenue Percentage Range of Total Accounts
Good Fee Averse Totally Free
or
Conditionally Free
(minimal requirement to avoid fees)
$308
 
$390
 
30%-50%
Better Value Flat Monthly Fee $563 25%-40%
Best Interest Interest $636 10%-15%

Source: StrategyCorps’ Brain database tracking the financial performance of nearly 5 million checking accounts. Average annual revenue is the total of all checking related fees (including debit interchange) per respective account type and the allocated net interest income from the account type’s respective annual average DDA balance.

So what does a GBB-based checking line-up look like for a financial institution like yours? Here’s a sample GBB checking line-up in action as shown on sales/marketing materials.

As your financial institution works to have a more successful checking line-up that’s modern, customer engaging, competitively different and optimally financially productive, learn from the successful product design strategy of GBB. Don’t overthink it, over complicate it or, in general, overdo it. Your customers will be happier and your bottom line will be healthier.

Integrating a New Product Line: Asking the Right Questions in the Boardroom


2-13-15-BryanCave.pngAs year-end results are finalized, many financial institutions are now budgeting for the coming year. With many banks struggling to find new revenue sources, these conversations are often focused on operational matters, including diversifying into new loan products and electronic payment applications designed to attract and retain new and existing customers. And while some boards of directors have a productive conversation regarding new products, these detail-rich discussions can result in the board overlooking the impact of the new product line on the bank’s strategic direction.

Directors, as part of their duty to maximize shareholder value, are responsible for charting the strategic course of the bank. Too strong of a focus on operational matters may have the effect of muddling the important distinction between the roles of directors and officers going forward, leaving management feeling micro-managed and directors overwhelmed by reports and data in their “second” job. Instead, a higher-level discussion may be necessary in order to ensure that the board is focused on overseeing the institution’s strategic plan, while management is charged with safely and profitably executing the new business line.

So what are the appropriate questions for directors to ask and resolve when considering a new product? The following can help ensure that the board achieves the right strategic decision for any new product or activity. 

Consider management first.  When evaluating a new line of business, the board should consider whether the institution has the appropriate management needed to supervise the activity in a safe and sound manner. For example, banks looking to diversify their asset portfolios into other types of lending, including C&I and SBA-guaranteed loans, may need to recruit a group of experienced lenders from another institution. But the board should first consider how the new lenders will integrate into the bank’s culture and if the bank’s credit department will have the expertise to underwrite the loans.  

The addition of new loan products is perhaps the simplest example, but for new online customer applications, finding and hiring the right team to manage the related franchise and regulatory risk may be more challenging. With a new mobile banking app, the institution will face new data security and “know your customer” challenges that may exceed the skills of the current staff. In either case, understanding the personnel required to execute the new business safely will give the board an idea of not only the new activity’s cost, but also its risk.     

Project the path to profitability.  After considering the personnel demands of the new product line, the board should then determine the timeline for fully integrating the new activity into the bank’s core business. Depending on the scope of the institution’s current product offerings, some new business lines may be easier to integrate than others, particularly where the bank and its management have prior experience.  

On the other hand, many institutions are now considering acceptance of new online payments products, recognizing these services will be essential to attracting younger customers. Even if ultimately profitable, these new applications can expose the bank’s operating system to new online threats and unfamiliar customer segments, which may result in more risk and expense than benefit for a significant period of time. Evaluating these costs and benefits, particularly within the context of the bank’s strategic plan, is a central component of the board’s role.  

Determine if changes are necessary to the institution’s strategic plan.  Any meaningful strategic plan includes a statement by the board of whether the bank will pursue a “buy,” “sell,” or “hold” strategy over the next three to five years. Depending on the importance, cost and risk of the new product line to the future success of the bank, the board’s discussion of the new product may change its buy, sell or hold determination. In some cases, if it appears too costly or risky to integrate an essential new product into the bank’s core business, the board of directors ought to consider whether a sale or strategic partnership with a larger institution would bring more value to their shareholders.   

So while some discussion of tactics is essential to the board’s consideration of a new product line, directors should stay focused on managing the bank’s risk appetite and strategic direction during these conversations. Boards that focus on the big picture have a great vantage point for considering a new product offering—they can better evaluate the bank’s strengths and weaknesses and have a better understanding of the bank’s core business. Using this perspective, some boards may conclude that staying the course in advance of an eventual sale, rather than steering the bank into the unfamiliar waters of a new product line, may result in the best returns for the institution’s shareholders.