​​Innovation must be built on foundation of trust

Michelle Bowman

EDITOR’S NOTE: Federal Reserve Governor Michelle Bowman spoke on innovation at the American Bankers Association’s government relations council meeting in September. Her comments are edited for length and clarity.


The financial services industry has experienced rapid technological change [which] continues to encourage new ways of interacting with and serving customers. Such innovation creates important opportunities for banks of all sizes.

When banks can be agile in developing relationships with third-party providers to meet unique customer needs, they can find their own paths to innovation. For example, community banks approach the evolving payment needs of tech savvy customers from many different angles. Their solutions include partnering with financial technology companies, developing peer-to-peer payment solutions with their core providers, even hiring outside developers to create their own apps.

While positive trends are encouraging, I am attuned to the challenges community banks face when seeking to innovate. I have heard from many community bankers about the constraints they face in taking advantage of new technologies — both in terms of the resources and the expertise required to adopt innovative technologies in a responsible manner.

Community banks engage in a range of partnerships with fintechs, each pursued for different reasons, with varying levels of investment of time and resources. The cost of conducting due diligence on prospective partners can be high for community banks. Seeking a partnership with a newly established fintech company may introduce additional complications. For example, a less experienced partner may be able to offer a product that fits a community bank’s needs but may not understand the bank’s regulatory obligations or have fully developed operational or compliance frameworks. Gaps in the ability to demonstrate or guarantee compliance can introduce risk that a community bank will need to fully understand and manage.

The Federal Reserve published a paper promoting access to innovation for community banks and overcoming related challenges. It lays out some important issues that banks must consider to maximize the effectiveness of the partnership and describes key partnership types and the associated benefits, risks and challenges. [It] also identifies fundamental considerations for effective partnerships as described by community bankers.

In our outreach, bankers noted that it is critical for partnerships to be built upon a foundation of mutual trust and alignment of values. In some cases, due diligence efforts reveal that potential partners do not share the banks’ values or objectives. One bank, for example, began discussions with a fintech company that could assist it with the bank’s Paycheck Protection Program loan originations by providing a customer-facing application portal. After learning that this partner intended to sell the small business customer information it would obtain, the bank opted out of the partnership. 

Harnessing the full potential of technology innovation also requires a long-term, strategic commitment to innovation. Many bankers spoke of the importance of knowing exactly what new technology is solving for, building a team they trust, and securing buy-in from both senior management and the staff responsible for implementation. Bankers who have forged successful partnerships have a clear vision of their goals. For example, one bank partnered with a fintech company to roll out limited banking services to teenagers. Its intention was to promote financial literacy among young people in the community and to prepare the bank to accommodate the preferences of a new generation. The bank also hired local college students to work with staff, combining the technological expertise of these more recent hires with the deep compliance background of the bank’s long-standing employees.

I have often heard from community bankers that the manpower and other costs related to due diligence are formidable barriers for banks seeking to establish new third-party relationships. The Federal Reserve, the OCC and the FDIC have published a vendor due diligence guide to assist community banks with their risk assessment when considering a new relationship with a fintech. This guide was developed to help reduce these burdens by providing a practical resource for community banks when assessing the risks of potential fintech partnerships.

This resource does not establish new regulatory expectations but it can serve as a starting point for banks in their due diligence process. A community bank can tailor how it uses the guide to meet its unique circumstances and the specific risk-management needs posed by each fintech relationship. A community bank can also share the guide with potential partners to help them understand the bank’s risk-management requirements.