Banks should more closely monitor third-party relationships to prevent customer harm, said Federal Reserve Vice Chair for Supervision Michael Barr on July 9 during a financial conference in Washington, D.C.
Barr’s comments came shortly after the bank accounts of tens of thousands of businesses and consumers were frozen amid the shutdown of Synapse, which serves as a middleman between banks and fintechs. The company filed for Chapter 11 bankruptcy protection in April and closed down its services to some bank or fintech partners, including West Memphis, Ark.-based Evolve Bank & Trust. The shutdown caused disruptions for customers of Synapse’s partners, and led to accounts being frozen or showing funds not existing. Evolve Bank & Trust customer data was breached. In August 2023, the Federal Reserve found Evolve Bank & Trust didn’t have an effective risk management framework.
“We have, unfortunately, seen examples of failures of banks to effectively manage the risks of partnerships with other companies that support services to their end customers, and these failures have resulted in customer harm,” Barr said. “In communities where people are living on tight budgets or with limited access to financial services, disruptions of this kind can be catastrophic.”
Third parties can include data aggregators, merchant payment processors, consultants and cloud computing providers. More banks are offering small-dollar loans, using alternative data to underwrite and price their credit products, and investing in products to better understand consumers’ financial health.
Barr called on regulators to ensure companies granted access to customer data protect their privacy and security. He noted the Federal Reserve will provide additional resources on the use of alternative data in the coming months.
“With the share of households with bank accounts much larger than the share with credit scores and especially with prime or near-prime credit scores, this information has the potential to allow underwriting of a much larger pool of potential reliable borrowers,” Barr noted.
Last year, the Federal Reserve, Office of the Comptroller of the Currency and FDIC called on banks to customize their risk management practices proportionally to their size, complexity, risk profile and third-party relationships.
The focus on safe third-party relationships comes as the agency should more explicitly state its desire to foster innovation, said Director Jonathan McKernan. Speaking July 10 during a conference hosted by online news service Semafor, McKernan said the existing regulatory framework must not entrench the power of incumbents. He also sees opportunities for clearer, activity-specific guidance for third-party bank partnerships.
McKernan said banks must expand beyond just having contractual third-party monitoring provisions to actively monitor third parties with effective internal risk management. “There is certainly a lot of potential for innovations to help reduce the barriers to entry, reduce the scaled economies that tend to entrench some of our largest financial institutions,” McKernan added. “That’s good for financial stability; that’s good for safety and soundness; that’s good for consumer protection.”