Traditional regional and community banks in the United States are challenged by financial technology providers to acknowledge the ongoing digitization and broadly applicable tech-focused future of banking. However, as many banks have discovered, fintech represents both great opportunities and real operational challenges. These costs and benefits are even more pronounced in the regional and community banking sectors, where engaging with fintech can be daunting but also transformational to a very traditional banking model. Here we will explore how these banks can engage with fintech and what fintech they should actually consider.
First, what do we mean by “fintech”? Generally, we refer to fintech as simply the use of technology in providing a financial product or service. This can manifest as an online banking platform allowing customers access to their accounts online, an online loan origination model that uses new or novel data points to determine creditworthiness in a more individualized manner, technology that allows for faster or more secure payments, or online “wallets” that can be used for automatic savings or other electronic transfers. The possibilities continue to grow and evolve; however, for regional and community banks, the focus is typically on providing and growing traditional banking services in a digital ecosystem.
Fortunately, these banks can leverage the experiences of larger banks and fintech participants, in addition to the guidance and examples provided by the federal banking agencies (the Board of Governors of the Federal Reserve System, the FDIC, and the Office of the Comptroller of the Currency) over the last decade. Indeed, the federal banking agencies outlined the following in a recent request for information regarding bank-fintech arrangements:
“The agencies support responsible innovation and banks pursuing bank-fintech arrangements in a manner consistent with safe and sound banking practices, and with applicable laws and regulations, including consumer protection requirements and those addressing financial crimes. Bank-fintech arrangements can provide benefits; however, supervisory experience has highlighted a range of potential risks with these bank-fintech arrangements.”
So, why do banks generally consider adding some technology or exploring a fintech relationship? As the federal banking agencies identified in the recent joint statement on banks’ arrangements with third parties to deliver bank deposit products and services, “banks may [enter into arrangements with third parties to deliver deposit products and services to end users] in order to increase revenue, raise deposits, expand geographic reach, or to achieve other strategic objectives, including by leveraging new technology or offering innovative products and services.”
Banks have deposits, capital, and strong customer relationships, whereas fintech providers have technology that creates efficiency and creativity for bank customers and strategic growth. Practically, there are countless reasons for engaging a fintech provider, but the reasons are typically very specific to the bank customer’s demands, the bank market’s demands, the competitive environment in which the bank operates, and the strategic growth and expansion plans of the bank.
The specific reasons to engage a fintech provider result in exploring what options are available to satisfy those needs. Some common needs are as general as moving to an online banking platform for customers to have digital access to their accounts, enabling a remote deposit service, or moving loan applications and corresponding documentation online for review and storage. Some needs are more tailored, such as allowing customers to send payments with Zelle, Venmo, or another peer-to-peer payments provider, or utilizing transaction reporting software to enhance regulatory compliance, such as anti-money laundering reporting compliance.
Once the reasoning is fleshed out, the appropriate board and management consideration and approval has occurred, and a potential partner is identified, the next question is how do we actually engage? This is where the federal banking agencies have provided a number of expectations, guardrails, and best practices, which provide a valuable road map.
Ultimately, “[e]ngaging a third party does not diminish or remove a bank’s responsibility to operate in a safe and sound manner and to comply with applicable legal and regulatory requirements, including consumer protection laws and regulations, just as if the bank were to perform the service or activity itself.” In other words, “you can outsource the activity, but you can’t outsource the responsibility” — no matter the product or service, or which party is performing what activity, the bank is always responsible.
Guidance from the federal banking agencies on third-party risk management examines the typical third-party relationship lifecycle from planning to due diligence and contracting to monitoring and termination of the relationship. Beyond the words on the page, the supervisory experience of many regional and community banks has focused on the actual capacity of the bank to engage fintech providers and the specific product or service offered. For example, does the bank have adequate staffing with the relevant expertise in the subject area? Does the bank have any existing experience with the relevant market for these products or services? Has the bank actually documented the planning and reasoning stages of the analysis above?
Next, supervisors look for the documentation. Has the bank actually negotiated contracts with those terms and conditions that the federal banking agencies have identified as particularly important for these relationships? Is the compliance function appropriate for additional risks associated with the fintech relationship? Has the bank actually performed a risk assessment to identify risks, such as those in hot-button areas such as fair lending, unfair, deceptive, and abusive acts or practices, data security, and privacy and anti-money laundering?
Then ultimately, what investments, offerings, or relationships should regional and community banks actually consider in the financial technology ecosystem? It is not an overly fancy or complicated product or service with little or no connection to the bank’s existing customer or product base.
For these banks, the opportunities most appropriate are those similar to what we have already identified — products or services demanded by the bank’s customers, the bank’s market, competitive considerations, or pursuant to strategic goals of the bank. Fintech relationships for these banks tend to focus on easing the challenges of providing financial products or services to customers, acquiring new customers, onboarding new customers and accounts, originating new loans, and monitoring compliance with the myriad laws and regulations that keep bankers up at night.
Joseph E. Silvia, partner at Duane Morris, focuses his practice on advising financial institutions and financial technology companies on general corporate matters, mergers, acquisitions, governance, payments systems, anti-money laundering, sanctions, and bank and consumer finance regulation. Mr. Silvia previously served as counsel to the Federal Reserve Bank of Chicago, where he focused on the supervision and regulation of banks, bank holding companies, and savings and loan holding companies, as well as consumer finance and compliance matters.
