Fintech Security

Compliance Is The Key To Successful Bank And Fintech Partnerships

Laura Spiekerman is the co-founder and President of leading identity decisioning platform Alloy.

In financial services, failing to be compliant has disastrous consequences: from severe reputational damage to regulatory fines to jail time. Never have these consequences been so clear than now, as the world has watched FTX implode. The exchange’s collapse has affected everyone with even the slightest connection to the company—from investors to Alameda Ventures’ portfolio companies to partner banks and banking-as-a-service platforms that helped power FTX products.

Some of the hysteria is overblown, but regardless, it’s a good reminder of why compliance is paramount, especially when it comes to partnerships among financial institutions.

As the financial services industry has grown, more established banking players are working closely with newer fintech companies pushing the boundaries of financial inclusion. Bank/fintech partnerships have been key for fostering openness and innovation across the industry, powered by the growing number of BaaS platforms.

These partnerships are mutually beneficial. They’re good for banks because adopting new technologies is very expensive for institutions that have operated on the same infrastructure for years. Partnerships with fintech companies help banks provide new features to eager customers without spending costly resources to build their own digital products, but while still earning a share of the profits.

The partnerships are also good for fintechs, which can utilize a single BaaS provider to create various products powered by multiple underlying banking providers.

These partnerships are also good for customers, who can use the convenient and innovative products offered by fintechs and know that their deposits are FDIC insured via the fintech’s partner bank.

The proliferation of these partnerships, however, has also resulted in new risks, including regulatory arbitrage. As regulators respond, players across the industry—from banks to fintech companies to infrastructure providers—will need to work together to be compliant, and ultimately create a more secure experience for customers.

One example of regulatory arbitrage was pointed out by the U.S. Treasury in a November report. The report notes how large fintech companies may be able to take advantage of regulatory arbitrage in the payments space through relationships with small card issuers, which are afforded an exemption from a regulatory limit on interchange fees imposed by the Durbin amendment. Ultimately, large fintech companies could compete with bigger banks in the market while benefiting from an exemption intended for smaller companies. This could result in smaller firms getting edged out of the market, resulting in fewer financial products available to customers.

Regulators are clearly taking note of these gaps and will respond accordingly, which is a good thing. While more competition among banks, fintech companies and other players in the industry is positive, the security of customers’ funds should always come first.

In addition to the Treasury report referenced above, the Office of the Comptroller of the Currency has also announced a new office of financial technology, which will in part focus on bank/fintech partnerships. The Consumer Financial Protection Bureau is examining extended guidance on Section 1033, which initially set the standard for open banking in the U.S. The list goes on.

One way regulators will likely respond is by providing a uniform framework for sponsor banks to conduct due diligence on both their fintech partners and any third-party service providers the fintech partner works with. The recent Treasury report also notes that neither the bank nor its regulator should have to face “unreasonable obstacles to gain access to personnel, audit materials, user data analysis or other information in the control of the service provider fintech firm for the purpose of evaluating whether the relevant activities are being conducted in compliance with the laws, regulations, and risk management standards” applicable to the bank.

Impending new regulations will require everyone involved in bank/fintech partnerships to step up their game if they want to continue to operate in a competitive and innovative environment. Banks will need to clearly and proactively share their oversight requirements. They may require everything from financial information, go-to-market strategies, a target customer base, sales plans and compliance plans from potential fintech partners.

Fintech companies will need to operationalize how they meet and how they demonstrate fulfillment of those oversight requirements from their banking partners, including creating a shareable explanation of how their solution meets compliance requirements. Third-party infrastructure providers will need to be prepared for due diligence requests and quickly share necessary information with fintech companies who can then pass that information on to their banking partners.

For example, banks are required by law to file suspicious activity reports (SARs) any time they identify fraudulent activity on their platform. Fintech companies need to proactively share these records, which their infrastructure providers can help operationalize. These steps will make the SAR filing process more efficient for banks and their regulators.

There are a variety of infrastructure platforms that are helping to make compliance easier and more effective in bank/fintech partnerships. Implementing one of these platforms may be a good solution for some companies that need to save their resources for product building. Implementing an infrastructure platform can help save both time and money.

If the power players in the financial services industry can put their egos aside and work together to maintain effective and compliant partnerships, they need not fear the wave of new regulations that we will almost certainly see in 2023. Consumers will be better off for that collaboration.


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