Over 3 years ago (when we discussed fintech & bank partnerships), an early theme was disruption and competition. Most financial institutions were hesitant in partnering with new fintech platforms. These emerging players delivered an inclusive experience for the unbanked and underbanked without monthly fees or minimums. Banks were unable to provide a no-cost model to match fintech offerings.

Since 2016, the model of partnerships started to shift towards collaboration — banks and fintechs working together to offer a modern solution that boosts activity and usage for all user types. Fintech companies need financial institutions with bank charters to hold customer deposits and sponsor card programs. Banks need fintechs to reach a wider scope of customer deposits without increasing infrastructure costs (such as building new branches & hiring new employees).

In 2022, the bank and fintech partnership framework now evolves to co-creation as away to customize new programs and avoid regulatory scrutiny.

REFRESHER on WAYS THAT FINTECHS & BANKS PARTNER

Not all financial institutions would like to take on the complexity of integrating an unknown fintech program as part of their core business. Not all fintechs are interested in managing a full scope banking program.

For these banks and tech firms, the format to partner is through a referral partnership program. Fintechs essentially refer their clients interested in opening a product/service to a bank (specifically the bank’s mobile app or website). This bank owns user communication and the banking relationship without the fintech company being involved (in exchange for a one-time referral fee). Banks then make recurring revenue from deposits and other user transaction activity. Pros and Cons:

Financial institutions

• PROS: Increase customer base and deposits, own customer relationship, eliminate need to audit 3rd party fintechs;

• CONS: Lack of control with quality of users referred, difficult to maintain lengthy customer relationships, fintechs can easily shift work with multiple banks;

Fintechs

• PROS: Minimal (or no) responsibility with compliance or program management, generates revenue, no fixed cost to refer users;

• CONS: Revenue potential is flat, banks may not onboard all referred users, customers may not feel comfortable interacting directly with a bank;

For banks and fintechs that believe in an integrated relationship, embedded partnership programs exist through Banking-as-a-Service (BaaS) frameworks. Licensed financial institutions partner with companies that directly offer digital banking services (accounts, payments, cards) to their end users via API (application programming interfaces). There’s no direct communication from the bank to the end-user.

An early version of BaaS came in the form of the first neobanks — Simple (launched through Bancorp Bank) served US-based users from 2012–2020. There was more of a one-on-one format about a decade ago, in which a bank only took on one fintech partnership. Many partner banks now accept multiple companies in an embedded model.

There’s a definite step-up in the working relationship and responsibilities, but the upside with revenue & scale is a true gamechanger (for both sides). Financial institutions are able to scale deposits at a faster rate. Fintechs are able to increase revenue share through interchange (from user’s card spend) and rebates (based on user’s deposit balances). Additional PROS and CONS:

Financial institutions

• PROS: Faster scale of customer base and deposits, increased user retention and overall activity levels;

• CONS: No direct control of type of customers that are onboarded, critical compliance oversight and monitoring of fintechs;

Fintechs

• PROS: Increased monetization per user, ability to manage the user relationship, deep control the user experience;

• CONS: Higher fixed cost to properly manage compliance obligations and bank relationships, lengthy & unknown review process from banks can delay launch;

With this type of embedded, direct bank partnership, there’s a larger emphasis on compliance policies and controls. Since financial institutions have less involvement with users, it’s up to the fintech company to ensure proper onboarding of users and continuous monitoring of transaction activity. If banks no longer feel comfortable with a program partner, a platform would be shut down and user accounts eventually closed. In recent weeks, regulators in the US started to demand rigorous standards and checkpoints between financial institutions and fintech companies.

Regulatory Headwinds are forming in the US

The regulatory shakeup that financial institutions were expecting is here. Executives from well-established banks were very vocal in the last 5 years about the bank-fintech partnership model circumventing compliance standards and regulator’s guidance. Fintechs (without bank charters) were allowed to operate in a gray area of offering financial services without government oversight underneath banks.

The most impactful announcement came this month from the OCC (Office of the Comptroller of Currency), which charters, regulates, and supervises all national banks & federal savings associations. The OCC is an independent part of the U.S. Department of the Treasury. The order (filed with the Securities and Exchange Commission) pertains to Blue Ridge Bank and its oversight of 3rd-party fintech partnerships:

• Blue Ridge Bank must now reinforce its anti-money laundering (AML) risk management, suspicious activity reporting (SAR), and information technology controls due to unsafe practices;

• OCC’s approval must be given before Blue Ridge enters a new contract with fintechs OR adds products with current partners;

• Other critical requirements include: new guidelines for assessing risks posed by third-party fintech partnerships (due in 60 days); BSA (Bank Secrecy Act) risk assessment including BSA audits and standards to assess and manage information technology activities (due in 90 days);

The overall sentiment is monitoring and mitigating against the risk from fintech partnerships, which had yet to come up as a topic. Some industry veterans see a pause coming with partnerships, but the theme moving forward seems to be “slow down.”

For experienced banks and fintechs, the announcement is welcomed. Lack of clarity from regulators regarding this partnership model made long-term growth and scaling of programs difficult. Platforms were moving cautiously based on interpretation of regulation from the OCC, SEC, IRS, and other agencies. The focus is now on adherence to compliance obligations and maintaining oversight of risk and controls.

For founders and teams that are new to the industry, the message is clear: lead with a mindset of risk mitigation across all activities. Many fintech startups bring up compliance towards the end of product building or rely on partner banks and BaaS providers for coverage. No longer possible.

DO FINTECH BANK PARTNERSHIPS GO AWAY?

No. Both fintech companies and financial institutions (especially regional and mid-size banks) still need one another for net new growth that is scalable. Non-banks aren’t willing to undergo lengthy & costly processes for licensing and bank charters. Banks can’t expand outside their local footprint by building and managing expensive retail branches.

The industry premise is still there to continue with a bank-fintech framework in a collaborative effort that addresses regulatory requirements. Fintechs will need to lead partnership discussions with policies, procedures, and controls that protect against money laundering and fraudulent activity. Banks need sufficient staff and internal practices to approve these fintech programs and regularly monitor user onboarding and transacting.

It seems fairly straightforward, but not all parties will be able to fulfill the increased oversight and cost of compliance reviews and audits. Established BaaS providers and experienced banks will start to create a moat in the industry as many of them have preached better controls from the start (after dealing with complaints or large losses from fraud).

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