Compliance will be in whole or in part for bank-fintech partnerships

Regulators must be mindful not to block collaboration, writes Harsh Sinha, chief technology officer at Wise.

Image source: Shutterstock.

Bank-fintech partnerships have exploded in recent years. Rather than viewing each other solely as competitors, banks and fintechs are choosing to collaborate instead, working together to build and bring more innovative products to customers.

The advantages of partnership are clear: for banks, cooperation with a fintech means being able to adopt new technologies faster and cheaper than building them internally. For fintechs, banks offer greater resources and the ability to reach thousands – perhaps millions – of more customers worldwide. And for these customers, bank-fintech partnerships open up more innovative ways for them to send, spend and manage their money.

Many of these partnerships are facilitated by Banking-as-a-Service (BaaS) providers, which act as intermediaries between banks and fintechs. These providers are particularly useful in countries where fintechs are unable to hold a banking license or connect to payment systems themselves.

But partnerships backed by BaaS may be under threat, as examples of companies falling short on compliance have inspired new regulatory scrutiny across the US, UK and Europe. Consider some recent examples.

In September 2022, US-based Blue Ridge Bank filed a public settlement with the Office of the Comptroller (OCC), after the regulator raised concerns about its BaaS model and whether its compliance infrastructure could keep up with growth. The concerns were particularly about the bank’s third-party risk management, monitoring of suspicious activity and IT controls.

To meet the OCC’s new requirements, Blue Ridge had to write and implement new policies to assess risk, appoint a compliance committee and obtain approval from the regulator before new partners were brought on board.

Not long after, Solaris, a BaaS provider based in Germany, faced scrutiny from their regulator BaFin when they reported high business volumes but were found to be falling short of compliance. This resulted in a similar restriction to Blue Ridge, and Solaris must now seek approval from the regulator before onboarding new customers.

Most recently in the UK, BaaS provider Railsr is being monitored by the Financial Conduct Authority (FCA) following concerns about the health of its business. After emergency talks about mergers and acquisitions, Railsr now appears to be sold through prepackaged management. This follows an investigation by the Central Bank of Lithuania into Railsr’s AML failure.

With several events taking place over the course of a few months, it is understandable that regulators will increase oversight of partnerships facilitated by BaaS providers. But there is a risk that what are in reality isolated incidents could lead to a backlash that makes bank-fintech partnerships appear far riskier than they are, putting banks and fintechs away from them for good.

There may now be an impulse to introduce broad, comprehensive regulation that cuts down on partnerships and BaaS. This impulse should be resisted, not because banks, fintechs and BaaS do not want more guidelines, but because existing regulation in most cases already works.

Most fintechs and BaaS providers already take compliance very seriously and have expert teams dedicated to staying in line with relevant regulation. These teams will be even more vigilant given the current climate – which is of course welcome. But initiating a crackdown on the industry as a whole is like punishing the entire class because one student didn’t turn in their homework.

Let’s also not forget that BaaS providers and especially early stage fintechs already have limited and often stretched resources. Even for big banks with strong compliance arms, partnerships can start to look like regulatory quagmires that soak up resources and negate the biggest advantage of working with a fintech, which makes innovation faster and cheaper. Ultimately, more – and stricter – regulation will make partnerships the domain of large, resourceful companies and eliminate new competition, doing a disservice to both the industry and consumers.

The truth is that regulation in its current form should be sufficient to prevent compliance failures and keep customers safe. The problem is not that this regulation does not exist, but that some providers either do not take it seriously enough, or struggle to understand the requirements.

Regulators can help. A set of specific learnings that can be taken from these incidents will allow all banks, fintechs and BaaS providers to re-examine their compliance procedures and ensure they have the tools in place to meet the requirements. This will give banks and fintechs the confidence to move forward with partnerships, ensuring that industry and customers worldwide continue to benefit from the products and services made possible by cross-industry collaboration for years to come.