Compliance is key to successful banking and fintech partnerships

Laura Spiekerman is the co-founder and president of the leading identity decision platform Alloy.

In financial services, failure to comply has catastrophic consequences: from serious reputational damage to regulatory fines to prison terms. Never have these consequences been more clear than now, as the world has watched FTX implode. The stock market’s collapse has affected everyone with even the slightest connection to the company – from investors in Alameda Ventures’ portfolio companies to partner banks and banking-as-a-service platforms that helped power FTX products.

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

As the financial industry has grown, more established banking players are working closely with newer fintech companies that are pushing the boundaries of financial inclusion. Bank/fintech partnerships have been key in promoting transparency and innovation across the industry, driven by the growing number of BaaS platforms.

These partnerships are mutually beneficial. They are good for the banks because it is very expensive to adopt new technology 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 expensive resources building their own digital products, but at the same time earn a share of the profits.

The partnerships are also good for fintechs, who can use a single BaaS provider to create different products powered by multiple underlying banking providers.

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

However, the proliferation of these partnerships 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, ultimately creating a more secure experience for customers.

An example of regulatory arbitrage was pointed out by the US Treasury Department in a November report. The report notes how large fintech companies may be able to benefit from regulatory arbitrage in the payments space through relationships with small card issuers, which are granted exemptions from a regulatory cap on interchange fees imposed by the Durbin Amendment. Ultimately, large fintech companies can compete with larger banks in the market while benefiting from an exemption intended for smaller companies. This can lead to smaller companies exiting the market, resulting in fewer financial products available to customers.

Regulators clearly notice these gaps and will respond accordingly, which is good. While more competition among banks, fintech companies and other players in the industry is positive, the safety 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 focus in part on banking/fintech partnerships. The Consumer Financial Protection Bureau is investigating expanded guidance on Section 1033, which originally set the standard for open banking in the United States. The list goes on.

One way regulators are likely to respond is by providing a uniform framework for sponsor banks to conduct due diligence on both of their fintech partners. and any third party service providers the fintech partner works with. The recent financial report also notes that neither the bank nor its supervisory authority should have to face “unreasonable obstacles to access personnel, audit materials, user data analysis or other information in the control of the service provider’s fintech firm in order to assess whether the relevant activities are carried out in accordance with laws, regulations and risk management standards that apply to the bank.

Impending new regulations will require everyone involved in banking/fintech partnerships to step up their game if they want to continue operating in a competitive and innovative environment. The banks must clearly and proactively share their supervisory 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 need to operationalize how they meet and how they demonstrate compliance with these supervisory requirements from their banking partners, including creating a shareable explanation of how their solution meets the compliance requirements. Third-party infrastructure providers must be prepared for due diligence requests and quickly share the necessary information with fintech companies who can then pass this information on to their banking partners.

For example, banks are required by law to file suspicious activity reports (SARs) whenever they identify fraudulent activity on their platform. Fintech companies must 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 number of infrastructure platforms that help make compliance easier and more efficient in bank/fintech partnerships. Implementing one of these platforms can 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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