Fintech-Bank Lending Partnerships: 8 Key Issues | Goodwin

Partnerships between financial technology companies (fintechs) and banks have revolutionized the financial services landscape. The convergence between technology and banking has resulted in financial products and services being delivered faster and better than ever. Lending partnerships are the most widespread type of fintech-banking partnership, and they can be structured in many ways. Each unique program offers enormous opportunities. For the close relationship between a fintech and a bank to succeed, the parties must find the right balance in the allocation of a program’s risk and reward.

This article discusses eight key issues along the risk-reward continuum that often arise in lending partnerships. The parties can improve the negotiation process and achieve better results by considering these issues early.

Problem No. 1: The bank’s retention of a financial interest

In lending partnerships, “true lender” risk is a critical regulatory risk facing banks and fintechs. Often a fintech will acquire a program’s loan or an interest in a program’s loan after the bank has granted the loan. A regulator or plaintiff may claim that the fintech is the true lender, not the bank, and that the fintech is therefore engaging in unlicensed lending or charging unacceptable interest rates or fees. One of the best defenses against these claims is that a bank has a continuing financial interest in the loans. Therefore, fintechs and banks should work together to structure their programs to ensure that the bank retains an interest, for example through the retention of a horizontal portion of receivables, subsequent loan fees or monthly account fees. There are many other structures as well. A true lender analysis can be complicated and should be tailored to the specific program.

Problem no. 2: The bank’s control over the program

A bank’s control over a program is another important factor in establishing the bank as the “true lender.” And from the bank’s perspective, control is also an understandable and important risk reducer more generally, especially in the face of significant changes in the law, regulatory actions and significant security and soundness concerns. However, from the fintech’s perspective, there must be some reasonable checks and balances on control so that the fintech can implement the program as expected and the program will have persistence. For example, where a bank has discretion to change any aspect of a program or to decline to finance a loan to an eligible applicant, the bank may act (or refuse to act) in a manner that effectively constitutes a right of termination or may otherwise be unfavorable to the fintech’s or the program’s interests. In drafting the Program Agreement, the parties should consider appropriate standards of conduct for each party’s decision-making processes (eg, reasonableness and good faith, cooperation and acting in the best interests of the Program). Timelines and effort standards can also be effective. A fintech should also consider insisting that a bank finance a loan where the applicant satisfies the applicable guarantee guidelines (which are controlled by the bank). This type of measure can improve the predictability and reliability of a program for both parties.

Problem #3: Exclusivity

A bank will often seek exclusivity for a fintech’s lending products (and sometimes additional products), especially if it is taking on risk as an early adopter of the fintech’s program. Although a fintech may begin with only a narrow product line, as the fintech grows and expands into new lines, broad banking exclusivity rights can become problematic. A fintech should consider whether exclusivity should be limited to products that are substantially similar to the product offered in the lending program (eg for a credit card program, which offers exclusivity for other credit card products but not mortgage products). In the same way, a bank should assess which products and services will complement its existing business lines and future plans. Where the parties agree on a certain level of exclusivity, the parties should also discuss common deviations. Common omissions in lending partnerships include those that allow a percentage of the product volume sourced by the fintech to be made by another lender, reserve arrangements where loans the bank does not make (e.g. those that do not meet the bank’s guarantee guidelines or during a suspension period) are made by a other lender, situations where the fintech itself acts as a lender, and others. These types of deviations are particularly useful ways for a fintech to reduce counterparty risk. A bank can suspend or terminate a program not only when a fintech fails, but also when the bank adopts a new business strategy or enters conservatorship or receivership, among other scenarios. These withdrawals can help the fintech pivot to another established, operational lender rather than being left out of business while searching for and negotiating a new fintech-bank partnership.

Problem #4: Expenses

A bank’s template program agreement will often make the fintech responsible for all of the bank’s own program expenses. From the bank’s perspective, fintech is often best positioned to manage and reduce program spend. However, these broad, open-ended requirements can be burdensome and unpredictable. The parties should consider specifying which expenses the fintech will be responsible for and include caps where appropriate (e.g. the bank’s reasonable legal fees in connection with a program change requested by the fintech, up to a specified amount).

Problem #5: Customer Relations

It is important for the parties to recognize that in many programs a given customer will have a relationship with both the fintech and the bank. For example, the fintech purchase establishes such a relationship, and by giving a loan to the customer, the bank also establishes such a relationship. Where the fintech has acquired the customer or established the first customer relationship, the fintech may intend to expand this relationship by offering the customer additional products and services beyond those available through the bank’s lending programme. These additional products and services may compete with other products and services offered by the bank. Accordingly, a fintech may wish to limit the bank’s ability to solicit additional business from customers that the fintech has brought in and introduced to the bank. Naturally, a bank may have strong views on this issue.

Issue #6: Intellectual Property and Data

Typically, a fintech will contribute its own branding, platform, technology or other intellectual property valuable to the lending program. Likewise, a bank can make similar contributions. The parties expect to continue to own the intangible property they respectively developed and contributed to the program. Ownership and use of customer data or other data generated by a program are often more heavily negotiated points because customers may have customer relationships with both the fintech and the bank (as mentioned above). The fact that customer data may constitute data from one party does not preclude the same data from being data from the other party. The parties should focus on the use of customer data more than on the ownership. For example, in some cases it may be that a license to use the data is sufficient.

Issue #7: Suspension, Termination and Transfer Rights

A bank’s template program agreement often has easy suspension or termination triggers, making it easy for the bank to suspend or terminate a program. From a fintech perspective, it is important to have a banking partner that can be trusted to advance the program, except in truly extenuating circumstances, such as significant changes in the law, action by regulators, and significant safety and soundness concerns. A compromise on other matters may be reached through appropriate processes and procedures, such as notice and remedy periods, cooperation between the parties, or limiting suspension or termination to only the particular jurisdiction where a problem has arisen. These processes and procedures can help the bank ensure that it can recover from dire situations, while helping the fintech to reduce the likelihood of an abrupt end.

In the event that the parties cannot avoid suspension or termination of a program, the program agreement should cover what happens to the applicant’s pipeline and existing customers. Often the most important issue for a fintech is the ability to transfer customers to a successor bank after termination. The program agreement should have well-developed transfer provisions, which require a mutually acceptable written transition plan that includes each party’s responsibilities, transfer procedures, and milestones with target dates.

Issue #8: Indemnification Rights

A bank’s template program agreement may attempt to make the fintech liable for all of the bank’s program losses, regardless of the cause or whether the fintech is at fault (eg, even if the bank acted negligently). Positioning the fintech as a guarantor is not helpful in the true lender analysis, because the “true lender” should retain the level of risk expected of a lender. Parties should endeavor to limit their indemnification obligations to third party claims resulting from breaches of the party’s representations, warranties or covenants within the four corners of the Program Agreement.

Next step

We find that fintechs and banks streamline negotiations and achieve better results when they reach consensus on these eight questions before drafting and restructuring the program agreement. It is important to either memorialize these issues along with important business terms in a term or more informally reach a business agreement on them before moving on to the program agreement.