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The U.S. Federal Reserve Board has published a paper with a view to helping community banks form compliant partnerships with fintech companies.
The paper, entitled "Community Bank Access to Innovation through Partnerships", discusses broad types of partnership and the benefits, risks and challenges associated with them. It also considers ways of making partnerships effective.
Building on discussions that the Fed held with community banks, fintechs and industry stakeholders, the paper says that community banks still face challenges when they consider setting up partnerships with fintechs.
For example, an inexperienced partner may understand a community bank's needs but may not understand its regulatory obligations and may not have developed full operational or compliance regimes.
“Gaps in the ability to demonstrate or guarantee compliance can introduce risk that a community bank will need to fully understand and ultimately to manage,” Federal Reserve governor Michelle Bowman said in a speech at a meeting of the American Bankers Association’s (ABA) Government Relations Council.
According to Bowman, two important themes stood out in the paper.
“The first is establishing trust and aligning with fintech partners and second, building a long-term culture committed to innovation.”
Due diligence efforts can reveal that potential fintech partners do not share banks' values or objectives, for instance, when it comes to processing or selling customers’ information, Bowman said.
On the other hand, community banks should have a long-term, strategic commitment to innovation. It requires support from both senior managers and the staff responsible for implementation, focusing always on what the new technology is trying to solve.
“Bankers who have forged successful partnerships don't innovate for the sake of being innovative but instead have a clear vision of their goals,” Bowman noted.
Depending on their strategic needs, community banks’ partnerships with fintechs typically fit into one of three broad categories.
They can be operational technology partnerships, wherein a community bank deploys third-party technology to its own infrastructure to improve efficiency and effectiveness; or customer-oriented partnerships, wherein a fintech enhances the customer-facing aspects of the bank’s business but the bank continues to interact directly with its customers; or they can be front-end fintech partnerships, wherein a bank combines its infrastructure with the third party’s technology and the fintech interacts directly with the end-customer to distribute banking products and perform services.
“With appropriate risk management and compliance guardrails, fintech partnerships present a notable opportunity for community banks to strengthen existing operations, particularly when the partnership serves the unique strategic objectives of both parties,” the paper concludes.
The Fed, aiming to support effective partnerships in a responsible manner, issued the paper as a resource for community banks to use. It does not establish new rules; it merely interprets existing guidelines that pertain to third-party risk.
Last month, the Fed, the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) published an interagency “vendor due diligence guide” to help community banks assess risks when considering new partnerships with fintechs.
That guide came in response to the findings of the Conference of State Bank Supervisors’ National Survey of Community Banks of 2020, which stated that human resource and financial burdens related to due diligence were hindering the establishment of new partnerships between community bankers and fintechs.
In July, the Federal Reserve, the OCC, and the FDIC proposed some new guidelines to help banks deal with the risks that they run when forming relationships with third parties, including fintechs.
According to Bowman, that guidance should reduce unnecessary burdens by eliminating variations between supervisory views.
Meanwhile, the Fed is assessing submissions that it has received in response to a request for information that it issued in March concerning financial institutions' use of artificial intelligence.
“Comment letters confirmed our understanding that at times community banks choose to engage with fintech partners and their models to tap into the benefits of AI,” Bowman added.
According to an ABA release, Bowman said that the Fed would issue a discussion paper in the coming weeks with regard to a central bank digital currency (CBDC).
“When I’m looking at CBDC issues, what I’m looking to understand is: what’s the business case?” Bowman said.
The Fed has not yet decided whether or not to develop a CBDC and is instead debating “whether and how a CBDC could improve on an already safe, effective, dynamic and efficient U.S. domestic payments system,” she added.
