Fintech
Banking regulators issue further warnings on fintech partnerships
WASHINGTON – JANUARY 22: The Federal Reserve Building in Washington, DC on January 22, 2008. … [+] The Fed cut its benchmark interest rate by three-quarters of a percentage point after two days of turmoil in international markets due to fears of a U.S. recession. (Photo by Chip Somodevilla/Getty Images)
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In a memorandum Released yesterday, the Office of the Comptroller of the Currency (OCC), the Federal Reserve, and the Federal Deposit Insurance Corporation (FDIC) expressed growing concerns about the relationships between traditional banks and financial technology (FinTech) companies.
This statement underlines the intention of regulators to closely monitor the increasing integration of technology into banking services, which has represented both a benefit and a potential risk to financial stability.
It also comes in the wake of multiple enforcement actions against banks in recent months, including Evolve Bank and Trust AND Wire Bankwhich are two of the largest banks supporting FinTech companies.
Growing scrutiny of FinTech and banking partnerships
According to the statement, federal banking regulators have been watching the landscape of bank-fintech collaborations in recent years. These partnerships have allowed banks to leverage advanced technology to offer innovative products and services, improving customer experiences and expanding market reach. However, this integration has not been without challenges.
Regulators’ primary concerns revolve around the operational and compliance risks these partnerships pose. The Federal Reserve report notes that while fintech partnerships can provide significant benefits, such as increased efficiency and access to new markets, they also introduce complexities that can strain a bank’s risk management frameworks.
Key Risks Banks Face With FinTech Partners
The memo highlighted several areas where banks have failed when it comes to FinTech partnerships, and this was clearly seen with the Synapse collapse which left thousands of Americans without access to their funds for months.
Operational complexity and responsibility: Integrating fintech solutions into banking operations can lead to high levels of operational complexity. This complexity arises from the need to reconcile different systems and processes between banks and fintech companies. Additionally, there is concern about the clear allocation of responsibilities, especially when consumer-facing services are managed by fintech companies rather than the banks themselves.
Compliance and consumer protection: Ensuring compliance with federal regulations, including those related to consumer protection and anti-money laundering (AML), is a significant challenge. The report notes that fintech companies often control customer interactions, which can complicate banks’ ability to effectively oversee compliance. This raises potential risks of non-compliance with regulatory requirements, resulting in potential legal repercussions for the banks involved.
Rapid growth and risk management: Many banks have experienced rapid growth through these fintech partnerships, especially smaller community banks. While growth can be beneficial, it can also pose risks if banks’ compliance and risk management systems do not adapt accordingly. The influx of new customers and transaction volumes can overwhelm existing systems, leading to potential declines in service quality and regulatory compliance.
Misrepresentation of Deposit Insurance Coverage: Many FinTechs are partnering with banks to offer FDIC pass-through deposit insurance coverage. This type of coverage has been widely advertised to consumers, who believe that their money is safely insured with these companies. However, the insurance coverage may not be valid, as we are currently seeing with Synapse. Regulators have repeatedly emphasized that banking partners must ensure the accuracy of any coverage advertisements, as well as ensure that steps are in place to maintain the coverage.
Future orientation
The OCC, the Federal Reserve, and the FDIC are seeking public comment on various aspects of the bank-fintech arrangements. Their goal is to gather information on effective risk management practices and the potential need for enhanced supervisory guidance.
In a separate statement Governor Bowman summarized the key issue: “We have seen that these relationships can present significant risks to banks and their customers, including retail deposit customers who reasonably expect that their deposits are insured and that their banking service provider complies with all applicable laws, including consumer protection laws.”
It is clear that the government is taking steps to address these issues, but it is also a sign that FinTech companies will face increasing pressure in the coming months. It could also be an existential threat to non-bank FinTechs, which will be forced to become banks, integrate into existing banks, or cease to exist.