FinXTech Intel 2023 report final 2 - Flipbook - Page 28
What Could Go Wrong: Banking as a Service
Fintech partnerships that are customer-facing carry special risk and concerns, and may require subsequent
investments from the bank.
In particular, the model known as banking as a service generates special business risks. BaaS, as it’s commonly known, is an arrangement where the bank provides the back end of a financial relationship for a
nonbank, such as a fintech or brokerage, that intermediates with the retail customer. That customer may be
outside of the community bank’s geography or existing customer demographic.
BaaS partnerships can “increase the risk of unfair or deceptive acts or practices because of the coordination, communication, and disclosure challenges involved in these partnerships, including coordination in
managing the customer relationship,” the OCC wrote in its fall 2022 semiannual risk perspective. The customer may not know what financial institution actually holds their deposits, which can lead to confusion or
worse if the neobank struggles to deliver services or outright fails.
To manage these business risks, banks must have oversight of how their BaaS partner is complying with
the Bank Secrecy Act and other Know Your Customer and anti-money laundering regulations. Banks
should negotiate how the partnership will handle disputes and complaints, and create a plan if the partner
declares bankruptcy and shutters operations.
“Unclear or arbitrary partnership agreements may result in implementation breakdowns, untimely resolution of issues, or failure to deliver products or services as intended, and may result in significant customer
remediation,” the OCC said.
Banks interested in these partnerships, or any other arrangement that adds more layers of complexity to
internal operations or new customers, may choose to cultivate closer relationships with their regulators
in order to keep them appraised of the bank’s actions and seek feedback. The consequences of failing to
manage these risks could be punitive: In 2022 and 2023, two community banks that provide these types
of services received a consent order from their primary regulator or a downgrade in their Community
Reinvestment Act ratings. Those consent orders, coupled with regulatory speeches and guidance letters, are
instructive for any institution interested in doing more work with fintechs.
Pro Tip: Check consent orders against banks that do what you’re interested in doing
before engaging in certain fintech partnerships.
Ultimately, regulators know that community banks need to innovate in order to stay relevant with customers and grow. But they want to remind banks that they can’t outsource the risk and oversight, and it needs
to be appropriate as their risk profiles change.
“The banks that are getting into trouble from a regulatory perspective [are not in trouble] because they
didn’t do good due diligence on their fintech partners,” says Shevlin. “It’s because they took business risks
that didn’t pan out.”
Kiah Lau Haslett is managing editor of Bank Director.
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