How Community Banks can help with FinTech Due Diligence

Since the last couple of weeks, bank regulatory bodies have released tons of publications applicable to Community Bank FinTech partnerships. This can be called a newly proposed guidance, a FinTech due diligence guide, and a Federal Reserve white paper on types of FinTech partnerships:

The growth of FinTechs is a major concern for Federal bodies and regulatory bodies. With the release of recent publications, the efforts made by regulatory cross agencies continue to ensure growth throughout the evolving space. To boost that growth, the FinTech due diligence guide was made.

FinTechs need to be careful moving forward and build sustainable mutually beneficial partnerships between banks and FinTechs. So what does the FinTech due diligence checklist have in place?

A Pathway Towards Innovation

The last 10 years have been an incredible time to build a FinTech company as global equity investments in FinTechs have reached more than a trillion dollars with a 45% annual growth rate. The FinTech industry is becoming a threat for banks as they offer better services when it comes to online banking services. When it comes to community banks, FinTechs are even a bigger challenge as they don’t have the scale to access the expertise of a large institution. 

Additionally, this is the best time for community banks to choose innovation over anything else. Community banks can provide their relationship experience and knowledge of compliance in partnership with FinTechs that are building innovative financial solutions that are focused on fulfilling customer needs. This is the core aim of the FinTech due diligence guide. 

The US Paycheck Protection Program (PPP) increased the possibilities of community bank-FinTech relationships as FinTechs helped in enhancing the PPP loan application portals and also became a source of distribution. After all their help in enhancing the banking sector during the pandemic, it’s clear that by building relationships with FinTechs, banks can take their services to the next level. Regulatory bodies have shown more interest in the role that innovation can play in the financial sector and this led to them addressing the FinTechs. There have been several regulatory bodies sponsored events to facilitate better community bank-FinTech relationships. 

The new proposed guidelines were released in July 2021, and the complementary guidelines released in August 2021 by regulators stated that FinTech partnerships are becoming vital in the growth of the financial industry. The proposed FinTech due diligence checklist acknowledges the importance of innovative partnerships for financial institutions.

With increasing relationships, the due diligence process should also be built around the relationships keeping in mind that FinTechs don’t have the compliance experience or infrastructure of a mature bank. The Federal Reserve even acknowledges that keeping up with due diligence is a huge burden for smaller banks, that’s why the “Due Diligence Guide” was built to reduce the burden by offering some tips and tricks.

What Should Sponsor Banks Do for FinTech Due Diligence?

Based on the new proposal guide, there are four main suggestions for sponsor banks to keep up with required FinTech due diligence:

1. Review the Current Due Diligence Process Against Suggested Process

The first and foremost step is to conduct a high-level assessment of the current due diligence process against all the suggested areas in the proposed guidelines. Regulators don’t want the process to be exactly as they suggest, but comparing your current due diligence process against their suggested key areas can help enhance the process in the future. 

This is also a great opportunity for businesses to review their contracts as the due diligence guide offers suggestions and examples of ideal contracts between sponsor banks and FinTechs. These contractual guidelines will help in mapping out the bank’s oversight and FinTech’s responsibilities.

2. Build a Due Diligence Process based on the Maturity of FinTechs

The second step for better FinTech due diligence as proposed by the guidelines is to tailor build the due diligence process based on the FinTech you’re partnering with. Sponsor banks should review their process for FinTechs that have several levels of maturity. 

Let’s say a FinTech company is taking its baby steps, its projected financials won’t have as much weight, and it won’t have a perfect management team and a stable source of funding. Understanding these things as a sponsor bank can help build better and secure bank-FinTech relationships.

3. Your FinTech Partnerships Should Act Like a Portfolio

The FinTech due diligence process is the best way to understand how a FinTech can help in making your relationship portfolio stronger. Similar to a portfolio manager that assesses the correlation and concentrations on their investments, sponsor banks also have to evaluate whether their FinTech partnerships are focused on specific customer segments or specific industries. 

For community banks that are always full of deposits, having a better understanding of balance sheets and regulatory ratio impacts can become an essential part of the due diligence process.

4. Learning When to Say No

Both the guidance and the Federal white paper revolved around a key factor “aligning the sponsor bank’s diligence and decision-making on partnerships.” In the Federal White Paper, there’s an example where a bank refused to partner with a FinTech solely based on how they handled customer data.

Each bank needs to have core principles and regulations regarding the type of FinTechs they’re open to partnering with. These principles can be based on product type, industry type, maturity, and level of sophistication. Sponsor banks should also be ready to present their concerns to regulators about why they turned down a deal due to certain findings or simply due to misalignment of business goals.