It’s no secret that banks and FinTechs are collaborating at a rate faster than ever before. Where once traditional finance companies viewed tech-driven service firms with caution and even a bit of skepticism, the realization more recently has been that joint efforts can reap dividends.
There’s the long-term lure, of course, of increased customer headcount and cross-pollination of new revenue streams.
But the regulatory landscape is becoming more unforgiving in some ways, with data privacy and consumer protection top of mind. The need is there for a comprehensive approach for risk management, which in turn means that both FinTechs and FIs need a strong, consistent strategy and roadmap from the very start of collaborations.
Marrying new tech with old(er) line, traditional services has its challenges, and they must be met even as rewards (the profitable kind) beckon.
Done right, a FI/FinTech whole can be greater than the sum of its parts.
In an interview with PYMNTS, John Epperson and Clayton Mitchell, principals at Crowe LLP, delved into the ways those partnerships can blossom even as contrasting abilities are brought together.
The apparent desire of FinTechs to link with banks — and of course vice versa — comes from a recognition that a sea change is afoot in financial services, the two execs told PYMNTS. Or as Epperson put it, there are tremendous levels of value that exist through several different channels, all of which are tied to different customers in different markets, whether financial services are being offered across, say, mortgages, checking accounts or asset management.
And not all of that value can be tackled, or realized, through the efforts of any one organization, he said.
“There’s a fundamental need for incumbent banks — just like we are seeing in many other industries — to learn how to partner with and engage with third parties to take advantage of the knowledge and the value that exists within the ecosystem today,” Epperson told PYMNTS.
An Evolving Value Proposition
The value proposition changes over time, and there’s a difference between what banks have to do now versus what they may have to do going down the line. So it is no surprise that partnerships are going to have to evolve, too, beyond the piecemeal approach that Epperson said is in place at the moment. Right now the focus is on the nuts and bolts of technology.
“There is a lot of apprehension on both sides as there is new and rapid advancement of technology and everyone is unsure — particularly the incumbent bank who isn’t accustomed to taking leaps and bounds on different risks,” Epperson noted.
Banks look to monitor third party risk of FinTech through any number of risk programs in place and the FinTechs have, themselves, historically been less heavily regulated. The two types of firms have to learn to adapt to, and adopt, one another’s business practices, sharing data and insight along the way.
Beyond software and hardware, beyond the minutiae of processes and systems, the transformation that is taking place is systemic in nature, one that in three to five years, Epperson and Crowe predict, will see banks open up to collaborating with these nimble tech upstarts, exponentially, as large-scale thinking finds firmer footing.
“Banks are going to start to say, ‘I am going to look at partner X for my deposit accounts, and I am going to look at partner Y for an insurance product and another partner for a wealth management product’ … and you will start to see banks become the center of the ecosystem that we are talking about,” said Mitchell. “The banks will be the trusted brand that consumers go to for financial products and they happen to be enabled using partnerships and technologies to drive that one-stop shop. This model is being proven as viable in organizations like Starling Bank in the U.K. and the cornerstones of similar models are starting to become present in North America.”
Thus, risk management must evaluate compatibility not just of tech platforms in place, but must also take a cue from strategic goals.
Speaking from the banks’ point of view, he said, the mindset is that they are dealing with entirely new products, entirely new services and entirely new markets where they might not have all of the answers to all of the questions that are out there.
Both parties need to work collaboratively and be transparent with the data, said the executives. For example, the FinTech that is deploying artificial intelligence (AI) and machine learning needs access to Big Data from the bank. The bank needs to trust that the FinTech that is on the receiving end of the information is able to secure and utilize that Big Data for specific purposes as outlined in the agreement. A bank that uses a FinTech’s proprietary algorithm needs to understand that algorithm and be able to demonstrate to a regulator that they understand how it should work. And, even with the shared day-to-day workload, both FinTechs and banks need to be mindful of the changing regulatory landscape.
“The other piece [of the relationship] that is important there is clearly defining the boundaries in which the parties are able to execute,” Mitchell added, citing the need to “provide flexibility and agility in partnering with a new organization to achieve a business objective, while maintaining the balance between risk and reward, keeping the collective partnership’s risk appetite and tolerance in mind. We can’t stranglehold innovation by putting all sorts of different rules and risk mitigation platforms in place.”
Embracing a Multidisciplinary Approach
Important too, said Mitchell, is a multidisciplinary approach to risk management, where there exist clearly dedicated teams — spanning legal and compliance functions, product development, engineering and more, from both the FinTech and the bank.
“There are other more tactical ways to embed trust,” added Epperson, “whether it's through contractual agreements on defining roles or responsibilities. A lot of organizations will require certain right to audit clauses or assurance provisions within their contracts to allow periodic testing to occur to make sure of things like security and privacy of data.”
The most successful partnerships, said Epperson, hinge on shared values and principles — and even some shared methodologies.
Mitchell noted that in the effort to engender trust, FinTechs are striving to provide transparency to their more traditional partners, and are in effect presenting what he termed “due diligence packages” that accelerate the understanding of risk management practices to help sell their controlled environments and compliance with laws and regulations. Those features can be provided to the bank as a sales enablement tool.
The more successful relationships between banks and FinTechs do not look at compliance efforts simply as a letter of the law responsibility, said Epperson. “They look — both of them — being accountable for the regulatory and the risk environment … when a bank is examined for regulatory purposes, the FinTech partners are in the room with them explaining their relationship,” he said.
The Stages of Risk Management
The stages of third-party risk management, including partnerships, Mitchell and Epperson explained, can be catalogued across identification, assessment, management and control. Each partner poses unique risks, after all.
The stages of risk management, then, across the aforementioned framework, help partnerships reap benefits. Identification means cataloging third-party relationships. The assessment phase demands that standardized procedures be put in place for management and reporting purposes. Management dictates that staffing and technological resources be dedicated in an ongoing manner. The fourth part of the framework, control, is done through clearly-defined audit procedures and independent monitoring.
Asked about measuring costs — and returns on investment — both Epperson and Mitchell said big-picture thinking and a roadmap, with a shared vision, are paramount. Costs can and should be measured not just in terms of expenditures —the dollars and cents tied to tech and headcount and salaries — but in training and ongoing monitoring, where time can be as precious as money.
“I think the more compelling way to look costs,” said Epperson, “is to ask what's the desired strategy and outcome of an organization as it relates to the strategy of a bank ... and how FinTechs or technology play into that overall strategy.”
FinTechs, Epperson told PYMNTS, have been able to transform some of the cultural aspects of banks, helping the latter surmount a fear of failure.
“They're quick to learn, experiment and adapt through very interactive and agile environments,” he said of FinTechs. “And we’ve seen organizations spearhead innovative thinking and transformation within legacy organizations.”