Nonbanks, Systemic Risks Highlight Need for ‘Know Your Business’ Due Diligence

For banks, forging partnerships with nonbanks and FinTechs has been a key way to capitalize on growth opportunities in private credit.

But the increasing connectedness between traditional financial players and these new partners underscores the need for additional due diligence, and for tech-enabled, robust “know your business” (KYB) protocols.

Generally speaking, KYB entails the verification of a business partner’s legitimacy, an ascertaining of its own business practices — touching on everything from risk management to info on company officers … all the way down to those partners’ own vendor relationships.

Updated Guidance, Oversight and Frameworks

Late last year, the Financial Stability Oversight Council issued updated guidance that calls for a new framework that would assess vulnerabilities and “transmission channels,” and notes that the Dodd-Frank Act “authorizes the Council to determine that a nonbank financial company will be subject to supervision by the Federal Reserve and prudential standards and lists the considerations that the Council must take into account in making such a determination.” That oversight would come if, the FSOC noted, it’s assessed that “material financial distress at the nonbank financial company could pose a threat to U.S. financial stability.”

On Thursday (June 20), the Federal Reserve Bank of New York said via its blog that nonbanks — funds, private credit vehicles, mortgage servicing companies among them — may be spurring growth, particularly at banks that are providing liquidity and partnerships (and provide assets to the banks’ balance sheets). But the “asset and liability dependencies” between the banks and the nonbanks may also pose systemic risk, per the Fed. That’s especially true in the event of “spillovers” where in the event of an economic shock, nonbanks are forces to sell assets (including even bank loans), which would create losses on bank portfolios.

“Since [nonbanks] operate under a less restrictive regulatory regime and monitoring standards, they may have incentives to originate even more risk than banks, which in turn may imply a higher likelihood of stress events and/or potentially even more severe amplification of systemic risks,” the Thursday report observed.

Among the nonbank firms are P2P lenders and other alternative sources of credit, and the fact that these firms offer bank-like services means that as they (and the banks) onboard new customers, KYB technologies and platforms ensure compliance while meeting fluid regulatory requirements. If the risks at these nonbank companies (in terms of their own customer exposures, fraud exposures, etc.) are shored up a bit, the upstream and downstream effects of transparency and better understanding of vulnerabilities throughout the financial ecosystem are magnified.

In recent examples of new product introductions and platforms, risk management platform provider Coris raised $3.7 million in its first funding round. The company has also introduced two new products — a fraud model and a KYB offering — that it will offer alongside its centralized risk management platform, designed to help prevent business impersonation fraud.

Elsewhere, earlier this year,  AU10TIX announced its KYB solution, in combination with know your customer (KYC) processes that identify businesses and documentation.