Federal Reserve Paper on Fintech Partnerships

Earlier this month, the Board of Governors of the Federal Reserve System (Federal Reserve) issued a paper on Community Bank Access to Innovation through Partnerships. In the paper’s preface, the Federal Reserve noted that partnerships between community banks, defined in the paper as “[banks] with less than $10 billion in assets[,]” and third parties providing financial technology solutions (fintechs) can help community banks provide better service to their customers by enabling community banks’ use of technological innovations that community banks could not develop by themselves. The paper looked at different things that community banks might want to consider if they were looking to partner with fintechs to use technology to provide innovations to their customers.

The Federal Reserve was quite clear in stating that nothing in the paper changed anything with respect to its expectations about third-party risk management. For more information about the banking agencies approach to third-party risk management, please see this recent NAFCU Compliance Blog post about the Proposed Interagency Guidance on Third-Party Risk Management. The paper resulted from the Federal Reserve’s outreach to different participants, including community banks, fintechs, and others.

The paper was organized into two different parts. The first part addressed the three types of community bank-fintech relationships that were observed and the pros and cons of each type. The three observed relationships include the following:

Relationships in which the fintech provides a technology solution that improves a community bank’s operational productivity and that “enhance a bank’s processes, monitoring capabilities, or technical infrastructure.”
Relationships in which fintech technology used by the bank improves the customer experience.
Relationships in which fintechs provide products and services directly to the customer.

There are two tables below. The first provides examples identified in the paper of the three different types of bank-fintech partnerships. The second summarizes the benefits and potential issues of each type of partnership addressed in the paper.

Examples of Different Partnerships

Operational	Customer-focused	Direct interaction between fintech and customer
Loan origination automation Technology that improves a bank’s fraud detection capabilities Software that increases the bank’s efficiency	Online account opening technology Peer-to-peer transfers Remote deposit capture technology Customer identification program technology for authentication and verification	“Relationships where a fintech interacts directly with the customer in providing banking products and services”

Benefits and Issues of the Different Partnerships

	Operational	Customer-focused	Direct interaction between fintech and customer
Benefits	Increased efficiency and cost savings permitting “reallocation of resources to other bank functions” Possibility of acquiring new customers because operational efficiencies permit banks to provide additional products	Delivering products and services your customers want	Possibility of acquiring new customers who may not have become customers of the bank through the bank’s existing products Symbiotic relationship between banks and fintechs in which banks improve their technological capabilities and fintechs get more customers
Issues/risks	Understanding how the technology works and considering how the use of the technology may impact other operations Banks may need to hire additional employees that have adequate expertise to use the technology or provide additional training to existing employees	Reputation risk may arise if banks provide this technology without fully vetting whether it is on par with the bank’s expectations related to customer service Ensuring that these technological solutions have the capability of providing required disclosures The use of multiple fintechs to provide this technology can lead to a disjointed customer experience if it is not easy to navigate from one area to another	Third-party risk management risks and ensuring that the fintech complies with all applicable regulations Reputation risk may arise through the fintech’s direct contact with customers Risks that fintech goes out of business and the bank is left responsible for the relationship between the fintech and the customer The need to update infrastructure to partner with the fintech

The second part of the paper examined common factors identified in the Federal Reserve’s outreach that led to effective community bank-fintech relationships. The paper looked at three factors: whether the bank’s culture emphasized innovation; whether the community bank and its fintech partners shared similar priorities and goals; and whether the bank approached the implementation of these fintech solutions in a thoughtful manner. With respect to the first factor, the paper noted the importance of being committed to technological innovation as a long-term goal. This commitment makes it more likely that a bank will continue to invest in technology, personnel, and resources even if there are negligible immediate impacts. The paper suggested that the second factor helped community banks find some level of comfort with their selected fintech partners. The paper explained that the third factor addressed the significance of reducing friction in the customer experience and incorporating technology in a manner that can integrate with the bank’s existing technologies. The paper explored the use of application programming interfaces, which the paper clarifies “enable real-time flow of information between separate entities,” created by staff, third parties, or core providers.

While credit unions may have additional concerns about fintech partnerships, the Federal Reserve paper may be a good place to start for credit unions considering going down this path.

About the Author

David Park, NCCO, Senior Regulatory Compliance Counsel, NAFCU

David joined NAFCU in September 2018. As part of the Regulatory Compliance Team, he provides daily compliance assistance to member credit unions on a variety of topics.

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