Banks create guide for managing fintech due diligence
As an increasing number of financial institutions are partnering with fintechs and other providers, a consortium of financial institutions is making efforts to standardize how banks approach third-party due diligence.
The initiative began after Alloy Labs Alliance member banks noticed that firms were implementing regulatory guidance in slightly different ways, said Alloy Labs CEO Jason Henrichs.
As a result, the Alloy Labs Alliance and a dozen of the consortium’s member banks have spent the past year working on a framework they hope will help serve as a guide for firms navigating the complexities of bank-fintech relationships.
Henrichs, who shared a summary of the guidance with Banking Dive, said the framework is not meant to replace existing regulatory guidance, but rather help banks better implement it.
“The challenge is usually to translate guidance into the practical: ‘What do I do on a day-to-day basis?'” he said. “Therefore, banks, starting from the same guidance, can end up in very different places in how they implement it. Think of this as an implementation guide that builds on regulation and guidance.”
Alloy Labs and several member banks created the guide after hosting regular, monthly work sessions with business, operations, risk and compliance leaders from about a dozen institutions.
Participants were divided into eight groups, covering categories ranging from business continuity, incident reporting, operational resilience and subcontractor assessment, Alloy Labs said.
Bankers shared knowledge and discussed best practices in sessions facilitated by public accounting, consulting and technology firm Crowe.
The groups developed a list of seven key questions banks need to address so they can assess the level of risk in a particular third party relationship.
Questions include: “How does this partner complement or enhance our strategy and align with our culture?”; “What type of customer interaction or data exposure does this partner have?” and “What monitoring and reporting is necessary for ongoing evaluation of the relationship?”
The questions were used to develop a consensus about the expected maturity level of a fintech partner, Alloy Labs said.
Based on an assessed level of maturity, the groups established due diligence expectations, requests, ongoing monitoring and triggering events for improved due diligence, which the consortium plans to publish in subsequent guides through 2023.
“This is a bank-driven initiative,” Henrichs said. “Why are we doing this now? Because the banks asked us to.”
As bank-fintech partnerships become more prevalent in the industry, the tie-ups have attracted increased regulatory attention.
Michael Hsu, acting head of the Office of the Comptroller of the Currency (OCC), called out bank-fintech partnerships in September, saying such bonds could put the financial system at risk of a crisis if not properly monitored.
The increased focus means that banks need to ensure that their deals with fintechs are thoroughly reviewed – not only to the satisfaction of regulators, but also to remain competitive.
Fintechs in the embedded banking market may become more selective as regulators increase oversight, Jonah Crane, a partner at financial advisory and investment firm Klaros Group, told Banking Dive last month.
“They may prioritize resilience and stability and a bank that is committed to getting the compliance part right over speed, whereas speed to market used to be a big factor for fintechs looking for banking partners,” Crane said.
Helping banks—primarily community and mid-sized institutions—remain competitive is a key mission of Alloy Labs.
Since its launch in 2018, the consortium has sought to leverage collaboration and the collective knowledge of its member institutions to help them compete with some of the nation’s largest banks.
In October, the group published a guide focusing on defining the roles and responsibilities in bank-as-a-service (BaaS) partnerships. The consortium’s members account for approximately 30% of the market share of banks offering BaaS, according to American Banker.
Alloy Labs also launched its own peer-to-peer (P2P) payment network, CHUCK, last year. It manages the platform in collaboration with the digital payment company Payrailz.
CHUCK has been touted as a competitor to Zelle, the network owned and operated by Early Warning Services (EWS) — a firm that is in turn owned by a group of the nation’s largest banks, including JPMorgan Chase, Wells Fargo and Bank of America.
“Ironically, the biggest banks have done a better job of working together,” said Henrichs, who noted the creation of The Clearing House and Zelle as examples of successful multi-bank collaborations initiated by the nation’s largest institutions.
But community banks are going through a mindset shift, Henrichs added, and efforts like the initiative to standardize best practices for third-party due diligence show how smaller firms “are not out of the game when it comes to innovation.”
“They’re reinventing what it means to be that community bank,” he said. “Third-party due diligence may seem mundane, but it’s a very important step, because if they don’t fix things like this, they won’t be able to do more interesting and innovative things.”
