Section 1.1: Partnership Models Recap

Not every financial institution wishes to navigate the complexities of integrating an unfamiliar fintech program into their core operations. Similarly, not all fintechs are eager to assume the responsibilities associated with comprehensive banking programs.

For these banks and fintechs, a referral partnership model is often more appealing. In this arrangement, fintechs direct clients interested in opening accounts to banks through the bank's mobile app or website. The bank retains ownership of customer communication and relationships, compensating the fintech with a one-time referral fee. This structure allows banks to generate recurring revenue from deposits and user transactions.

Here are some pros and cons of this model:

Financial Institutions

Pros:

• Expanded customer base and increased deposits
• Ownership of customer relationships
• Reduced need for auditing third-party fintechs

Cons:

• Limited control over the quality of referred users
• Challenges in maintaining long-term customer relationships
• Risk of fintechs shifting partnerships to other banks

Fintechs

Pros:

• Minimal responsibility for compliance and program management
• Revenue generation without fixed costs for user referrals

Cons:

• Flat revenue potential
• Banks may not onboard all referred users
• Customers may feel uneasy about direct interactions with banks

For those banks and fintechs committed to a more integrated approach, embedded partnership programs have emerged through Banking-as-a-Service (BaaS) frameworks. Licensed financial institutions collaborate with companies that provide digital banking services directly to end users via APIs (Application Programming Interfaces). In this model, there is no direct communication from the bank to the end user.

An early iteration of BaaS was exemplified by neobanks like Simple, which operated in the U.S. from 2012 to 2020 through Bancorp Bank. Initially, partnerships were more exclusive, with banks typically engaging with only one fintech. Today, many banks accommodate multiple fintech collaborations.

The stakes in these partnerships are higher, presenting an opportunity for revenue growth and scalability that benefits both parties. Financial institutions can accelerate the growth of their deposits, while fintechs can boost their revenue share through interchange fees from card spending and rebates tied to user deposit balances.

Financial Institutions

Pros:

• Rapid scaling of customer base and deposits
• Enhanced user retention and activity levels

Cons:

• Limited oversight over the types of customers onboarded
• Increased compliance monitoring responsibilities

Fintechs

Pros:

• Greater monetization per user
• Enhanced control over user relationships and experiences

Cons:

• Higher costs associated with compliance and bank relations management
• Lengthy and unpredictable approval processes from banks can delay launches

With embedded partnerships, there's an intensified focus on compliance and controls. Since banks have limited interaction with users, fintechs must ensure proper onboarding and ongoing monitoring of transactions. If banks lose confidence in a program, they can terminate partnerships, resulting in user account closures.

In Q4 of last year, U.S. regulators began enforcing stricter standards for fintech partnerships, marking a significant shift in oversight.

The first video titled "Why Fintech and Bank Partnerships Are Becoming Increasingly Common" explores the growing trend of collaboration between fintechs and banks, highlighting the benefits and challenges of these partnerships.

Section 1.2: Regulatory Challenges in the U.S.

The anticipated regulatory changes impacting financial institutions have arrived. Executives from established banks have voiced concerns over the potential for fintech partnerships to sidestep compliance standards and regulatory guidelines.

A significant announcement from the OCC (Office of the Comptroller of Currency) last September mandated that Blue Ridge Bank enhance its anti-money laundering practices, suspicious activity reporting, and IT controls due to unsafe practices linked to third-party fintech partnerships.

The OCC's directives included:

• Blue Ridge Bank must secure OCC approval before engaging in new contracts with fintechs or adding products with existing partners.
• New guidelines for assessing risks associated with third-party fintech partnerships are due in 60 days.
• A comprehensive BSA (Bank Secrecy Act) risk assessment must be completed within 90 days.

The prevailing sentiment is one of increased vigilance against risks associated with fintech partnerships, a previously overlooked issue. Industry veterans anticipate a slowdown in partnerships, with a clear message to "proceed with caution."

For experienced banks and fintechs, this announcement is seen as a positive development. The lack of regulatory clarity had previously hindered the long-term growth and scalability of partnership programs.

Platforms have been operating with caution, interpreting regulations from multiple agencies, including the OCC, SEC, and IRS. The focus is now shifting toward compliance adherence and robust risk management.

For newcomers to the fintech space, the takeaway is simple: adopt a risk mitigation mindset from the outset. Many startups tend to address compliance late in the product development process or rely on partner banks and BaaS providers for compliance coverage, which is no longer a viable strategy.