Community Banking Connections

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November 2024

Complex Bank–Fintech Partnerships
by Clay Kitchura, Senior Financial Institution Policy Analyst, Division of Supervision and Regulation, Federal Reserve Board

The community banking sector has seen a great deal of technological change and innovation in recent years. However, while community banks continue to explore and adopt emerging technologies, their mission remains the same: to provide high-quality financial services to the communities they serve.

In recent years, community banks have explored innovative approaches to achieve that mission, often turning to nonbank companies, including financial technology companies, or fintechs, to access new technologies and skill sets. In some cases, they have formed complex partnerships with fintechs;¹ in such partnerships, a fintech provides end customers with access to a bank’s products and services. While the details of these partnerships vary, they commonly facilitate deposit-taking, payments services, and lending activities. This article provides an overview of the Federal Reserve’s supervisory approach to complex bank–fintech partnerships and discusses common risk factors associated with them.

Support for Responsible Innovation

Complex bank–fintech partnerships can enable community banks to leverage newer technology and better compete with larger banks in offering innovative products and services. They may also help banks meet changing consumer demands and expectations and reduce the prices consumers pay for banking services. The Federal Reserve recognizes the importance of these benefits for community banks and the communities they serve. However, it is also important to understand that new practices often involve risk. Harnessing the benefits while ensuring that the risks are appropriately managed is foundational to responsible innovation in the banking sector. Supervision and regulation must balance the risks from overregulation, which can stifle innovation, with those from underregulation, which can lead to harm to households, financial institutions, and the financial system. As part of the Federal Reserve’s support for responsible innovation, it aims to use its perspective as a regulator to engage with and provide helpful resources for the banking sector.

The Federal Reserve’s Novel Activities Supervision Program

In August 2023, the Federal Reserve established the Novel Activities Supervision Program,² with dedicated staff to help strengthen oversight of novel activities at supervised institutions. By bringing together staff focused on novel activities, the Federal Reserve continues to build upon and expand its knowledge of novel activities, to identify associated risks as early as possible, and to assess the ability of banks to appropriately manage those risks.

Complex bank–fintech partnerships are one focus of the Novel Activities Supervision Program. While these partnerships can provide benefits, supervisory experience has identified a range of safety and soundness, compliance, and consumer protection–related concerns with the management of these partnerships. Supervisors are working with banks to assess the benefits and risks of such partnerships as well as the effectiveness of banks’ controls to manage these risks. Information gathered from examination, analysis, and monitoring activities, and from stakeholder engagement, helps to inform policymakers as they work to enhance the Federal Reserve’s regulatory and supervisory frameworks to support responsible innovation.

Recent Policy Developments

In July 2024, the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (collectively, “the agencies”) published two documents to share their understanding of the issues associated with complex bank–fintech partnerships with the public and to continue building on that understanding by inviting public comment.

• Supervision and Regulation (SR) letter 24-5, “Joint Statement on Banks’ Arrangements with Third Parties to Deliver Bank Deposit Products and Services,”³ is an interagency statement that identifies risks present in arrangements with third parties to deliver bank deposit products and services, offers examples of practices to manage those risks, and reminds banks of existing requirements and supervisory expectations. The statement includes an extensive list of resources, including rules and guidance, that are relevant to these arrangements.
• The Request for Information (RFI) on Bank–Fintech Arrangements Involving Banking Products and Services Distributed to Consumers and Businesses⁴ solicited information from the public on complex bank–fintech partnerships that involve deposit, payments, and lending products and services. The RFI shared the agencies’ understanding of these arrangements, including their benefits and risks. Moreover, the RFI provided the agencies with an opportunity to hear from the public on various aspects of these arrangements.

Risk Factors Associated with Complex Bank–Fintech Partnerships

As the agencies explain in the RFI, complex bank–fintech partnerships can pose risks to banks and consumers in new ways, from new places, or with more severity. These novel manifestations of risk can be challenging for some compliance and risk management frameworks that are calibrated to more traditional risk patterns.

While risk is inherent in the business of banking, supervisors expect banks to be adequately prepared to identify, measure, and manage the risks they face. Community bankers engaging in complex bank–fintech partnerships will want to consider how their governance and risk management frameworks are fit for new risk patterns. The following are some commonly observed risk management challenges:⁵

• Accountability: Banks and fintechs may divide contractual accountability for aspects of the customer relationship between them. However, the bank remains responsible for compliance with all applicable laws, and this contractual division of labor can complicate a bank’s ability to monitor and address risk issues when they arise.
• Rapid Growth: Partnerships can lead to rapid growth in deposits or payments volume. Banks may have trouble scaling their risk management capabilities fast enough to keep pace with the growth in the volume and complexity of their operations, which can increase the chance of risk management failures, including regulatory violations.
• Funding Concentrations: Partnerships can result in significant concentrations that challenge a bank’s ability to manage liquidity risks, particularly if funding is deployed in illiquid or long-term assets or if a large partnership suddenly ends.
• Customer Confusion: When a fintech is an intermediary between a bank and its customers, the customers may not know that the fintech they are interacting with is not itself a bank, particularly when the fintech refers to FDIC insurance in its marketing. Customers may not understand that deposit insurance does not protect against the fintech’s failure.
• Data Use and Ownership: The division of roles between a bank and a fintech can create issues around data ownership, particularly in regard to the bank managing its operations and meeting compliance obligations. Therefore, it is important for the bank to have access to its data held at the fintech. If the bank cannot access its data, the bank faces multiple challenges, including challenges related to customer account recordkeeping and Bank Secrecy Act/anti-money laundering compliance.

Conclusion

The comment period for the RFI closed on October 30, 2024. The Federal Reserve and the other federal banking agencies are reviewing the public comments and appreciate the thoughtfulness of these comments and the time taken to make them. The agencies continue to devote considerable effort to building on their understanding of complex bank–fintech partnerships and addressing the related risks to help ensure that community banks can innovate in a safe and sound manner.⁶

• ¹ Partnerships may be structured as a direct relationship between a bank and a customer-facing fintech, or they may involve a separate intermediating entity that connects the bank and the fintech.
• ² Complex bank–fintech partnerships are included within the scope of Supervision and Regulation (SR) letter 23-7, “Creation of Novel Activities Supervision Program,” available at www.federalreserve.gov/supervisionreg/srletters/SR2307.htm, and the Novel Activities Supervision Program.
• ³ SR letter 24-5 is available at www.federalreserve.gov/supervisionreg/srletters/SR2405.htm.
• ⁴ The RFI is available at www.federalregister.gov/documents/2024/07/31/2024-16838/request-for-information-on-bank-fintech-arrangements-involving-banking-products-and-services.
• ⁵ This is not an exhaustive list of the risks associated with complex bank–fintech partnerships. Banks should consider the individual facts and circumstances of each partnership and conduct a comprehensive risk assessment to identify the relevant risks.
• ⁶ Additional resources for community banks’ arrangements with third parties include SR letter 24-2/Consumer Affairs letter 24-1, “Third-Party Risk Management: A Guide for Community Banks,” available at www.federalreserve.gov/supervisionreg/srletters/SR2402.htm; Conducting Due Diligence on Financial Technology Companies: A Guide for Community Banks, available at www.federalreserve.gov/publications/conducting-due-diligence-on-financial-technology-firms.htm; and Community Bank Access to Innovation Through Partnerships, available at www.federalreserve.gov/publications/community-bank-access-to-innovation-through-partnerships.htm.