Unless the new administration squashes it, soon banks and fintechs will need to work with the FDIC's so-called
"The majority of responsible, embedded finance and innovative banks are doing that today, or they're in the process of making sure that they're able to do that," said Phil Goldfeder, chief executive officer of the American Fintech Council. "The fundamental responsibility of the bank partnering with a fintech company is reconciliation and ensuring that they know what money is coming and going. In bank-fintech partnerships, the buck stops with the regulated entity."
For some smaller banks, this will be a tall order, said Konrad Alt, co-founder of Klaros Group.
"But it's not unreasonable for regulators to expect this," Alt said. "If you put your money in your bank, you want to be absolutely sure that your bank always knows where it is. That's part of the deal when you give your money to a bank."
This requirement is one of several challenges banks will need to cope with in the new year, as the ongoing dispute between
The need for daily reconciliation
Banks' core systems track most transactions that happen throughout the institution — in mobile and online banking, branches, ATMs and more — on a daily basis. Most U.S. banks use core systems from FIS, Fiserv and Jack Henry. (The three companies did not respond immediately to requests for interviews.)
To synchronize these systems with fintech partners' daily transaction ledgers, a small cottage industry has emerged: companies that offer technology that can sit on top of a bank's current core platform to track transactions to and from fintech partners. Treasury Prime, Unit and the now-bankrupt Synapse are all in this category.
Treasury Prime says it has been doing daily reconciliation between banks and fintechs for seven years. It connects directly with banks' core systems and has active integrations with FIS, Fiserv, Jack Henry and COCC cores, according to Jeff Nowicki, chief banking officer. These integrations allow for real balancing between the end user accounts and "for benefit of" accounts with backing deposits, he said.
The company also maintains a separate FBO account for each fintech, rather than commingling accounts as Synapse did. It provides a bank console with views at the individual end-user level and at aggregate program levels, updated several times a day, Nowicki said.
Some people (mostly vendors of blockchain technology) think distributed ledgers would be a good answer to the reconciliation issue. Over the years, banks have made many attempts to share distributed ledgers (colloquially known as blockchains). But most have fallen apart over issues of control and not wanting to share data with competitors.
Future of banking as a service
One question about the future of banking as a service is whether or not the current regulatory crackdown will continue.
"I can't think of a time when a particular corner of the banking system has been so thoroughly papered with enforcement actions," Alt said. "It's unusual by historical standards, and it's obviously had a huge impact on these banks and a pretty big impact on their fintech partners."
Some bankers and fintechs are hopeful this will change under the new administration, which is likely to be more friendly to nontraditional financial businesses, like fintechs and their partner banks. But Alt, who was formerly the second-ranking executive at the Office of the Comptroller of the Currency, pointed out that enforcement actions typically don't start with the leaders of regulatory agencies.
"You don't start out as an agency head saying I want to bring an action against Bank X," said Alt. "What happens is your supervisory staff and legal team work together to develop findings and propose an appropriate order. By the time it works its way up to senior levels of the agency, it's a well-documented case, and unless a staff member has committed a very clear error, which doesn't often happen, intervening to stop a well-documented enforcement action from going forward means taking a ton of political risk."
Alt expects to continue to see a disproportionate level of enforcement activity in banking as a service for at least another couple of years.
"It's clear that the regulators have got a well-founded belief at the staff level that many of the banks in this space don't manage risks very well," Alt said. "That's a bona fide, old-fashioned safety and soundness problem that these agencies are well within bounds to worry about."
Customers of fintechs affected by Synapse's bankruptcy have been waiting since May for money they had in their accounts, and $65 million to $85 million still appears to be missing.
Yet because of the Republican administration coming in, Klaros has been fielding calls from community bankers who are thinking about dusting off plans to get into or expand banking-as-a-service activity.
"If they're asking us for advice, we would say there might well be opportunity there," Alt said. "But unless you're prepared to invest, and you have the capital to invest in building really strong risk management and compliance, it is probably not a great idea. You will end up out over your skis, and you will eventually get into trouble."
Most community banks are not flush with cash, Alt pointed out.
Banks are also becoming more cautious about choosing fintech partners, especially fintechs that are the subject of an enforcement order.
"Why would you take on that additional scrutiny?" Alt said. "Why would you bring in a new fintech partner that's clearly got a regulatory target on its back? It's just going to invite more regulatory scrutiny of your own risk management skills."
On the other side of the equation, fintechs are getting choosier about their bank partners, too.
A handful, including Block, Brex, Mercury, Relay, Rho and Stripe, recently joined the Coalition for Financial Ecosystem Standards.
"We've seen a need on the fintech side for increased clarity and better standards on how fintech-bank partnerships operate right now," said Mercury's chief counsel, Robert Gonzalez.
Written rules are sparse in this area, he noted. And when banks receive guidance from their regulators, that guidance is not communicated to fintechs openly, he said.
"Because of the confidential supervisory information rules, the banks are receiving the guidance from their examiners, and then they have to play this game of telephone to the fintechs to get the fintechs to make changes on how they do things, without telling them exactly why or what the regulator said or what the discussion was about," Gonzalez said.
The Coalition for Financial Ecosystem Standards is like a SOC II standard for fintechs, Gonzalez said. The group will agree on compliance standards for fintechs.
"Once this is up and running, there'll be a mechanism to audit fintechs against those requirements, and someone could be CFES certified," Gonzalez said. "So as a bank partner, if you're going to work with a fintech, you know this fintech has passed some universally accepted, industry-leading benchmarks."
