Banks create guide to manage fintech due diligence

As As a growing number of financial institutions are partnering with fintechs and other vendors, a consortium of financial institutions is working to standardize how banks approach third-party due diligence.

The initiative began after member banks of the Alloy Labs Alliance noticed that companies were implementing regulatory guidelines slightly differently, said Jason Henrichs, CEO of Alloy Labs.

As a result, Alloy Labs Alliance and a dozen consortium member banks have spent the past year working on a framework they hope will serve as a guide for companies navigating the complexities of bank-fintech relationships.

Henrichs, who shared a summary of the guide with Banking Dive, said the framework is not intended to replace existing regulatory guidelines, but rather to help banks better implement them.

“The challenge, usually, is translating advice into practice, ‘What do I do day to day?'” he said. “That’s why, starting from the same direction, banks can find themselves in very different places in the way they implement it. Think of it as an implementation guide that builds on regulation and advice. »

Alloy Labs and several member banks created the guide after holding regular monthly working sessions with business, operations, risk and compliance leaders from a dozen institutions.

Participants were divided into eight groups, covering categories ranging from business continuity, incident reporting, operational resilience and contractor assessment, Alloy Labs said.

Bankers shared knowledge and debated best practices in sessions hosted by accounting, consulting and technology firm Crowe.

The groups have compiled a list of seven key questions that banks need to answer in order to be able to assess the level of risk present in a particular relationship with a third party.

Questions include: “How does this partner complement or enhance our strategy and align with our culture?” ; “What kind of customer interaction or data exposure does this partner have?” and “What monitoring and reporting is needed for ongoing relationship assessment?”

The questions were used to develop consensus on the level of maturity expected of a fintech partner, Alloy Labs said.

Based on an assessed level of maturity, the groups established due diligence expectations, requests, ongoing monitoring, and trigger events for enhanced due diligence, which the consortium plans to publish in future guides anytime. throughout 2023.

“This is a bank-led initiative,” Henrichs said. “Why are we doing this now? Because the banks told us so.

As bank-fintech partnerships become more prevalent in the industry, the tie-ups have attracted increased regulatory attention.

Michael Hsu, Acting Chief of the Office of the Comptroller of the Currency (OCC), call for bank-fintech partnerships in September, stating that such mergers could put the financial system in danger of crisis if not properly supervised.

The heightened scrutiny means banks need to ensure their deals with fintechs are thoroughly vetted – not only to the satisfaction of regulators, but also to stay competitive.

Fintechs in the integrated banking market could become more selective as regulators step up oversight, Jonah Crane, partner at financial services and investment advisory firm Klaros Group, told Banking Dive last month.

“They can prioritize resiliency and stability and a bank that is committed to getting the right compliance over speed, where before speed to market was a big factor. for fintechs looking for banking partners,” Crane said.

Helping banks – primarily community and medium-sized institutions – stay competitive is a core mission for Alloy Labs.

Since its launch in 2018, the consortium has sought to leverage the collaboration and collective knowledge of its member institutions to help them compete with some of the largest banks in the country.

The group released a guide in October focusing on defining roles and responsibilities in bank-as-a-service (BaaS) partnerships. Consortium members represent 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 partnership with the digital payment company Payrailz.

CHUCK was touted as a competitor to Zelle, the network owned and operated by Early Warning Services (EWS) – a company which, in turn, is owned by a group of the country’s largest banks, including JPMorgan Chase, Wells Fargo and Bank of America.

“Ironically, the larger banks have done a better job of collaborating,” 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 experiencing a mindset shift, Henrichs added, and efforts such as the third-party due diligence best practice standardization initiative show how small businesses “are not excluded from the innovation game”.

“They’re reinventing what it means to be this community bank,” he said. “Third-party due diligence might seem trivial, but it’s a really important step because if they don’t fix things like that, they won’t be able to do more interesting and innovative things.”