Mark Westmoreland, Eric Reusch, and Kathlyn (Lyn) L. Farrell
Note: This article is based upon a three-part series on bank partnerships with FinTech companies that appeared in Banking Exchange Magazine. The full series is available at http://bankingexchange.com/news-feed/item/7077-taking-a-risk-based-approach-to-innovation-partners?Itemid=257.
Traditional financial institutions are partnering with innovative FinTechs in increasing numbers, and for good reason. Digitally native FinTechs often perform processes more efficiently than banks can, as already demonstrated across a range of services including payments and marketplace lending. And they often target and acquire customers more efficiently because of their advanced data analysis capabilities.
Some banks gain access to new markets by funding a startup, while others enter into collaborations to provide their own customers with innovative products or services. Innovation partnerships can provide an entree into an expanding range of products and services, including marketplace lending to consumers and small businesses online, using alternative credit underwriting criteria and models to increase access to credit, issuing prepaid cards to low- and moderate-income consumers, providing peer-to-peer payment channels, and developing financial health and wellness applications.
From a FinTech’s perspective, big banks have money to fund innovation, access to the banking system, and a huge customer base. Those attributes are enticing to a FinTech looking to scale their business or brand quickly.
Whatever the motivation, there are common elements of risk that both financial institutions and FinTechs need to address at each phase of a relationship with a partner.
The right balance is important, because while financial institutions and FinTechs have a lot to offer each other, their cultures and risk appetites differ dramatically. While banks are heavily regulated, FinTech companies generally receive much less regulatory scrutiny. The stakes are high, from business performance to regulatory compliance to brand reputation and customer satisfaction.
How Financial Institutions Choose an Innovation Partner
Strategy should drive innovation partnerships, not technology. This means that a financial institution’s first step in choosing an innovation partner is to determine whether its product or service dovetails with its own strategic direction.
It is also essential for banks to select a partner with the right risk management culture. Finding a partner where the executive management is willing to make the necessary investment and commitments to accommodate both the bank and its regulatory agency is key to protecting a bank’s own risk management performance and culture. If a partner with an inappropriately high risk tolerance is chosen, a bank could regret the choice later if the partner’s actions, or lack thereof, end up tarnishing the bank’s reputation.
Thorough due diligence is employed, including reviews of complaints against the prospective partner and of its policies, procedures, controls, and governance in such areas as fair lending and anti-money laundering. Many FinTech companies are unprepared for what is needed to be fully compliant. If the company is deficient in any of these areas, it must be willing to put in the resources and effort to shore up its risk management framework. If not, the best course for the bank might be to walk away.
Financial institutions also take a careful look at a potential partner’s data security risk management infrastructure. Data breaches rightfully get a lot of media attention and can taint a bank’s reputation by association, even if the breach does not involve the bank’s own systems.
Setting up an Innovation Partnership
Financial institutions usually have an extensive risk control and vendor management framework, while FinTech companies are focused more on innovation and speed to market. Pulling these partnerships together and making them work takes a mutual regard for each partner’s values that must be demonstrated day-to-day through transparent communications, trust, a clear alignment of incentives, and agile problem solving.
To make an innovation partnership succeed, banks should not lose sight of what made the partnership attractive in the first place—most likely, that is what’s also attractive to customers. Let’s say that a FinTech has developed a tool that can expand a bank’s services or make customer relationships stickier. The trick is to strike a balance between necessary controls and preserving the culture and innovation that produced the tool.
But striking a balance is challenging, since financial institutions must always remain focused on mitigating partner risk. And the risks are real. For example, a promise of instant online credit advertised by a bank's chosen partner could pose a potential truth-in-lending violation by not properly disclosing all appropriate fees. If a bank is not regularly monitoring what partners are promising customers, it could run afoul of regulators—facing all of the collateral reputational damage, fines, and remediation.
But while risk management is critical, so is the ability of FinTechs to be agile, to innovate, and to take calculated risks. Perhaps the most difficult challenge is how to apply compliance policies, procedures, and systems to the partnership without transferring a full regulatory construct. An early stage FinTech may not be able to support a large bank compliance risk framework; and such a framework could end up stifling or killing its innovation incentives and culture.
What’s usually required is a “trust but verify” approach, in which banks perform regular (and transparent) monitoring and testing of partners—especially in the area of consumer complaints, if their brand is facing the customer on the new product or service.
Communications are pivotal, including clear lines of communications and explicit roles and defined responsibilities. Both sides should be conversant in their partner’s language, mastering terms of art in banking as well as technology. Transparency also needs to be established on both sides of the relationship, encouraging openness about what’s working and what’s not.
Expectations should be set from the start of the partnership about such matters as whose brand is going on the product and who “owns” the customer relationship. Incentives should be clearly aligned—which partner stands to gain what from the relationship, whether strategically, economically, or otherwise.
Put it all down on paper—contractually, to mitigate risk, and be sure to include indemnification, insurance, termination rights, audit rights, and performance reporting. The tone of the contract is important. It can be written strictly as a basis for enforcement—boxing in the partner with a series of “thou shalt not” commandments. Or, the contract language can be more nuanced as a basis for trial, error, and learning. The latter choice is more conducive to innovation through “test and learn” protocols.
Making Innovation Partnerships Work
From the very outset of your innovation partnership, prepare for something to go wrong—because likely, something will. That way, you can make sure any issues are rapidly identified and just as quickly dispatched. Even better, set up an issues task force—at the ready to solve problems and bridge communications gaps.
Issues can vary in size and scope—across operational, marketing, regulatory, and other aspects of doing business together. But they all have at least one thing in common: problems rarely get better on their own. And if you ignore a small issue, it could become a big one.
Take deliberate steps to be sure any issue that emerges is recognized, owned, addressed, and analyzed for future improvements.
If you or your partner are not the first to recognize an issue, that only compounds it. You certainly don’t want to learn of problems from customers or regulators. That’s reason enough for one large bank to crawl thousands of websites a day, to be sure its various partners’ marketing materials do not get ahead of in-place approval processes or contain any misrepresentations. The higher the regulatory, financial, or reputational risk, the faster an issue needs to be recognized—sometimes to the point of proactive monitoring.
Come to an agreement about who will be responsible for evaluating, tracking, and fixing any problem. Issues must be addressed in a carefully planned manner. Haphazard patches will do little for the integrity of the partnership and its products or services. Consider forming a task force including members of each team. Along the way, don’t engage in the blame game. Trust that both parties have acted in good faith and continue to do so.
Will you fix the problem or is the issue severe enough to decide to dissolve the partnership? Business is filled with difficult decisions, and either is a viable outcome. If it’s a small issue, of course, you can deal with it and move on. Make plans, including assigned accountability and realistic timelines, then execute against them. On the other hand, culture mismatches may be the thorniest problems to resolve so watch for those early and often.
Learning from Issues.
There are lessons to be learned through all of this. Debrief quickly to make sure the findings are fresh and not lost in the press of daily business. Inventory what you’ve learned, and socialize the lessons both internally and with relevant external parties. Use what you’ve learned to mitigate the likelihood or impact of future problems.
Successful partnerships in innovation can be win-win-win propositions for financial institutions, FinTechs, and the customers they
serve. But no one ever said they would be easy—especially in the heavily regulated financial market. Banks and FinTechs need to go into innovation partnerships with their eyes wide open and be prepared for things to go sideways or stall at certain points. When they do, working together on problem-solving can make your partnership even more resilient and serve your customers and markets better and more efficiently.
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