Why are regulators cracking down on bank-fintech partnerships?

First, while the OCC is prominent given the public enforcement action regarding Blue Ridge Bank, our understanding is that the higher level of regulatory scrutiny cuts across federal banking agencies. 

Second, regulatory scrutiny is typically generated by normal exam findings, and as a result lags market shifts and can be idiosyncratic. In this instance, it appears that Blue Ridge filed an application to merge with another bank, which triggered unrelated regulatory applications and exams, which in turn flagged problems that appear to center on their fintech partnerships. The Blue Ridge action is public, but market noise suggests that other bank partners undergoing regulatory exams are facing challenges.

Third, changes in regulatory agency leadership over the last 18 months have shifted the focus and introduced public policy questions (such as whether bank and fintech partnerships somehow allow fintechs to avoid consumer protection regulations) that can get wrapped up into, and reinforce, the normal exam- and growth-driven uptick in regulatory scrutiny. 

It wouldn’t surprise me if the issues identified at Blue Ridge have caused the OCC and the other agencies to reach out to select banks that are involved in this business. That outreach may well identify substantive problems with certain entities.

Why is the regulation of bank and fintech partnerships eliciting so much traction from the media?

That’s a question for the media, which I want to be clear I’m not. From my uneducated perspective, media attention tends to follow money. A lot of money has poured into fintech in the last decade (and in particular in the last couple of years). And a lot of value has been created – as witnessed by the number of unicorns in fintech – that similarly attracts attention, even if some of that value was ephemeral. 

More practically, regulation of financial services increases in importance when the number of consumers impacted becomes material. When fintechs were tiny and had de minimis numbers of customers, it was easy and likely appropriate for regulatory scrutiny to be more muted.

As the number of consumers being served by fintechs has grown – Chime alone now has more than 13 million customers – concerns and scrutiny will inevitably follow. In a very real sense, increased regulatory scrutiny is a positive in that a) it signals that fintech matters to the real world, and b) it will result in a more resilient and safe market to the benefit of consumers (even if they aren’t served by a fintech, since greater competition will work to their benefit regardless).

How long has this current partnership model been going on?

While partnerships have been around for decades, the last 10-12 years have been particularly important to the development of bank and fintech partnerships, for three high-level reasons. 

The last ten years have seen dramatic increases in the amount of funding pouring into fintechs, and as a consequence increased the demand for bank partnership capacity. 

In parallel, the passage of Dodd-Frank in response to the global financial crisis included the Durbin amendment, which severely limits debit interchange revenue for banks over $10 billion in assets; given the criticality of debit interchange to many fintech business models, the law led to the space being dominated by community banks rather than the largest banks.

Finally, those community banks have faced an increasingly difficult competitive environment as regulatory and other fixed costs have grown, making the partnership space a potentially attractive alternative to traditional CRE and mortgage lending.

Based on your experience, how do you see this regulation enforcement playing out in the long run? 

Some banks will be found to be deficient, as we are witnessing with respect to Blue Ridge. All banks engaged in these partnerships will face a much higher bar in terms of regulatory expectations and scrutiny. 

This will require significant investments in both compliance/risk management and technology. New bank players will see opportunity in the disruption, if they make the required investments. At the end of the day, hopefully (i.e. unless the regulators paint with a broad brush), we will have a smaller set of bank partners that perform their duties to a higher standard of compliance and resilience.

Some fintechs will hit a wall if their bank partner suddenly pulls out. Others, particularly new firms, will have trouble finding bank partner capacity. This will increase the advantages of the more established fintechs and likely accelerate and contribute to consolidation in the space.

But none of this will make fintech “go away.” There is more money waiting to be invested by fintech VCs than ever before. While the recent market/valuation correction will cull the herd as some companies fail or are rolled up, that is likely only to make the fintech space a more attractive investment opportunity. That’s why it is so important for the regulators, even as they appropriately crack down, to distinguish between the good and the bad. Fintechs will continue to grow in importance and they all need resilient, compliant bank partners.

For community banks that are willing to be thoughtful about their existing challenges, the opportunity in fintech partnerships is compelling (and there aren’t that many opportunities available for smaller banks). The key, especially as regulators crack down, is for those banks to do it right, to invest in technology and compliance to meet ever higher expectations and scrutiny.