US Gives Banks ‘Powerful’ Guidance for Partnering With Fintechs

Banks now have a clearer roadmap from US regulators to ensure their financial technology partners comply with fair lending, privacy, and anti-money laundering laws.

The Federal Reserve, the Federal Deposit Insurance Corp., and the Office of the Comptroller of the Currency finalized long-awaited guidance this week on the due diligence banks are supposed to conduct before and after partnering with fintechs and other third-party vendors.

The guidance covers familiar ground laid out by regulators for banks working with vendors in more traditional areas, such as back-office functions, debt collection, and other processes. But the three main bank regulators are now highlighting the specific steps that banks must take to ensure fintechs, particularly smaller startups, are following federal law, said Jenny Lee, a Reed Smith LLP partner and former Consumer Financial Protection Bureau enforcement attorney.

“It’s pretty powerful, because the status quo before this guidance was a little more ambiguous,” Lee said.

The June 6 joint guidance aims to stop the gaming of financial regulations by laying out how banks are responsible for a fintech’s compliance failures. The guidance also explains what types of data that banks must obtain from fintechs to ensure compliance, and how to handle situations where a smaller fintech can’t provide the necessary information.

The rise of fintech has led to partnerships that are more customer-facing. In some instances, banks merely provide funding while an online fintech lender does the work of offering, underwriting, and servicing a loan.

Regulators are concerned that some bank-fintech partnerships have been used to skirt regulations.

Acting Comptroller of the Currency Michael Hsu said in a November 2021 speech that he was worried about “regulatory arbitrage being facilitated” through some banking-as-a-service and “rent-a-charter” agreements between banks and fintechs.

Along with guidance, the regulators have taken a series of enforcement actions against banks for failing to appropriately police their fintech partners. In March, the FDIC issued a consent order with Cross River Bank for allegedly failing to monitor fintechs’ compliance with fair lending and privacy laws.

“There’s been an ongoing link between recent enforcement actions and expectations that banks really understand how their fintech partners are operating,” said Peter Dugas, an executive director at financial consultancy Capco.

The new guidance should provide sufficient clarity and make it easier for banks to understand their responsibilities under federal rules, said Phil Goldfeder, CEO of the American Fintech Council, a trade group.

“The updated guidance will help ensure that responsible bank-fintech partnerships and companies who are committed to compliance, transparency and accountability will continue to thrive,” he said.

Small Bank Challenges

Smaller banks and fintechs may have a harder time keeping up with the new guidelines.

Fed Governor Michelle W. Bowman voted against the final guidance, saying that it fails to “mitigate regulatory burden on smaller institutions.”

A Fed staff memo, which was released along with the third-party risk management guidance, said the three agencies will develop further policies that will make it easier for community banks to comply.

“We just have to see what the agencies do next with this because there are areas in here that have become a lot more prescriptive than the proposal was,” said Michael Nonaka, the co-chair of Covington & Burling LLP’s Financial Services Group.

Regulators gave more details in the final guidance about contracting with fintechs and working with smaller partners that can’t provide necessary compliance data, among other changes from the original July 2021 proposal.

Regulators will continue to keep a close eye on bank-fintech parterships, particularly with the increased use of artificial intelligence and machine learning in fintech apps.

“The regulators are very focused on making sure that while those products are being launched in the market that there’s also a careful attention paid to the fair lending laws,” Lee said.