4/3/24, 09:58 Why Banks Say BaaS Turmoil Primes Future Growth

Bankers Say BaaS Turmoil Primes

Future Growth
With regulators upping their expectations for banking as a service
this year, bankers are assessing what the future looks like for BaaS.
The outlook is not all negative. In fact, those working in banks –
especially those in compliance positions – see this phase as a key
step forward in the maturation of BaaS banking.
Por Matt Doffing, Editor Senior en La Marca Financiera

Al observador casual, podría parecer que el campo emergente de la banca

como servicio (BaaS) — en el que los bancos se asocian con empresas
fintech para ofrecer servicios bancarios fuera del ámbito de las sucursales
bancarias tradicionales — es bajo asalto.

En 2023, los bancos BaaS representaron el 13.5% de los reguladores de

bancos federales’ acciones severas de cumplimiento, según S&P Global. En
una serie de medidas represivas de alto perfil, los reguladores federales
impusieron acuerdos de consentimiento y multas a numerosos bancos,
incluidos Blue Ridge Bank, Cross River Bank, First Fed Bank y Metropolitan
Commercial Bank, el último de estos enfrenta $30 millones en sanciones.

Ex Federal Deposit Insurance Corp. La presidenta Jelena Williams llegó a

sugerir que la actual cosecha de reguladores federales simplemente no le
gusta BaaS. Si bien entienden que pueden detener por completo el
crecimiento de las asociaciones entre los bancos y las fintech, dijo
McWilliams, los reguladores están “tratando de hacer más difícil” que esas
asociaciones florezcan promulgando una guía regulatoria diseñada para tener
lo que ella llamó un “ efecto escalofriante” en su expansión.

Sin embargo, en un panel de discusión reciente sobre el futuro de BaaS y las

estrategias para el cumplimiento, un grupo de banqueros se mostraron en
gran medida optimistas sobre el futuro. El enfoque regulatorio actual en el
espacio, dijeron, representa una oportunidad para que la industria desarrolle
las mejores prácticas y abra aún más opciones para las asociaciones fintech-
bank que podrían mejorar la banca para todos.

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Banks Still See BaaS as an Opportunity

The current upheaval, said Andreas Westgaard, a director with Klaros Group, is
more about the learning curve inherent to innovation in a regulated industry.
“I don’t think that the regulators are rooting for bank fintech partnerships to
fail or trying to set them up for failure,” he said on a panel hosted by
compliance tech company Cable at the end of 2023. “I think they’re just
increasingly scrutinizing the risks and wrapping their head around the fact
that these types of relationships pose novel risks that weren’t previously
supervised as closely as they could have been.”

To be sure, the increased regulatory scrutiny places a burden on banks to

move safely into the BaaS space, a rising number still see it as an opportunity.
Compared to yearend 2022, when there were 116 BaaS providers, the industry
now has 136, according to analysis by Bobby Button, CRO at FedFis, a more
than 17% increase.

Growth in the number of BaaS, while slowing, still rose quarter-over-quarter

at the end of 2023, according to Button’s most recent count in “Data
Timeout,” even as regulatory actions ramped up. In fourth quarter 2024, the
industry had 136 BaaS providers, up from 131 at the end of the previous
quarter.

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Now, banks are in an “enviable position” Westgaard said. Because of the

number of fintechs seeking bank sponsors, they can be “quite picky” in
choosing partner organizations.

Learn from Others’ Mistakes in BaaS

While enforcement actions are painful for banks, said Jame Sloan, executive
director at Main Street Bank’s Innovation Lab, the overall effect has been
increased certainty about regulatory expectations.

“I think we’ve got a diminishing amount of uncertainty given the amount of

enforcement activity we’ve seen in the banking-as-a-service space,” she said.

“Looking at criticisms play out in public gives us a lot more insights into what
the regulators are discovering and learning from as they pursue enforcement
activity. A natural evolution of what happens is that the regulators start to see
what happens when it really goes wrong, and get smarter about what they’re
looking for and more direct as they spread out into the array of financial
institutions that might be occupying a certain space.”

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“I think we’ve got a diminishing amount of

uncertainty given the amount of enforcement
activity we’ve seen in the banking-as-a-service
space.”
— Jame Sloan, Main Street Bank

Natasha Vernier, co-founder and CEO of Cable, which provides automated

account monitoring services, pointed out an obvious vulnerability for banks
operating in the BaaS space, especially when it comes to embedded finance.
There can be a major gap between the risk management gap culture of the
operational “first line” employees at a fintech and the higher level “second
line” risk management functions at a bank.

“You’ve got the fintech that might be the first line, and then you’ve got the
second line at the bank,” Vernier said. “And it’s really interesting to put those
two things together and think about how the core of the problem is here,
perhaps.”

Janine Jakubauskas, chief risk officer of BankProv agreed, noting that some of
the most valuable takeaways from recent enforcement actions is the
evidence that many of the banks targeted by regulators appear to have failed
to bridge that gap.

“As risk professionals we always hear that the risk culture has to be across
the entire organization, not just at the second line,” she said. “These
regulatory findings [indicate] that doesn’t seem to have been the case.”

A key lesson, Jakubauskas said, is that top management at the bank needs to
set the tone for its fintech partners. “It’s really important for the CEO and the
full executive management team, and the business lines to also support the
risk and compliance function to ensure that they have the resources
necessary so that they don’t [face] these potential enforcement actions,” she
said.

Westgaard, of Klaros, urged banks to pay close attention to interagency

guidance released over the summer when they structure their relationships
with BaaS partners.

“A critical component in many of the breakdowns that we’ve seen in these

partner banking relationships — I would say one of the root causes — is a
lack of clear delineation in terms of roles and responsibilities and who is
doing what.”

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He recommended that banks consult the guidance closely, and treat it like a
checklist for assuring that all areas of responsibility for risk and compliance
management are specifically defined.

“Heading into 2024, that will be a really critical aspect: To make sure you know
that gaps are identified,” he said. “If you have policies where you’re saying
‘Everyone is responsible,’ then oftentimes, in effect, that means that nobody is
responsible.”

Read more about BaaS trends:

Will Federal Guidance Have ‘Chilling Effect’ on BaaS?
Is BaaS the Last Strategy Your Bank Should Be Looking At?

Even More Active Due Diligence

The participants on the panel were unanimous in their assessment that banks
need to do extensive due diligence when they choose which fintechs to
partner with, developing a deep understanding of the kinds of products and
services potential partners are offering and of their corporate culture.

Sloan, of Main Street Bank, urged banks to drill down into the way their
fintech partners have approached key issues, like growing their businesses.

“FinTech firms looking to scramble to offer more products and services may
not be paying as much attention to building out risk and compliance as they
build out new products and features,” she said. “And so, they accumulate
‘compliance debt.’ And that comes with a cost.”

Donald Todd, director, financial crimes, at Midland State Bank in Wisconsin,

said that assessment of potential fintech partners needs to start with
background checks of executives and directors, and an analysis of employee
turnover rates.

However, he stressed that the process “is not just an exercise in checking
boxes,” emphasizing the importance of on-the-ground, face-to-face meetings
with potential partners.

“I can’t stress enough to the banks out there: Go on-site and meet with
potential partners. Zoom or Teams calls are not a natural conversation,” he
said. “You really want to make sure that you have these free-flowing
conversations and get a better sense of what these fintechs are saying and
what they plan on doing.

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“Ultimately, what you want to make sure is that everything is matching up

from a capability standpoint to your company’s goals and objectives,” he said.
“We’re all in there to generate revenue, but there’s different ways of going
about that, and you want to make sure that they align appropriately with your
bank’s goals and objectives.”

Create Networks of Cooperation

Because of the nature of the BaaS space, where a fintech may partner with
multiple banks, and a bank with multiple fintechs, the experts on the panel
pointed out that these relationships can create self-supporting networks of
compliance professionals able to share insights and best practices.

Jakubauskas, of BankProv, urged her fellow bankers to view compliance as

something that happens outside the realm of day-to-day competition among
institutions operating in the same market.

“Traditionally, one might have thought that if a competitor was under an

enforcement action, ‘Well great, that’s more business for us.’ But I think that
kind of attitude is not the case at all, especially now and in this industry,” she
said. “Ultimately, we all benefit if we can all stay out of trouble, because we
want this industry to maintain a good reputation, both from a regulatory
standpoint, from a congressional standpoint, and also with the general
public.”

“I can’t stress enough to the banks out there: Go on-site and

meet with potential partners. Zoom or Teams calls are not a
natural conversation.”
— Donald Todd, Midland State Bank

Midland Bank’s Todd agreed. “I see an opportunity for the platforms and the
banks that are within those platforms of having more open information
sharing. That might be contractually or through memorandums of
understanding. We’re all in this together, right?”

Under such an arrangement, he said, it would become possible for banks to

compare notes about how different compliance regimes are functioning and
develop best practices.

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“If one of us fails, that’s going to have huge reputational effects on all of us,”
he said. I think in the future, we’re going to see a lot more banks working
together to ensure that…compliance is in place, and it will be great because
we can share stories as to what we’re seeing, how we’ve corrected those
issues and really work together. So, if one bank finds an issue, then all of the
banks across the platform can also fix that.”

Dig deeper: Value of Embedded Finance [Webinar]

Develop Regulatory Communication

If there is anything that’s certain about the next few years of development in
the BaaS space, it’s that bank regulators will continue probing the bank-
fintech relationship for weaknesses and potential threats to banks’ safety and
soundness.

For that reason, maintaining a close and open relationship with a primary
regulator is essential.

“What was good enough during the last examination might not be good
enough now,” said Westgaard. “Think about your regulatory communications
and how you are managing ongoing supervision between exams. It will mean
being really transparent about the risks associated with your BaaS program
and [talking with regulators] about how to mitigate those risks.”
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