Financial technology, or fintech, refers to the broad set of financial innovations that apply new technologies to a financial service or product. Although potential competition from fintech companies initially raised concerns for the banking industry, banks quickly recognized and adapted to the changing market as consumer and regulatory demand for better technology increased. Today, banks have implemented fintech solutions for both back-end processes (monitoring of account activity) and consumer-facing products (applications to apply for loans and pay bills online). Many community banks now partner with fintech companies, often through their core processing service providers, to provide modern platforms and services to their customers, obtain data about their customers to offer individualized products and services, and increase security.
The COVID-19 pandemic also forced banks and customers to innovate, often changing how banking transactions were conducted. Banks rushed to provide solutions to open accounts and close loans remotely. These critical fintech solutions heightened banks’ awareness of the need to analyze their fintech strategy, including the processes and products that need to be changed and the best model to pursue that change.
Community banks should consider the following two questions when reviewing their fintech strategy: (1) what are the bank’s goals for using fintech, and (2) what is the best model to pursue those goals? There are various options available to banks looking to incorporate fintech more fully in their business. These options include:
- Develop Products In-House: develop fintech products and services by employees;
- Partnerships/Collaboration: enter into an arrangement with one or more fintech companies to provide new products or platforms;
- Investment: invest in a fintech company; and
- Acquisition: acquire a fintech company or an established product.
The most challenging strategy is to recruit the talent to develop new processes and services in-house. This model takes more time and funding than the other models and the talent may not be available. However, if this model is successful, the bank will attract new customers, obtain additional revenue, and sell or lease the technology to other financial institutions.
The model being pursued by most community banks is the partnership/collaboration model where banks enter into third-party arrangements with fintech companies to provide new products and services to the bank’s customers. Community banks have certain advantages that are attractive to fintech companies, including a large customer base, access to the settlement system, regulatory compliance expertise, and funding. By leveraging these advantages and partnering or collaborating with a fintech company, community banks can provide safe and secure financial transactions for a wide range of products and services, often with high transaction volumes and low operating costs. By adopting this model, banks can provide fintech solutions and individualized products and services for their customers more quickly.
When considering each model, community banks should undertake the same risk assessment and due diligence procedures that apply to other products and services.
The last model is to invest in a fintech company or purchase an already established fintech product. This model elevates the bank from a fintech user to fintech provider and, if done correctly, can be the fastest method of offering new services to customers. Banks taking this approach must be prepared to provide the infrastructure necessary to support the model. This model also requires banks to actively oversee the fintech program and provide compliance and regulatory support. Banks also need to be ready to scale up depending on the success of the model. This model may require prior regulatory approval depending on the level of control exercised by the bank.
When considering each model, community banks should undertake the same risk assessment and due diligence procedures that apply to other products and services. Banks will need to manage relationships with fintech companies and develop and implement systems to mitigate risk and address regulatory concerns.
Finally, banks may want to explore whether state-sponsored “regulatory sandboxes” offer a way to develop and test new fintech products and services. Many states, including West Virginia, have adopted laws designed to promote innovation in the financial sector and analyze the emerging risks. These “regulatory sandboxes” establish programs through which firms can experiment with new products while simultaneously allowing regulators to study the risks associated with the latest technologies.
The West Virginia Division of Financial Institutions has adopted a FinTech Sandbox. The West Virginia FinTech Sandbox enables entities that would typically require licensure in West Virginia to test an innovative financial product or service for a limited period of 24 months. After the end of the sandbox period, if the test of the product or service has been deemed successful, the entity would be able to continue operating in West Virginia subject to any licensure requirements at that time. The program is intended to encourage startup activities and entrepreneurship. The West Virginia Division of Financial Institutions is currently creating a process for accepting and reviewing applications on a secure platform. Until that process is fully operational, any individual or entity interested in discussing potential sandbox activities should contact the Division at fintech@wvdob.org or 304-558-2294 to schedule a pre-application meeting.
About the Authors:
Amy J. Tawney is a partner in the Charleston office of regional law firm Bowles Rice. She focuses her practice on banking law, mergers and acquisitions, securities law, and regulatory matters. Contact Amy at (304) 347-1123 or atawney@bowlesrice.com.
Sandra M. Murphy leads the Bowles Rice Banking and Financial Services team. Practicing from the firm’s Charleston office, she focuses her practice on acquisition, regulatory, enforcement, corporate governance, and securities law matters for banks and other financial institutions. Contact Sandy at (304) 347-1131 or smurphy@bowlesrice.com.
