FinTech and Third-Party Service Providers
Financial technology (known as FinTech) companies offer new channels to financial products and services for consumers and small business. Fintech companies can serve as valued partners to community banks. The regulatory frameworks governing these relationships should maintain harmonized due diligence requirements to reduce burdens for both the bank and fintech companies. Third-party service providers provide both products and services to the financial sector in the form of software, core solutions, processing, cybersecurity, and other services.
Technological innovation and deployment, particularly digital innovation, continue to alter the ways that consumers and businesses conduct banking and commerce and influence the products that community banks offer. Additionally, technology deployment may alter the risk profile of community banks and subject them to a myriad of regulatory requirements and oversight while often FinTechs and third-party service providers are not held to the same regulatory requirements thereby creating a competitive advantage over banks and increasing risk within the financial sector.
Guidance for Novel Technologies
The banking agencies play a valuable role in defining and identifying the risks of existing and emerging technologies for both community banks and their service providers. However, guidance should be crafted in a manner that does not hamper innovation or impose undue burden. For example, there have been great advancements in the use of artificial intelligence and machine learning, quantum computing, and alternative data. Continued publication of guidance is helpful for community banks that want to explore these technologies, while still maintaining compliance with safety and soundness, consumer protection, and data security/privacy laws.
ICBA strongly urges core processors and other technology partners to help community banks enhance their market position and achieve ongoing efficiency by:
ICBA urges technology partners to negotiate bank contracts that are reasonable, fair, and clearly disclose fees.
ICBA urges core processors to provide adaptable, flexible, timely, and affordable platforms that enable community banks to innovate in a nimble and efficient manner through open application programming interfaces (APIs).
ICBA encourages core processors and digital banking providers to develop systems that permit bank customer-authorized data sharing with third parties through APIs, which replace third-party collection and storage of customer online banking credentials and limit the amount of data accessed by third parties.
ICBA urges core processors to provide access to secure data analytics solutions so community banks can better understand and serve their customers and leverage market opportunities.
The Critical Role of the Core Processor Relationship
Over the years, the community bank-core processor relationship has evolved from a back-office record-keeping vendor relationship to a digital cornerstone of the bank’s relationship with its customers. Core processors play a critical role in providing open communication and education regarding new and enhanced products and services, modern technology, and marketplace developments. The community bank-core processor relationship should be treated as a key strategic relationship, given the critical role of the core processor in supporting a community bank’s long-term technology and business objectives and continued success.
Community banks must negotiate relationships with technology providers which bolster their ability to compete and flourish. Contracts must clearly define terms, with reasonable fees for services and access to bank data, and provisions that assign liability to the technology partner when it is responsible for failing to meet service level standards or is unable to deliver the contracted services.
Core Processing Technology
Core processing technology, the foundational infrastructure for customer transactions, balances, and histories, is now under greater industry scrutiny and market pressure due to advances in digital banking channels, as well as the entry of non-traditional firms. The established and interconnected nature of core processing technology further compounds community banks’ reliance on these capabilities to stay competitive, efficient, and viable. Forward-thinking core processors enable early adoption and speed to market at a price supporting community banks’ revenue growth, providing community banks with a considerable competitive advantage.
Open core infrastructures allow banks to innovate more efficiently, reducing the effort and expense of fintech and third-party integrations with the core platform. APIs are becoming the preferred industry standard for allowing bank customers to securely share their personal financial data with authorized third parties without forfeiting usernames and passwords. Access to core data through APIs enables community banks to offer enhanced customer experiences while limiting the scope of data a permissioned third party can access.
Data Analytics Solutions
To compete, community banks require access to their data and analytical solutions which provide actionable insights for serving their customers. Currently, many of the core processor solutions are limited to historical reporting or may be cost-prohibitive, and therefore do not provide community banks with the ability to harness the power of sophisticated data analytics to execute their strategy. Uncovering the needs and expectations of today’s digital consumers requires new tools. Community banks need analytical tools for interrogating their own proprietary data as well as data from third-party sources to create improved customer experiences.
According to the 2019 Triennial Federal Reserve Payments Study, Americans still write a significant number of checks. The study reveals that Americans exchanged 14.5 billion checks in 2018 for a combined value of $25.80 trillion, a decline of 3.6 billion checks and $3.39 trillion in value since 2015.
The study uncovered other interesting details about the evolving use of checks. Specifically, the Federal Reserve notes that the average value of a check continues to increase—up from $945 in 2000 to $1,779 in 2018.
However, the Triennial Federal Reserve Payments Studies have also captured swift declines in total value and volume since 2000. Checks represented 58.8 percent of all noncash payments in 2000 but dropped to 8.3 percent by 2018. Similarly, checks’ share of total noncash value plunged from 67.4 percent in 2000 to 26.6 percent in 2018.
Much of today’s volume is driven by small businesses due to the slow, but gradually increasing, adoption of electronic payments for B2B payments. Community banks, however, have championed solutions, notably remote deposit capture, to improve check processing for small-business customers.
Regardless of the recent decline, checks continue to be an important payment method, especially for businesses. Although the extinction of the check has been predicted for years and the pandemic has accelerated the switch to electronic payments, there is no indication that checks will completely disappear anytime soon.
The United States has never retired a payment system despite the addition of newer, faster, and more efficient methods. However, the expansion of remote deposit capture, aided by the proliferation of smartphones, indicates that fewer people will need to make a trip to a bank branch to deposit a check.
This is an important development because it demonstrates that community banks are meeting the challenge to deliver electronic payments and financial services to wherever their small-business customers are located—at home, at the office, or on the go.
Checks are one of America’s most enduring payment methods. However, as the economy grows increasingly digital, banks and consumers are embracing the technology of remote deposit capture. The adoption of this technology allows community banks to meet the modern needs of customers and bridge the physical-digital divide by bringing the “bank branch experience” to mobile devices.
Remote deposit capture (RDC) describes technologies that allow bank customers to electronically “deposit” an image of a check without having to visit a branch or ATM to deposit the physical item. There is a misconception that smartphones with cameras inspired the development of RDC. In fact, RDC was developed a few years before the surge in smartphone popularity.
The critical first step in the development of RDC was the passage of the Check Clearing for the 21st Century Act, also known as the Check 21 Act. Check 21, which took effect Oct. 28, 2004, allowed for the creation of a new negotiable instrument called a “substitute check,” which serves as a replacement and legal equivalent of the original paper check.
Like a paper check, a substitute check has images of the front and the back—both sides are required for a bank to process the item. Customers transmit these images to the bank via the internet. Upon receipt, banks then clear and settle the substitute check electronically.
By using the speed of the internet and electronic clearing and settlement, RDC allows for much faster and efficient processing of checks, thereby saving banks time and money and expediting funds to customers’ accounts. ICBA supports ongoing innovation with RDC to reduce fraud concerns, improve customer experiences, and introduce even greater processing efficiencies for checks.
As new technologies become available and more Americans gain access to high-speed and mobile internet services, digital banking is proving to be a critical service and differentiator for community banks.
According to the FDIC’s most recent report on the state of banking in the United States, more consumers said mobile banking is their primary method of bank account access. The 2019 survey found 34 percent claim mobile banking as their preferred method, up from 2017 when 15.6 percent said mobile banking was their main form of access. The same study also recorded a decline in online banking as a primary method of access—22.8 percent claimed “online banking” as a primary method in 2018, down from 36 percent in 2017.
The growth in mobile banking is also supported by studies conducted by researchers with the Federal Reserve Bank of Boston. The 2019 Federal Reserve Mobile Financial Services Survey of Financial Institutions queried respondents about the range of retail customer enrolled in mobile banking.
According to the survey 65 percent of banks reported at least 21 percent of their customers signed up for mobile banking services. A close examination of mobile banking also revealed that 71 percent of banks indicated that customer usage rates exceeded 21 percent—clearly a sign that customers have eagerly adopted enhanced digital and mobile financial services[BL1] .
Consumers, however, are not the only ones embracing the digital economy—businesses are also doing much more with digital and mobile banking.
The Federal Reserve study asked respondents for information on the mobile financial services they offer to business clients. Not only did more banks offer such services than credit unions, a higher percentage (14 percent vs. 7 percent) revealed plans to provide mobile banking for businesses in the next two years.
Perhaps more significantly, the survey highlighted a reluctance among credit unions to help businesses—29 percent had no plans to offer mobile products for businesses. The three most popular business mobile products and services were:
Innovation in financial services is unfurling at a rapid pace. New faster payment technologies seem poised to power the next generation of financial services.
Although faster payments, especially instant payments, are not yet ubiquitous, the launch of the FedNow will usher in a new era of digital banking for community banks and customers.
Instant payments will give banks and their service providers a new infrastructure with which to build augmented digital platforms to meet the needs of a high-speed economy increasingly driven by mobile devices.
ICBA supports the efforts of community banks and their technology partners to enhance relationship-based banking through innovative technologies to meet the diverse needs of customers.