Start the Journey
Community banks are, and will remain, the keystone for providing consumer financial services. This is because they are responsible for maintaining the insured deposit accounts with which customers identify as the foundation of their primary financial
relationship. Nonetheless, the way banks provide services will continue to change in the coming decades, due both to technological advances and in response to demographic shifts in the US population.
Once a bank has identified financial technology projects to supplement and support its strategic plan, it should next consider how it will go about developing those projects.
Route 1: Create In-House
Some banks have elected to develop financial technology products or services internally, either directly in the bank itself, or in an affiliate of the bank.
- Differentiation: Successful, internally developed product can be leveraged not only for the benefit of the bank’s existing customers but can serve as a differentiator to attract new customers to the bank.
- New Revenue/Added Value: The product can generate new revenue through sales and/or leases to other banks or financial institutions. For example, increases in computing power have led to an increase in the amount of data that can be stored, processed and analyzed. Recognizing the value of this data for business development, many banks have developed in-house “big data” financial technology teams to manage customer data, develop new analytical methodologies and tools, and to leverage technology to provide more efficient financial services to bank customers.
- Higher Costs: The costs associated with an extended rollout of a new product or service can be cost prohibitive.
- Hard to Find Talent: Finding the right expertise to staff such projects can be a challenge.
Route 2: Collaborate
A bank could choose to collaborate with a third party to bring a new product to market. Potential partners may be sought out and identified by a bank itself, or a bank may find itself approached by potential partners with fintech business proposals.
- Play to Your Strengths: The tasks associated with developing the product could be divided and allocated to the party best suited for such tasks. The bank could retain regulatory compliance, marketing, securing liquidity and access to settlement infrastructure while the bank’s partner could be responsible for software development and other IT-related functions.
- Faster Than Producing In House: This could enable a bank to bring its idea to the market faster and with less cost than if the bank had tried to bring its idea to market by itself.
- Be Sure the Partner is Good: Prior to entering into a partnership or joint venture with a financial technology company, a community bank should consider several regulatory steps and conduct due diligence.
The Three Types of Collaboration
(Click to see marketplace lending fintech product examples below)
The fintech company works the front-end of the relationship, handling the market branding, customer relationship and data collection. For example, a Utah-based bank is a leader in developing business partnerships to structure and originate alternative financing products. The bank provides money to companies like LendingClub that arrange peer-to-peer loans.
When a borrower applies for a loan with LendingClub, the bank issues the loan, and then, two business days later, LendingClub buys the loan and parcels it out to the investors who pledged to fund it. The bank’s partnership allows it to collect interest on the money for that window and earn a fee from LendingClub.
Generally, securitization requires limited upfront investment and can increase a bank’s ability to absorb increases in its loan book without proportionate increases in costs. However, regulators are quickly moving to a model where banks are required to apply the same level of due diligence on securitized loans as they would apply to a selforiginated loan. That, in turn, raises the thorny issues of regulatory compliance and third-party risk management (addressed below), which may impact the profitability of the securitization model.
The third method of MPL collaboration—technology partnership—allows banks to work with fintech partners that most closely align with the bank’s own customer base and risk tolerance. These partnerships are often win-win scenarios: banks receive access to new methods of lending and increased revenue; MPLs get access to a bank’s CMS, credibility, liquidity from its customer/depositor base and the bank’s institutional knowledge. These relationships can work in three broad ways:
- REFERRAL SOURCES
The fintech company provides a referral service for bank customers, often using an algorithm to match the bank likely to be the best lender based on the customer’s information.
- LENDING RELATIONSHIPS
The fintech company provides a bank with access to its technology platform and
data-driven decision-making criteria. Lending platforms can be customized for different types of loans, including consumer, mortgage and commercial loans.
- TECHNOLOGY PROVIDERS
When a bank does not have the internal resources to develop and/or staff its user interface and lending platform, the fintech provider can provide the lending application and integrate it into the bank’s core system. These often take the form of licensing partnerships.
Customers snap a picture of the barcode on the back of their driver’s license and the personal identification needed for the application is automatically populated on the form. The bank also has a partnership with the New York Currency Exchange (“NYCE”) shared deposit ATM network to allow customers to make deposits and withdrawals at non-proprietary ATMs across the U.S. with zero ATM fees. In addition, the bank offers a high-yield checking account (called “Hybrid”) through a partnership with on-line investment firm Aspiration, and personal loans between $2,000 and $35,000 through its partnership with the Prosper platform.
Route 3: Purchase or Invest
A third option is for a bank to purchase an established product or invest in an established company.
- Fastest Route: Purchasing an existing product is the fastest path to offering a new service to the bank’s customers.
- Plug and Play: Other banks have integrated off-the-shelf products—essentially, plug and play, out-of-the-box technology—to offer clients new financial technology services like finance management and financial planning capabilities. By doing this, banks can leverage financial technology to provide customized, highly self-directed services that have the potential to deepen relationships with digitally savvy customers with little effort.
- Acquisition is Similar to In-House Production Minus Risks: Acquiring an established company has many of the same benefits of creating a product in-house (e.g., potential for additional revenue streams) without some of the associated risk (e.g., that the product developed may not be viable).
- Investment is Similar to Collaboration: If a bank chooses to make an investment in a company, rather than acquire it, the potential risks and rewards resemble those associated with a collaboration business model.
- Limited Customization: A bank may have a limited ability to customize the product.
- Exposure to Vendor Management Risk: A bank may expose itself to vendor management risk if the bank is also purchasing ongoing services related to the use of the product.