Breaking down the Risk that spikes the potential Reward. Fintechs: A Q&A with CEO Justin Fischer
Updated: Jan 19
One way for community banks and credit unions to hit 2023 goals is to partner with technology innovators either by banking Fintechs or through BaaS - banking-as-a-service - relationships. While financial institutions are intrigued by the possibilities of getting closer to the latest innovations in finance, RiskScout CEO, Justin Fischer, recommends entering into these relationships with comprehensive review, policy and tools.
In a recent conversation with Fischer, he defines BaaS, explains the pros and cons of Fintech relationships, and discusses how financial institution professionals must adapt to accommodate higher-risk endeavors.
Be sure to check this blog space next week for the second part of this Q&A, when Fischer lays out the top compliance demands for BaaS sponsors and/or FIs operating in the Fintech space.
Q: Would you please explain what a Fintech is and what BaaS is?
A: Ten or fifteen years ago, Fintech was defined as a business that was building financial technology. Back then, Fintechs were basically payments businesses or payments apps. Later, loans, personal wealth tools and business banking became targets for technology providers wanting to improve some traditional processes but also capture revenue on money movement.
BaaS is “banking as a service,” and it follows the moniker of SaaS, or software as a service. You can think of BaaS as a general term when a financial institution (FI) says, “I have bank accounts and a charter, and I’m willing to open these up to your technology and your service company in exchange for some revenue participation or a joint venture deal.” In addition, an FI generally lays out some requirements or rules that the Fintech has to follow and then they are off to the races.
Q: What forces are pushing FIs towards BaaS relationships?
A: A lot of FI CEOs have shared that they are unsure how and where they will drive growth in the years ahead. “Do we sell the FI?” They have exhausted the original context of the FI regionally or through products and services and are looking for out of the box options to expand.
Usually, the bottom line is that they want to participate in the Fintech boom, and the main thing they have of value is their charter. And that banking charter is valuable because starting a new institution (de novo) or acquiring a charter isn’t easy
Also, remember, when you’re an FI, you don’t have someone saying, “Hey, here’s $100 million you can spend on whatever you want to spend” like we have seen investors give tech companies. When you’re an FI, it’s more like “How is this going to be profitable immediately or will we continue to run the organization as is?”
Q: What should a FI professional know before embarking upon a BaaS relationship?
A: Right away, an FI is going to incur a much bigger risk profile by extending its charter to a 3rd party. There are a lot of risks to the way Fintechs operate. Say the Fintech facilitates money transfers to anonymous recipients (could be criminals), and it’s unable to be recalled. Even when something isn’t criminal and it’s just a mistake, the problems can be serious.
Recently, there were multiple examples in crypto wallets where the network made a mistake and moved the decimal one or two spaces. Those networks have to try and claw back millions of dollars. One of them didn’t notice the problem until seven months later, and the customer had already moved the money out and bought a house. Now the Fintech is fighting to get its money back.
Why, as an FI, do I want to be a sponsor and take on that risk? Why would I open myself up to a third-party that’s going to offer services to the market, who, by the way, could compete with my existing business, as well?
So your first question should be: What’s our motivation for entering into a BaaS arrangement?
The second question is: Have you vetted the Fintech’s idea carefully? An FI building a payments system may be stuck with a two-day transfer window. A Fintech building a similar system might think: “Forget that. I want to send hourly transfers so customers get their money right away.” The FI has to ask itself: Are hourly transfers even feasible? Can this company do what it says it wants to do? And then, does it violate FFIEC or NCUA regulatory requirements? Ultimately the FI is responsible for the transactions that transit its accounts (see the Zelle news) and the West Virginia based bank not too long ago.