Innovating in a regulated environment

Note: This is the second in a three-part series of articles on bank partnerships with fintech companies. The first part addressed the challenge of finding a good fit for an innovation partnership. Here we discuss how to set the partnership up to succeed. 

Big banks and fintech startups can seem like strange bedfellows. Sure, they have a lot to offer each other, as innovation partners in a vast and rapidly transforming financial services industry. But their cultures and risk appetites differ dramatically.

For starters, banks usually have an extensive risk control and vendor management framework, while fintech companies are focused more on innovation and speed to market. Pulling these partnerships together and making them work takes a mutual regard for each partner’s values that must be demonstrated day-to-day through transparent communications, trust, a clear alignment of incentives, and agile problem solving.

Finding the right partner is the essential first step. (See “Taking a risk-based approach to innovation partners”). So, congratulations, if you’ve found a match. Now the hard part begins.

Solving the cultural conundrum

Your mission is to support both cultures and get them to work together. As challenging as this will prove, therein lies the synergy.

To make an innovation partnership succeed, don’t lose sight of what made the partnership attractive in the first place— because what drew you to your partner is likely what is also attractive to your customers.

Let’s say that your partner has developed a tool that can expand your services or make your customer relationships stickier. The trick is to strike a balance between necessary controls and preserving the culture and innovation the partner brings to the table.

But striking a balance is challenging, as banks must always remain focused on mitigating partner risk, because the risks are real.

For example, a promise of instant online credit advertised by a bank's chosen partner could pose a potential truth-in-lending violation by not properly disclosing all appropriate fees. In other words, if you are not regularly and programmatically monitoring what your partner is promising customers, you could find yourself running afoul of your regulator(s)—facing all of the collateral reputational damage, fines, and remediation.

But while risk management is critical, so is the ability of your partner to be agile, to innovate, and to take calculated risks. Perhaps the most difficult challenge is how to apply compliance policies, procedures, and systems to the partnership without transferring a full regulatory construct. A fintech would not be able to support a large bank compliance risk framework; as a startup, it simply doesn’t have the same resources (people, time, or money) and you could end up stifling or killing its innovation incentives and culture.

And, along the way, resistance could begin to mount, driving progress off the rails.

What’s required is a “trust but verify” approach. Perform regular (and transparent) monitoring and testing of your partner—especially in the area of complaints, if your brand is facing the customer on the new product or service.

Keep in mind, as well, that different types of partners could require different levels of monitoring. For example, the bar might be set higher for an origination/customer acquisition channel partner (due to consumer protection and data privacy considerations) than for a technology/code acquisition.

And, even as you are receiving regular data and performance reporting from your partner, remember that the data flow should be a two-way street. Your data collection and analysis could provide your partner with important insights—to do what they do even better, in terms of targeting customers, cutting cycle time, or identifying fraud.

Setting the stage

Communications are pivotal, and here is a good place to start: Celebrate both partners’ strengths.

Large banks have capital to fund innovation, access to the banking system, and a huge customer base. What better way for a fintech to scale fast? Fintechs should even come to see those big bank risk management systems in a good light. Even smaller startups need to understand that innovation and compliance are not diametrically opposed. After all, for any financial product to scale and succeed in the long run, it has to comply with the rules of the game.

For their part, digitally native fintechs can often perform processes more efficiently than a large bank, as currently being demonstrated across a range of services including payments and marketplace lending. And they often target and acquire customers more efficiently because of their advanced data analysis capabilities as well as being able to meet digital consumers where they are and on their terms.

Another big part of communicating is setting expectations from the start of the partnership. This applies whether you are entering into a collaboration, joint venture, merger—even a vendor relationship. Set expectations up front about exactly which type of partnership is in play, or risk setbacks. This applies, as well, to matters of whose brand is going on the product and who “owns” the customer relationship.

Be sure to clearly align the incentives—which partner stands to gain what from the relationship, whether strategically, economically, or otherwise. If incentives are unbalanced or misunderstood, the individuals involved could begin to act in their own interests—to the detriment of others.

And put it all down on paper. Contractually, to mitigate risk, be sure to include indemnification, insurance, termination rights, audit rights, and performance reporting.

The tone of the contract is important. It can be written strictly as a basis for enforcement—boxing in the partner with a series of “thou shalt not” commandments. On the other hand, the contract language can be more nuanced as a basis for trial, error, and learning. The latter choice is more conducive to innovation through “test and learn” protocols.

Communicating as a constant

On an ongoing basis, both sides have to be able to converse in their partner’s language. A term of art in banking might be inscrutable to a fintech. And, vice versa, the vocabulary of digital transformation might not be a banker’s vernacular. Bridging this communications gap is key to an effective innovation partnership.

Transparency also needs to be established on both sides of the relationship. The environment should encourage openness about what’s working and what’s not. Bad news does not get better with age and in the digital space, you can’t take time for things to ‘shake themselves out’. The market moves very rapidly.

This should all be reinforced by clear lines of communications, as well as explicit roles and responsibilities. Assign the right individuals to actively manage the relationship – preferably led by the owner of whichever process, product, service, or experience your bank is trying to enhance.

By preparing for something to go wrong—because likely something will—you can make sure any issues are rapidly identified and just as quickly dispatched. Even better, set up an issues task force – at the ready to solve problems and bridge communications gaps.

The final analysis

Trying to harmonize big bank and fintech cultures is hard. The easiest way to fail is to get the communications wrong across the two cultures. So do your innovation partnership a favor and don’t try to morph your fintech partner into a big bank culture. Meet somewhere in the middle and you’ll see synergies flourish.

Read the conclusion of this series now: "Making innovation partnerships work"

About the authors

Mark Westmoreland, Principal with Treliant Risk Advisors, is head of the firm’s Financial Technology (Fintech) practice and co-head of its Compliance practice. He is an attorney and experienced regulatory compliance executive, having worked in the field for over 15 years. Email him at [email protected] 

Eric Reusch, a Senior Director with Treliant Risk Advisors, has over 20 years of experience in the consumer financial services industry as a senior executive and former regulator. He has held key roles with Top 10 banks, fintechs, a venture capital firm, and the Consumer Financial Protection Bureau. Email him at ereusch@ treliant.com