Fintech: partner, build, or buy?

It’s hard to walk the hallways of banking these days without hearing the buzz about exploring partnerships with fintechs.  

“Fintech” covers many things, but is often used to refer to nonbank firms that leverage cutting-edge technology to deliver financial services directly to consumers and businesses. In that sense, banks initially viewed fintechs as competition, as they compete for lending, personal finance, payments, and other consumer services.

But that view has evolved, as banks increasingly realize that the pace of technological change and customer expectations demands the advanced capabilities of fintechs, while fintechs need established bank customer bases.

In addition, there are some fintech companies—Mirador being one example—that work only through financial institutions.

So the bank-fintech landscape is an interesting one that has all parties exploring build-buy-partner options and morphing the separation between what is a fintech and what is a vendor.  

Build, buy, or partner?

When it comes to organically creating needed customer functionality, banks can build capabilities themselves, buy tools from a vendor, or partner with a fintech. As with BBVA’s acquisition of Simple in 2014, there is also the option of acquiring a fintech that has built or acquired such capability.

Even partnering has permutations. Chase’s partnership with OnDeck, for instance, involves an investment in OnDeck and use of OnDeck’s tools to acquire loans, but with the retention of loans as Chase assets.

Beyond such higher profile fintech situations, the build-buy-partner framework of choices is one all tech companies face. And that is the point of the situation: All companies are increasingly tech companies—including banks.

As the industry automates and shifts toward self-service delivery as the primary access point in the delivery mix of banking that includes technology, people, and facilities, only technology is increasing in the mix. That goes for both banks and fintechs.  

What critical considerations must banks factor into exploring fintech partnerships? The sidebar on the opposite page outlines factors common to all new tech implementations. Below are others, using a business-lending example at a mid-sized banking company.

One bank’s experience

A mid-sized bank in the $10 billion- to $30 billion-assets range needed to automate its commercial origination processes and wanted to offer borrowers and third parties (CPAs, attorneys, appraisal firms) a way to interact with the bank via a digital web portal to submit loan applications and upload due diligence items.

This was less of an issue for larger commercial clients serviced by relationship officers, but more for small businesses that want to do business with their local bank, but not be subjected to lengthy, extensive due diligence processes typical of larger commercial loans. It’s not an accident that small businesses prefer to deal with local institutions that take time to know and understand them, but those same small businesses don’t want to sacrifice speed, ease, or efficiency.

When building a front-end business loan application and third-party processing portal, performance, cost, and risk considerations must be examined as well. But many banks quickly realize they don’t have the appetite for this development.

In this bank’s web portal example, an analysis of the needed development effort revealed the bank did not have the resources in house to develop and maintain this portal, and the costs and ramp-up risks associated with building the needed infrastructure, or to subcontract it, would exceed that of other options for obtaining the needed digital presence.

Buying the functionality would come with the broader commercial loan origination and portfolio management system functionality that the bank needed. Vendor performance, client references, system availability (especially for application service provider or cloud-based systems) can be documented and analyzed.

Vendors must provide detailed costs, including license fees, per-user costs, and implementation, integration, support, maintenance, and test environment costs, for the life of the contract. Risk assessment is typically performed by a bank’s procurement/contract unit, with well-defined processes to review the vendor’s finances, contract performance record, trade payments, and the like.

In this bank’s case, most of the origination vendors under evaluation offered the needed web portal, but related add-on module, maintenance, and variable volume pricing prompted it to consider a fintech partnership. Partnering with a fintech entails the same performance, cost, and risk considerations, but there are three critical differentiators:

1. What’s the problem to be solved?

Sounds like common sense, but a fintech partnership should necessitate an extensive evaluation of the underlying need, such as filling in product or service gaps, or, in this bank example, offering borrowers a digital channel for applying and getting to closing quicker on a commercial loan as their primary competitors offered. Clear objectives help the bank and fintech determine if the match is on solid ground from the start.

A fintech partnership should offer the bank an upside—quantitative and qualitative—that simply isn’t available at more favorable cost, risk, and performance measures under the build or buy options.

2. What’s the difference between buying vs. partnering with a fintech?

Is it a shared risk and shared reward? Does the reward justify the risk? Or is it just the innovation culture of the third party? The definition is critical as the process of evaluating a fintech’s performance, costs, and risks entails unique considerations from a typical vendor evaluation.

Many partnerships are really just vendor relationships. That’s okay. In many cases, banks with extremely low risk appetites prefer the typically lower risk of a vendor relationship. One fintech exec noted how impossible it is to run many banks’ risk gauntlets because they don’t understand what they are getting into.

A bank’s procurement/contract function often isn’t equipped to evaluate fintechs, which often have huge R&D expenditures that enable them to devise cutting-edge technologies, and likely won’t pass standard vendor evaluation criteria. Instead, a potential fintech partnership requires Legal and Finance to play critical roles in the evaluation, as a shared risk/reward dynamic needs to be understood and quantified.

Lastly, the board should be involved in any significant partnership decisions, as many entail unique risks or potential impacts to the bank’s strategic vision.

3. Is the attraction to a fintech largely due to its ability to invest and move quickly with innovations and not really a desire to share risk/reward?

That’s important to know because there are different types of vendors that could fit the bill within a bank’s risk appetite.

While there are some mature vendors driven by near-term profitability who don’t move as quickly with new capabilities, there are other start-up vendors driven by revenue and client growth who move more quickly. Some even have banks as owners. In turn, the lines between what is a fintech or vendor and between build-buy-partner are blurred.

And the result?

The mid-sized bank’s analysis of a fintech partnership revealed that the incremental cost and risks weren’t warranted given that the needed functionality was included with the origination system that the bank was simultaneously evaluating and purchasing.

By vetting each option via a build-buy-partner evaluation, including performance, cost, and risk considerations, the bank gained tremendous knowledge for future use in evaluating a fintech partnership and the critical factors in making a partnership a success for both parties.

Making it happen: Consistent performance management approach

Every build-buy-partner situation has critical performance, cost, and risk considerations to manage.

1. Performance must be monitored
by line-of-business executives to ensure the bank is getting the benefits projected from the system. Banks must commit to operationalizing all the features that won the execs over.  

2. Cost variables require continual monitoring. Volumes or other pricing parameters may change during contract terms and impact the original justification. Bank CFOs should not wait until contract renewal to evaluate original expenditure decisions, as the cost-benefit relationship will change.

3. Risk factors are critical. They include tracking vendor or partner performance and assigning risk ratings. The complexity of the vendor-partner services and risks dictate periodic reviews, ideally by a risk officer. Vendor management systems can provide tools. Fintech partnerships often can be more complex to assess.

Finally, it is best that the assessors of these three factors be different executives. Not only due to expertise, but as a healthy check and balance.

About the authors

Joe Ganzelli Sr. is senior director at Cornerstone Advisors. He spent 15 years as a banker. Sam Kilmer is senior director at Cornerstone, and has worked at two mid-sized banks and two fintechs.