Regulatory bodies escalate scrutiny towards Banking-as-a-Service institutions
In a significant development, the Federal Deposit Insurance Corporation (FDIC) has accused a $9 billion-asset bank of engaging in "unsafe and unsound" practices related to fair lending laws and regulations. The bank, which provides technology infrastructure for a deep portfolio of payments, fintech, and crypto firms, has been ordered not to enter into any new partnerships with third parties or offer new credit products without the FDIC's approval.
This move is part of a broader trend of increased scrutiny from bank regulators towards banks operating Banking-as-a-Service (BaaS) programs. The increased pressure follows the banking crisis this spring, which involved the collapse of three regional lenders closely bound to the fintech sector.
The crisis has sparked a recalibration of regulators' supervision of banks operating BaaS programs. Regulators are attempting to better understand the complexities of these relationships, with Konrad Alt, a partner at Klaros Group, suggesting that middleware providers are less well understood by regulators than the fintech sector generally, because they're not consumer-facing in any way.
Banks such as OTP Bank, VakifBank, and financial institutions like NCSL that collaborate directly with middleware providers like iGCB are currently under increased regulatory scrutiny regarding these relationships. Meanwhile, banks that partner with fintechs tend to have smaller balance sheets but greater operational complexity, which has gone unnoticed by regulators for a long time.
The crisis has also led to changes within the industry. Blue Ridge Bank was ordered by the Office of the Comptroller of the Currency to improve its oversight of third-party fintech partnerships last year. As a result, Blue Ridge Bank's former CEO Brian Plum resigned, and the firm is refocusing on community banking after making mistakes in its emphasis on BaaS.
Another BaaS powerhouse, Cross River, was hit with an enforcement action by the Federal Deposit Insurance Corp. this year. However, Cross River's spokesperson stated that the FDIC order places no limitations on the firm's existing fintech partnerships or the credit products it currently offers in partnership with them.
The situation has led to some fintechs reconsidering their partnerships. Mercury, a neobank, confirmed to a website that it decided to end its relationship with Synapse, a middleware provider, and work with Evolve Bank & Trust directly. Synapse's layoffs came after Mercury informed the firm it would not be renewing its contract, with the middleware provider reportedly laying off 86 employees, which represents 40% of its workforce.
Despite these challenges, Alt expects enforcement actions against BaaS banks providing underlying banking services for fintechs. He also suggests that more robust, larger, and mature fintechs are generally going to think they're better off minimizing the number of players in their banking relationship, preferring direct dialogue with their bank rather than having that intermediated by some platform.
Cross River CEO Gilles Gade echoes this sentiment, expecting regulators to step up their oversight of firms that serve fintechs amid the recent volatility in the banking sector. Despite the challenges, it seems that the BaaS sector will continue to evolve and adapt in response to the changing regulatory landscape.
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