While initially fintechs entered the financial services industry as competitive disruptors looking to compete directly with financial institutions, most fintechs now follow a similar business strategy: develop a great product, secure venture funding, build a user base (often by giving away product for free), partner with financial institutions and/or established industry vendors and ultimately, be acquired by one of those financial institutions.
Similarly, financial institutions have increasingly recognized the value of driving innovation through acquisition versus in-house development of new technologies. Despite this interest from both sides, however, there is still a great deal of friction that exists between fintechs and financial institutions as they navigate the acquisition process.
A 2018 study by the Fintechs Innovation Lab of New York sheds some light on this issue. It found that 60% of polled bankers cited regulatory, compliance or security issues as “major stumbling blocks” in purchasing technology. Fintech executives, on the other hand, identified budgeting issues, competition with internal products and perceived risk of displacing internal teams or negating past expenditures as their top concerns.
The root cause of this friction — on both sides — is risk management.
The reality is that fintechs rarely understand what risk management looks like from the perspective of financial institutions. Since launching, they have typically focused the majority of their attention on creating a viable, marketable product, and not on creating a due diligence package that outlines their business structure stability, business continuity and/or the security of their product, all of which represent red flags for financial institutions.
On the other hand, financial institutions are struggling themselves in navigating the nuances of risk management, particularly technology vendor risk management, something that is becoming even more complex with technologies utilizing blockchain or cloud-based application programming interfaces. It is important for fintechs to understand that because their solutions are usually customer- or member-facing, financial institutions are taking a significant reputational risk when partnering with or acquiring fintechs .
Perhaps the biggest obstacle to overcome, however, is related to regulatory compliance.
Financial institutions are under increasing levels of scrutiny and pressure from regulators to consistently evaluate and report on their risk management protocols, which by default, extends to their vendors as well. So not only do institutions need to conduct internal and external IT audits to validate their controls, but so too do fintechs at the same level of standards.
Depending on the services supported, fintechs may find themselves subject to direct regulatory scrutiny. In these instances, fintechs must ensure that they meet the applicable requirements under the FFIEC’s Supervision of Technology Service Providers guidelines before examiners even arrive and be prepared to quickly address any deficiencies uncovered by regulators during an exam.
Beyond the practicalities of risk management and regulatory compliance, there are organizational and cultural differences to overcome as well. fintechs by their nature are smaller, more nimble organizations and are capable of rapidly affecting and implementing change. For several reasons (from sheer operational size and complexity to multi-departmental decision making) financial institutions are simply not in a position to move as quickly on initiatives. fintechs must keep this in mind when developing their own roadmaps and business strategies.
Financial institutions should appreciate that for fintech startups, every cost matters and every hour spent with one financial institution is an hour that cannot be spent with another. Ideally, institutions will set expectations early in discussions with fintechs to help avoid diving too deep into the sales, demo and/or beta testing processes if they only have a perfunctory interest in the fintechs ’s solution.
The future of retail banking will be built on the ability of financial institutions and fintechs to effectively collaborate and bring to market technology and services that will resonate with consumers. To make this collaboration as successful as possible will require a greater understanding from both sides.
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