A group of financial institutions is working to standardise how banks undertake third-party due diligence as more financial institutions form alliances with fintechs and other vendors. Banks that are part of the Alloy Labs Alliance started the initiative after realising that different companies were following the regulatory instructions in diverse ways, as explained by Alloy Labs CEO Jason Henrichs.
In order to aid businesses in negotiating the intricacies of bank-fintech interactions, Alloy Labs Alliance and a dozen of the consortium’s member institutions have spent the past year developing a framework.
Henrichs said the methodology is not intended to replace current regulatory guidance but rather to assist banks in better implementing it.
The difficulty, according to him, is putting advice into practise by answering the question, what am I doing on a daily basis? Because of this, institutions that begin with the same guidance may wind up implementing it in completely different ways. Consider this to be an implementation manual that complements existing laws and instructions.
After holding frequent, monthly brainstorming sessions with business, operations, risk, and compliance executives from over a dozen institutions, Alloy Labs and a number of member banks prepared the handbook.
According to Alloy Labs, the attendees were split up into eight groups to discuss topics such as operational resilience, continuity planning, incident reporting, and subcontractor evaluation. Bankers discussed best practises and exchanged expertise in sessions hosted by Crowe, a public accounting, consulting, and technology company.
The committees came up with a list of seven crucial inquiries that banks must respond to in order to determine the degree of risk associated with a certain third-party connection.
Consider asking, how does this partner match with the culture and support or strengthen the strategy? How does this partner connect with customers? How much data is exposed to them? What tracking and reporting are required for ongoing relationship evaluation?
According to Alloy Labs, the questions were used to get an agreement on the anticipated maturity level of a fintech partner. The groups defined due diligence standards, requests, continuing monitoring, and triggering events for heightened due diligence based on an evaluated level of maturity. The consortium expects to distribute these guidelines in the following instalments throughout 2023.
Bank-fintech alliances have drawn more regulatory attention as they become more commonplace in the sector. In September, Michael Hsu, the acting chief of the Office of the Comptroller of the Currency (OCC), criticised bank-fintech alliances, warning that if not properly regulated, they might put the financial system at risk of a collapse.
Due to the increased scrutiny, banks must ensure that their agreements with fintechs are carefully reviewed in order to satisfy regulators and maintain their competitiveness. According to Jonah Crane, a partner at financial services consultancy and investment firm Klaros Group, fintechs in the marketplace for embedded banking services may grow more selective as regulators increase monitoring.
In contrast to the past, when fintechs were looking for bank partners, they may value robustness and consistency, and they may value a bank that has pledged to get the regulatory component right over speed, said Crane. One of Alloy Labs’ key goals is to assist banks, primarily community and midsize institutions, in maintaining their competitiveness.
Since its inception in 2018, the consortium has worked to help its member institutions compete with some of the biggest banks in the nation by utilising cooperation and the combined experience of its members.
A manual on defining the roles and duties in partnerships for banking-as-a-service (BaaS) was published by the organisation in October. According to American Banker, the consortium’s members account for around 30% of the market share of banks that provide BaaS. Additionally, Alloy Labs introduced CHUCK, its own peer-to-peer (P2P) payments network, last year. In collaboration with the online payment provider Payrailz, it operates the platform.
One of the nation’s top banks, including JPMorgan Chase, Wells Fargo, and Bank of America, owns Early Warning Services (EWS), the company that runs the Zelle network. CHUCK has been positioned as a rival to Zelle. Ironically, according to Henrichs, the largest banks have performed a better job of cooperating, citing the development of The Clearing House and Zelle as successful multibank cooperation started by the country’s biggest institutions.
Henrichs noted that community banks are undergoing a paradigm shift, and initiatives like the one to define best practises for third-party due diligence show how smaller businesses are not out of the game when it comes to innovation. He said that they were reinventing what it meant to be a community bank. Third-party due diligence may seem unimportant, but it’s actually a crucial stage since if they don’t fix issues like these, they won’t be in a position to do more intriguing and creative things.