More and more, traditional banks are looking to acquire or partner with fintech firms. For the banks, it’s a way to expand their digital offerings across the financial services sector. And for the fintech firms — typically small, agile start-ups — it’s a way to get much needed capital. This “fintech revolution” and the business combinations it is spawning are changing the landscape and bringing new compliance risks to banks. In this post, I’ll discuss some of those risks and how to manage them.
First, what is fintech? The U.S. Chamber of Commerce defines it as . . .
any technology that delivers financial services through software, such as online banking, mobile payment apps or even cryptocurrency. Fintech is a broad category that encompasses many different technologies, but the primary objectives are to change the way consumers and businesses access their finances and compete with traditional financial services.
Why has fintech suddenly become so important to traditional banks? Although largely protected in the past by high barriers of entry — mainly capital requirements and regulatory hurdles — those barriers have started to crumble. Fintech is one reason, Covid-19 and the changes it has brought to consumer expectations is another.
Fintech firms have responded to the new environment by leveraging non-traditional platforms such as e-commerce, telecom, and social media. Through these platforms they’ve created advantages such as superior data and access to customers. Banks, meanwhile, often encumbered with legacy structures and business systems, are confronted with a paradigmatic shift that has the potential to leave them behind as customers find solutions that are less expensive and friendlier to them. All this has propelled traditional banks to look for ways to integrate or acquire new technologies that will allow them to adapt and compete.
As traditional banks seek combinations with fintech firms, here are some of the unique risks that need to be identified and managed:
Banks need to ensure that compliance programs are adopted before integration and expansion. Quite often under a start-up mindset, costs are minimized and compliance is not at the forefront, be it lack of knowledge or concern. However, when a bank invests into these companies, quite often it is looking for rapid integration and expansion along with the host of problems that can come with new markets. Contractual provisions for an anti-corruption program should be in place to ensure that it is established beforehand.
Banks should review for potential successor liability, particularly related to critical licenses or patents. The concept of successor liability under criminal law is that liabilities that are created from the misconduct of the predecessor will continue to exist post-acquisition or merger and therefore, become the responsibility of the successor. Perhaps in recognition that there is a significant deterrent effect, the DOJ has attempted to place limits on the wide-ranging doctrine by incentivizing due diligence and disclosure. While ideally considered pre-investment, banks should review retrospectively to determine whether a disclosure should be made within the first six months. Failure to do so can jeopardize the entire investment.
Banks need to find a balance of cultures with transitioned staff. While banking and finance are publicly known for high salaries and aggressive risk-taking, this is not always the case as banking regulations have existed to help reign these behaviors in against the backdrop of a compliance culture. In contrast, fintech entrepreneurs are often enticed by the potential of a windfall and operate within a start-up environment where growth is prioritized. They are not subject to substantial regulation and seek to create a new model that rewards aggressive expansion and eventually, an IPO. As Richard Cassin wrote in his post about groupthink and goal-setting, this can be problematic and lead to disaster.
Tone-at-the-Top needs to be re-established. Drawing from the above points, it is possible that critical staff that transition from the acquired company can create a cultural pocket that resists banking oversight. Leaders that transition to the new venture need to benchmark their own behaviors against a compliance culture. The risk of not doing so can be substantial and can become a very expensive problem post-acquisition when similar behaviors continue.
Comments are closed for this article!