The collapse of San Fransisco based fintech firm Synapse earlier this year highlighted some of the vulnerabilities around the way banks and fintech firms work together. It showed how a problem at one firm, or even within one part of its operations, can have a knock-on effect on firms and operations externally.

In this case, issues at Synapse meant that banking startups such as Copper and crypto apps such as Juno were were affected. According to one author, this episode showed “just how treacherous things are for the often-interdependent fintech world when one key player hits trouble.”

The banking-as-a-service (Baas) part of the fintech operation has received much scrutiny recently, and has been described as a ‘downright mess’ by experts. This was unexpected, since Baas was the sector that promised a lot of potential until recently.

One of the key questions being asked within the industry is around the topic of oversight. In a complex triangle of banks, fintech developers and regulators, there is often confusion around who should be responsible for ensuring efficiency and compliance.

“The banking agencies should educate consumers about what makes a bank a bank.”

The Bank Policy Institute and the Clearing House Association

Finding an answer has remained a challenge so far, partly due to the different nature of the actors within the triangle. For example, developers want to be left alone to do their job of developing technology. Regulators on the other hand need to keep an eye on things, to make sure that any technological advancement and its application falls within regulatory frameworks.

Banks are often stuck in the middle. On the one hand they want the technology they need to provide services to customers. Operational costs are often the key factor behind the shift from traditional human resources to fintech. But, at the same time, they have to comply with the law, and make sure that the technology they use does not cross any regulatory redlines.

Who should take the blame?

So, when things go wrong, which they often do in a sector with high operational, technological and legal complexities, there is often a lot of blame gaming and scapegoating.

Regulators can find it tempting to point fingers at the banks for not choosing the right technology. Banks on the other hand can expect regulators to share some of the burden when it comes to fintech oversight.

In the wake of the Synapse collapse, a number of US agencies, including  the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, and the Federal Reserve have sent out a request for information on bank-fintech working arrangements.

“Bank-fintech arrangements can provide benefits; however, supervisory experience has highlighted a range of potential risks with these bank-fintech arrangements,” the notice says.

In response, the Bank Policy Institute and the Clearing House Association have called on regulators to review their approach towards oversight and work closely with the banking sector to ensure more efficient risk management.

In a joint letter they have said: “The current approach, in which the agencies place all responsibility for ensuring appropriate fintech risk management on the banks, suggests that compliance is primarily a ‘bank issue’ and need not be a major concern for the fintech.”

And what about the fintech industry? Well, it has asked regulators to see the positives in its work. CEO of the Financial Technology Association, Penny Lee, has stressed that bank-fintech working arrangements are already subject to oversight by the bank’s regulators.

She has also warned that any new rulemaking “could cut off access to innovative financial services for tens of millions of consumers, small businesses, and entrepreneurs.”

Working together?

So, can all the stakeholders come and work together to ensure efficient risk management in a sector that is linked to the lives and well-being of millions of individuals around the world? There seems to be a willingness to do so, at least on paper.

Regulators in the US agree that “bank-fintech arrangements can provide benefits.” They also stress that they support “responsible innovation.” However, they insist that any innovation should happen “in a manner consistent with safe and sound banking practices, and with applicable laws and regulations, including consumer protection requirements and those addressing financial crimes.”

“We urge regulators to reconsider rulemakings that could cut off access to innovative financial services for tens of millions of consumers.”

Penny Lee, CEO, Financial Technology Association

There is a similar tone from regulators in the UK. Emily Shepperd, Chief Operating Officer and Executive Director of Authorisations at the UK FCA, said last year the UK was “the most attractive destination for financial technology investment in Europe.”

She stressed that: “Regulators can help firms innovate by setting firm foundations on which they can grow. The sooner firms get a handle on regulatory issues, the sooner they can thrive and grow.”

And the banking industry seems to agree with this approach. The Bank Policy Institute and the Clearing House Association have said: “We believe the combination of direct agency oversight of fintechs and consumer education is imperative to achieve our shared goal of effective fintech risk management,” 

They have also recommended that “(1) regulators should regulate fintechs, (2) loopholes used by fintechs to engage in regulatory arbitrage should be eliminated and (3) the banking agencies should educate consumers about what makes a bank a bank.”

The International Monetary Fund also stresses that the rapidly growing fintech industry poses a challenge to both banks as well as regulators around the globe.

But the agency has a simple piece of advice to ensure efficiency and compliance. “Policies that target both FinTech firms and traditional banks proportionately are needed. This way, the opportunities that FinTech offers are fostered, while risks are contained,” the IMF has said.

And that combination of working together as well as proportionate policymaking is, perhaps, the best way of moving forward in a sector that is complicated, widespread and unpredictable.