What Fintechs Need to Know About Risk Before Opening FBO Accounts

Choosing the right BaaS provider could help reduce risk and fuel your fintech’s growth
Headshot of Sheetal Parikh
Sheetal Parikh
General Counsel & Chief Compliance Officer
October 22, 2021
Infographic showing various aspects of FBO navigation

If you want to avoid any unnecessary regulatory scrutiny for your fintech startups, it’s important to understand the features and risks related to the specific bank accounts and their frameworks. 

By choosing the right banking as a service (BaaS) provider, you can ensure that you can manage these risks successfully as your business matures. 

Watch our on-demand seminar, "The 5 Critical Elements of Compliance for Fintechs."

How do BaaS providers facilitate bank accounts for fintechs?

For nearly all fintechs, a bank account is the foundation of its product offering. If you want to offer financial services directly through neobanking, or indirectly through embedded banking products like card products or payment services, you need a bank partner in order to enable the product offering.

However, fintechs and banks have different systems that are often not compatible. BaaS providers like Treasury Prime connect these systems so that fintechs can link up with bank systems directly via APIs. These APIs allow fintechs to open accounts at one of the partner banks and build a wide range of banking products on top of the bank’s regulated infrastructure.

On-core vs FBO account — What is the difference? 

So how are these accounts structured?

BaaS providers like Treasury Prime enable two types of account opening models through the banking partner: on-core accounts and FBO accounts. 

What are on-core accounts?

An on-core account is an account that is opened directly in the end user’s name at the bank and works just like a traditional bank account. This can be a great option for your fintech because it allows you to leverage the bank’s expertise, policies and procedures. When the customer applies for an account on the fintech platform, the bank will ask the customer for pre-defined know your customer (KYC) information to verify identity, and the account will sit directly on the bank’s core banking infrastructure. Additionally, the funds will be eligible for FDIC coverage up to $250,000.

If you are a fintech that can benefit from leveraging the bank’s established policies and procedures, the on-core account is a great solution for your customers. Treasury Prime is unique in this product offering, as many BaaS providers do not provide on-core accounts. 

What are FBO accounts?

An FBO Account (For-Benefit-Of Account) is an umbrella fiduciary account that pools various funds “for the benefit of” a number of beneficiaries, such as end-users, without the fintech assuming ownership interest in the accounts. For fintechs that want to control more of the user experience and not leverage pre-defined bank processes, a fintech may choose to open an FBO account instead.

Choose an FBO Account for faster account opening process

The fintech company can open up the FBO account that sits on their partner bank’s core for the benefit of all of its customers, and use it to establish virtual accounts. In this scenario, the fintech’s end customer would have a sub-account (or “ledger” account) that sits within the umbrella FBO account. The fintech can then track these virtual accounts on a ledger with the support of its BaaS provider.

Deposits held by the customer as a beneficiary to the FBO account are FDIC-insured on a pass-through basis to the same extent as if the deposits were made directly, assuming specific requirements are met. 

Significantly, the fintech has no ownership interest in the FBO account and has no control over the funds. The bank maintains control over the funds at all times. 

This is how fintechs can make the case that they’re not engaging in money transmission activity. It's important because money transmission is regulated in all states (except Montana) and the laws require fintechs to obtain licensure to take custody of funds and transmit funds to third parties; a complex and timing consuming undertaking, unless they partner with banks. Because chartered banks are exempt from money transmission licensing requirements, many fintechs leverage the FBO account structure where the banks have custody of the assets; this allows the fintechs to open accounts more quickly.

Finally, because the FBO account holder is in some instances the fintech itself, often the level of KYC required could be less extensive than with on-core accounts. 

The decision to leverage on-core accounts versus FBO accounts is based on fintech preference as well as whether a particular bank partner prefers to have a direct relationship with end customers. 

How do banks perceive FBO accounts?

Banks and their regulators perceive FBO accounts to be potentially riskier than on-core accounts for two reasons:

  1. Historically, in instances where the account holder may be the fintech and not the end-user directly, there is generally less prescribed KYC collected during the onboarding process than the pre-defined bank process. As discussed in my last post, the level of KYC collected helps mitigate financial crimes and fraud. 
  2. Because the ledger accounts within an FBO are virtual, banks historically do not have direct visibility into these accounts through their ledgering tools and transaction monitoring systems. As such, bank partners often rely on support from the fintechs to understand and view transactions that flow through the FBO accounts.

Even though FBO accounts may inherently be riskier than on-core accounts, the risk is by no means insurmountable. With the proper level of oversight and transaction controls, bank partners should feel comfortable with having tools to regulate this level of risk. Just like on-core accounts, FBO accounts could be a valuable solution for fintechs.

Treasury Prime partners with Unit21 to offer transaction monitoring tools for both the fintech and the bank partner in connection with FBO accounts so that the bank partners have direct visibility into these transactions.

The risks of an intermingled FBO model

Some BaaS providers offer an intermingled FBO model through bank partnerships. In this particular model, the BaaS provider opens one FBO account for the benefit of all of its fintech end-users across various companies, rather than have each fintech open an FBO account with the partner bank directly.

The level of risk in this arrangement could be profoundly greater than the risk of a traditional FBO account. 

First, the level of KYC collected is a one size fits all KYC waterfall for all fintechs, as the account holder is the BaaS provider itself and not the fintech or the bank. What this means is that each fintech is adopting the same KYC waterfall established by the BaaS regardless of the use case and its customer base. Secondly, all customers across multiple fintech partners have ledger accounts within the same pool. 

If just one fintech partner or any single end-user presents a high risk, the entire portfolio could be subject to that same risk, which may lead to more accounts being scrutinized or even closed. This could jeopardize the entire line of business. 

Even more concerning to the fintech in this arrangement is the significant ledgering precision and reconciliation required in this model. Any slight ledgering error or calculation gap could require rebalancing and re-ledgering all ledger accounts or sub-accounts in the entire FBO account. This could potentially create a domino effect and impact the records and corresponding funds of a large number of accounts. 

This model may also present greater transaction monitoring challenges for a bank, as fintechs and corresponding transactions are all commingled into one large FBO account, making it harder to identify potential bad actors committing financial crimes.

When established responsibly, dedicated FBO accounts can be extremely valuable

Although FBO accounts may present a greater regulatory risk for banks and fintechs than traditional on-core accounts, they are extremely valuable in facilitating banking services for fintechs in collaboration with bank partners. 

Here’s how we do it at Treasury Prime:

  • A separate, dedicated FBO account is opened or enabled by each fintech at a partner bank
  • Appropriate transaction monitoring tools are integrated 
  • Adequate KYC is established for end-users and the fintech itself

With these features, an FBO model is often just as valuable as on-core accounts. 

Treasury Prime employs a comprehensive risk-based approach in its product offering and works with a network of bank partners in offering FBO accounts and on-core accounts to its fintech partners. The nuanced feature set and framework are incredibly important for both fintechs and banks as they seek to empower innovation while mitigating risks. Treasury Prime is unique in its product offering because it enables both FBO and on-core accounts, unlike many BaaS providers. You can compare the differences between dedicated FBO and intermingled FBO accounts.

Bottom Line

The labeling and structure of FBO accounts are critical to how banks and regulators assess the risk for a particular fintech. 

Even if a fintech is not directly regulated, it will absorb all the reputational and financial harm resulting from a potential regulatory action. Banks face the direct scrutiny of the regulators. In extreme cases, that could mean a shutdown of an entire business line. 

But fintechs should not fear the FBO arrangement itself. Rather, they should understand the implications of the frameworks and models using these accounts.

To learn more about the fundamentals of compliance, watch our webinar, “The 5 Critical Elements of Compliance for Fintechs,” on demand.

Please note that the contents of this post should not be construed as legal advice. To the extent you have specific questions related to the risks and structure of an FBO account, you should engage counsel to provide a legal opinion.

Think Treasury Prime might be the BaaS provider you’ve been looking for? Contact us here. Want to learn more about our process? View our API reference or play around with our Developer Sandbox. Many fintech programs and corresponding bank partners have not undergone regulatory exams or any level of regulatory scrutiny at a state or federal level when it comes to account structure. Yet the way these accounts are set up can drastically impact a fintech’s risk profile and its ability to scale in the future.

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