The Takeaway — Treasury Report, Shadow Banking Loopholes
Welcome to our first edition of The Takeaway for 2023. Every first Tuesday of the month we compile some of the most important and interesting embedded finance, fintech, and banking news stories and tell you why they matter. If you’re interested in revisiting some of our top stories from 2022, read our December issue of The Takeaway here.
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1. New report on bank-fintech relationships:
The United States Department of the Treasury alongside the White House Competition Council recently released a report with findings and recommendations associated with the rising popularity of the bank-fintech relationship. As more and more non-banks enter the market to offer financial services to their end-users, the government report cautions against the possible dangers this surge poses to consumers and the added regulatory pressure it gives to banks and insured depository institutions (IDIs).
Because regulatory parameters have yet to be solidified, the report warns that non-bank entities like fintechs, who race to offer attractive embedded financial services, can take advantage of regulatory loopholes, exposing consumers to more risk in the form of data breaches.
The report outlines, “When done responsibly, bank-fintech relationships can be beneficial for competition and consumers. However, the increasing variety and complexity of these relationships highlight the need for a clear and consistently applied oversight framework to reinforce the bank regulatory perimeter and protect consumers.”
To maintain consumer safety and the integrity of the market, the report recommends that a regulatory perimeter should be standardized and applied to the bank-fintech relationship, non-bank entities should be subject to the same regulatory standards as their partner IDIs, and regulators should have a “robust” and vigilant eye on bank-fintech relationships.
The Takeaway: Federal regulators are increasingly expressing more concerns over the growing popularity of the bank-fintech relationship — and scrutiny will only continue as some experts say the banking as a service industry could top $74 billion before the next decade.
It’s become clear that as regulators scrutinize the industry more, not only will bank partners have to abide by regulations, but their fintech and enterprise clients will be on the hook as well. As regulators have voiced, if it looks and functions like a bank, it should be regulated as such.
The best way forward for fintechs who are currently working with a bank or are looking to do so is to take an active role in their compliance and be prepared for any regulatory changes coming down the pike. Work with an embedded banking software platform that not only provides the functionality to integrate with a bank, but one that empowers your business to build a scalable regulatory framework.
At Treasury Prime, we equip our customers to build long-lasting regulatory frameworks that fit their business needs. We don’t absorb compliance or regulatory responsibilities as many of today’s middleware providers do. Learn why this is a key difference for the soundness of your business.
2. Hsu outlines OCC’s future plans:
Michael J. Hsu, Acting Comptroller of The Office of the Comptroller of the Currency (OCC) recently penned his thoughts on the changing landscape of American banking and the OCC’s efforts to have a “re-integration of banking services”.
Hsu finds that fintechs have found new ways to innovate the banking space to meet consumers’ changing behaviors driven by the pandemic. However, he says that fintechs have also found ways to avoid being directly regulated.
“While fintechs generally are subject to most of the same consumer-protection regulations if they offer covered products or services, some fintechs make technical—and questionable—arguments that their products or services fall outside the existing regulatory framework.” Hsu writes. “These differences create an unfair business advantage for fintechs over banks.”
In his assessment, Hsu says that proactive measures now will help ensure fair competition, consumer protection, and risk mitigation in the future. He says that the OCC has a five-year plan in place to address the changing bank-fintech relationship, and is approaching it with an “adaptive, open mindset”.
He is also calling for regulators and governmental bodies to work together, and with, as he puts it, “less regulatory competition, less parochialism, [and] less go-it-alone independence”. The federal agency is already working on a plan to “subdivide bank-fintech arrangements into cohorts with similar safety and soundness risk profiles and attributes, mapping out the risks and risk-management expectations.”
Hsu also advocates for asking the right questions — should banks and fintechs be regulated in the same way? Is enforcing a regulatory perimeter meant for banks on fintechs the right solution? While the answers aren’t yet clear, Hsu is confident that the next handful of years will be pivotal in determining just how banks and fintechs work together responsibly.
The Takeaway: The OCC has already announced an Office of Financial Technology set to oversee the bank-fintech relationship and with Hsu historically advocating for stricter oversight of the industry, it’s likely there will be more codified regulatory changes.
Despite how popular embedded banking has become, it is still a relatively new and unstudied sector. Banking as Americans have known it has stayed relatively the same, but with the introduction of fast-moving technology platforms, consumers are learning how to interact with their finances in a completely new way. This has made it difficult for regulators to keep up and has forced them to work collaboratively to figure out the best way to ensure compliance.
Because of this, fintechs and enterprises must stay vigilant. It can be very attractive, particularly for smaller organizations, to want to offload compliance responsibilities to a banking as a service provider, however as we’re seeing, that’s simply untenable. As regulators eye the space more intensely, having no active role in your business’ compliance only does it a disservice in the long run.
“The reality of this space is that it's so regulated, partly because you're dealing with people's money and people's data,” Treasury Prime Associate General Counsel and VP of Compliance Sheetal Parikh said. “These two areas are so highly protected and regulated that this idea of, ‘I don't want to deal with it,’ or ‘I want somebody else to do it for me’ is not a sustainable model in the long run because regulatory compliance is inextricable to the core of a fintech’s business.”
Why is compliance so important? Because it’s quickly changing and can be a make-or-break component of your business. Watch our on-demand webinar featuring the former chairman of the FDIC to learn more.
3. Shutting down “shadow banking”:
Soon after Elon Musk announced plans to add payment services to Twitter — going so far as to register as a payments processor with the Treasury — Senate Banking Committee Chairman Sherrod Brown introduced a bill called the Close the Shadow Banking Loophole Act.
The bill would prevent “industrial loan companies” (ILCs) from acquiring full-service banks and operating as banking institutions, effectively offering banking services to customers without being regulated or subject to typical banking oversight.
Brown said in a press release that allowing large tech enterprises like Twitter and Meta to buy ILC charters "will only open doors for predatory lending, invasions of consumer privacy, and broader financial instability. To protect consumers' pocketbooks and ensure a strong banking system for Main Street, we need to ensure all banking institutions play by the same rules".
Supporters of the bill say that current permissions give tech companies an unfair advantage and also minimize the impact of smaller and community banks that have a vested interest in serving their local customers; tech titans would be less likely to focus on smaller communities.
Twitter, of course, isn’t the only company to want to become a payments processor aiming to get an ILC charter. It joins companies like Rakuten, Edward Jones, and Ford.
It is unclear when the bill may pass the senate.
The Takeaway: While our cofounder and CEO Chris Dean may not completely agree with Musk’s starting plans for embedded payments, it’s clear that regulators are keeping a close eye on every organization looking to work with or become a banking services provider. Not only can ILCs gain an unfair competitive edge against banks, but fintechs and enterprises as well that have fewer resources to compete.
There are no shortcuts to safely and compliantly offering embedded financial services as a non-bank entity. Working with a reputable embedded banking software platform enables your business to work directly with a bank quickly and easily, while also upholding the American banking system.
Working with an embedded banking platform like Treasury Prime enables your business to integrate with one or several bank partners, ranging from larger legacy financial institutions to smaller community banks.
Treasury Prime has a large growing multi-bank network that is 16 banks strong. There are major benefits to working with an embedded banking platform with many bank partners. Learn what they are.
4. Walmart-backed Fintech to launch BNPL:
No stranger to offering financial services in its own stores, including check printing and sending and receiving money, Walmart has taken a majority stake in One, a fintech working to provide a buy-now-pay-later (BNPL) service in as early as 2023.
While Walmart, the country’s largest private employer and grocery chain, already offers a BNPL in-stores and online (a replacement for its previously long-standing layaway program), One’s services would be available on the Walmart site as well as at other retailers, similar to existing BNPL players like Klarna and Affirm.
Representatives from Walmart say the push towards BNPL is a response to tighter purse strings during a bleak economic climate. BNPL may be a way for many Americans, particularly those who are now much more budget-conscious, to make their purchases a bit easier.
One operates as a private company despite being created by Walmart and an investment firm and is led by a Goldman Sachs vet. If trends continue, Walmart may continue purchasing or creating more fintechs as it has now come to own One and another fintech called Even since 2021.
The Takeaway: Walmart demonstrates one of the biggest benefits of embedded banking: Meeting your customers where they are.
Walmart knows that shoppers are less willing to make big purchases, not only at their stores, but everywhere. By offering a way for shoppers online and in-store to make their purchases in affordable installments, Walmart (and its affiliated fintech) stand to greatly expand its footprint by offering a service many customers will likely want and need.
There’s a reason why companies that embed financial services into their platform can increase revenue two to five times.
5. SAFE Banking Act goes up in smoke:
In yet another blow to the longstanding bill, the SAFE Banking Act did not make it on the docket for a $1.7 trillion government funding package. This effectively means that there will still be no cannabis banking reform in the United States.
The SAFE Banking Act, which would have safeguarded banks from working with cannabis businesses, has been kicked down the road several times since being introduced back in 2019. Cannabis business advocates say it's an unfortunate situation as it forces the already underbanked cannabis industry to rely almost solely on cash while opening up businesses to robberies and theft. Experts also say that without federal protections for banks, it undermines legitimate cannabis businesses — which are now legal in 39 states — and allows illegal trade to continue.
Despite this setback, critics are optimistic that there will be a better outcome for SAFE in 2023.
The Takeaway: Emerging industries like cannabis continue to gain in popularity while also simultaneously being embroiled in legal and regulatory limbo. It’s no wonder why many banks are wary of working with businesses and fintechs in this industry.
That’s why it’s becoming increasingly important for these businesses to find an embedded banking software platform that is powered by a large bank network. Not only does this increase the likelihood of finding a bank partner that is aligned with and willing to work with a cannabis company, but also helps to avoid a single point of failure.
As we’re seeing with the stalling of federal cannabis protections and the regulatory scrutiny sponsor and partner banks are experiencing, a banking-as-a-service platform that only offers relationships with one or a handful of banks can be quite risky for all involved.
Treasury Prime works with a variety of banks in its multi-bank network, including some that are open to a wide range of industries including cannabis. Contact us to learn more.