Banking organizations stay competitive by working with payment service providers (financial technology firms, or fintechs) through partnerships or contracts. Such relationships can help financial institutions serve a wider market without having to innovate from ground zero.
Expectations or demand from consumers and small businesses also drive innovation. In a statement to Congress
last December, Michael S. Gibson, director of Supervision and Regulation at the Federal Reserve Board of Governors, stressed that the Federal Reserve is receptive to innovation:
The Federal Reserve has not taken and does not take a position on who banks can offer services to, so long as they remain within the confines of the law. Banking organizations are neither prohibited nor discouraged from providing banking services to customers of any specific class or type, as permitted by law or regulation.
At the same time, banking regulators must ensure the safety and soundness of banks and credit unions. A banking organization can have multiple relationships, and each new partnership can introduce risk if not managed appropriately. Banking organizations or their service providers who have complex payment systems, crypto activity, or blockchain may want to take note of the Federal Reserve's new Novel Activities Supervision Program. This program aims to better identify and manage risks associated with four activities. All include innovative applications of payments and involve partnerships:
- Complex technology-driven partnerships, in which nonbanks, such as payments and fintech firms, provide banking services to end customers. This also includes payments messaging systems, which are important to instant payments.
- Crypto-asset-related activities include asset custody, lending, trading, and dollar token (or stablecoin) issuance or distribution.
- Distributed ledger technology—for example blockchain technology—could significantly affect the financial system. DLT can be used in payments for automation, clearing, and settlement and for issuance of dollar tokens.
- Banks concentrating on servicing crypto entities and fintechs make payments, deposits, and loans to these companies.
Of course, banking organizations and their service providers should have systems to identify, monitor, and control risks. Supervision is generally tailored to size, risk, and complexity. To better understand expectations and guidelines, a good approach would be to communicate early and often with supervisors about new programs and partners.
Risks from novel activities can affect a bank's entire infrastructure, whether from back-end liquidity and operational risks or front-end consumer compliance risks. Resources from the Fed that can help banking organizations and their service providers navigate these risks:
- Conducting Due Diligence on Financial Technology Companies - A Guide for Community Banks
- The Fed - SR 23-4: Interagency Guidance on Third-Party Relationships: Risk Management
- The Fed - SR 22-6 / CA 22-6 Engagement in Crypto-Asset-Related Activities by Federal Reserve-Supervised Banking Organizations
- The Fed - SR 23-8 / CA 23-5 Supervisory Nonobjection Process for State Member Banks Seeking to Engage Certain Activities Involving Dollar Tokens
By Lali Shaffer, payments risk expert in the Retail Payments Risk Forum at the Atlanta Fed