Banking as a Service: A Comprehensive Guide to Regulatory Success for Banks and Fintechs

In the dynamic world of financial innovation, Banking as a Service (BaaS) represents both an extraordinary opportunity and a complex regulatory landscape. As banks and fintechs converge to deliver cutting-edge financial solutions, navigating compliance has never been more critical.

The partnership between banks and fintechs is transforming financial services, but it comes with a caveat: unprecedented regulatory scrutiny. Recent enforcement actions have made one thing clear: compliance is not optional—it's fundamental.

To that end, here are five tips for both banks and fintechs involved in BaaS activities, based on reputable industry guidance and recent regulatory developments.

Banks: 5 Strategic Compliance Imperatives

1 - Ensure Robust Oversight and Due Diligence of Fintech Partners

• Regulatory Guidance: The OCC has emphasized the importance of strong oversight of third-party relationships. Banks must perform comprehensive due diligence on fintech partners, evaluating their compliance history, risk management practices, and financial health.
• Enforcement Example: The OCC's 2022 actions against banks with inadequate oversight of their fintech partners highlight the need for banks to implement continuous monitoring, not just initial vetting.

2 - Strengthen AML and KYC Programs

• Regulatory Guidance: FinCEN has warned that weak Anti-Money Laundering (AML) and Know Your Customer (KYC) programs in BaaS arrangements can result in significant penalties. Banks need to ensure that their fintech partners comply with AML and KYC rules, and that these processes are well-integrated with the bank’s own systems.
• Enforcement Example: Recent FinCEN actions against BaaS platforms that failed to prevent money laundering emphasize the need for banks to maintain a vigilant AML framework, particularly with respect to customer onboarding and transaction monitoring.

3 - Define Clear Roles and Responsibilities Under SLAs

• Regulatory Guidance: Banks should establish clear Service Level Agreements (SLAs) with their fintech partners, defining roles, responsibilities, and accountability for regulatory compliance.
• Enforcement Example: The OCC has highlighted failures in responsibility sharing between banks and fintechs as a key risk in BaaS. Banks should define the scope of operations for fintechs and regularly audit these activities to ensure compliance with regulatory expectations.

4 - Enhance Data Privacy and Cybersecurity Measures

• Regulatory Guidance: The Federal Reserve and OCC require banks to have stringent data security practices, especially when partnering with fintechs. Banks should ensure their partners comply with data privacy laws like GDPR and CCPA, and that they have adequate safeguards against cyber risks.
• Enforcement Example: The Fed’s actions against banks with weak data governance in fintech collaborations show that weak data privacy protections can result in significant reputational and financial risks.

5 - Monitor for Compliance with Consumer Protection Regulations

• Regulatory Guidance: The Consumer Financial Protection Bureau (CFPB) has stressed the importance of protecting consumers in BaaS offerings, including transparency on fees, clear communication, and ensuring fintechs comply with Truth in Lending Act (TILA) and Fair Credit Reporting Act (FCRA) requirements.
• Enforcement Example: Recent regulatory scrutiny has focused on banks that fail to ensure their fintech partners provide consumers with clear and transparent financial terms, which can lead to enforcement actions.

Fintechs: 5 Pillars of Regulatory Excellence

1 -  Align with Bank’s Regulatory Framework

• Industry Guidance: Fintechs must ensure they understand and operate in accordance with the regulatory frameworks that govern their partner banks. This includes adhering to guidelines from the OCC, FDIC, and Federal Reserve, especially regarding safety and soundness.
• Enforcement Example: The OCC’s actions against fintechs failing to comply with regulatory standards demonstrate that fintechs must adopt a bank-level compliance posture, even if they are not directly regulated in the same way.

2 - Invest in Comprehensive AML and KYC Systems

• Regulatory Guidance: FinCEN has underscored the critical role fintechs play in preventing financial crimes. Fintechs need to implement strong AML and KYC protocols to prevent illicit activities through their platforms.
• Enforcement Example: Fintechs in the BaaS space have faced penalties for insufficient AML programs. Building sophisticated identity verification and transaction monitoring systems is crucial to avoiding enforcement actions.

3 - Maintain Transparent and Fair Consumer Practices

• Regulatory Guidance: The CFPB and OCC require fintechs to adhere to strict consumer protection standards, particularly in the disclosure of fees, interest rates, and other charges. Transparent communication with end customers about financial products is essential.
• Enforcement Example: Recent CFPB enforcement actions against fintechs have highlighted the need for clear and transparent consumer disclosures. Fintechs should ensure that all marketing and communication with consumers is compliant with consumer protection laws.

4 - Develop a Robust Incident Response and Cybersecurity Program

• Regulatory Guidance: Fintechs should align their cybersecurity measures with federal standards like the NIST Cybersecurity Framework. Strong encryption, access controls, and incident response plans are necessary to protect sensitive financial data.
• Enforcement Example: Federal regulators have increasingly focused on fintechs that fail to protect consumer data. A breach or mishandling of data can lead to costly enforcement actions and erode consumer trust.

5 - Establish Clear Compliance and Risk Management Governance

• Industry Guidance: Fintechs should build a governance structure that includes a Chief Compliance Officer (CCO) and Risk Management function to ensure compliance with applicable regulations. Collaboration with banks on compliance issues is critical.
• Enforcement Example: Regulatory enforcement actions, such as those from the OCC, often target fintechs that lack structured compliance programs. Having a formal compliance and risk management team ensures fintechs can meet regulatory expectations in a BaaS context.

The Road Ahead: Collaborative Compliance

Success in the BaaS ecosystem demands more than just meeting minimum standards. Both banks and fintechs must navigate the complex and evolving regulatory landscape of BaaS by adopting best practices in compliance, consumer protection, data security, and risk management. Recent enforcement actions by the OCC, Fed, and FinCEN serve as a stark reminder of the importance of strong oversight, transparency, and adherence to federal regulations in these partnerships. By staying proactive and aligned with regulatory expectations, both banks and fintechs can mitigate risks and foster successful collaborations in the BaaS ecosystem.

Bates Group offers comprehensive consulting services that can be invaluable for banks, Money Services Businesses (MSBs), and cryptocurrency companies navigating the complexities of Banking as a Service (BaaS). Our expertise spans a wide range of areas crucial for effective risk management, including AML compliance, regulatory advisory, and risk assessments. Bates Group’s consultants can help institutions develop and implement robust compliance programs tailored to their specific needs, ensuring adherence to regulatory requirements such as those outlined by FinCEN and other relevant authorities. We also provide training and education programs, as well as ongoing support for audits and monitoring processes, helping businesses stay ahead of emerging risks and regulatory changes.

Learn more about our Compliance services for banks, MSBs, and Fintechs