In the popular HBO series “Game of Thrones” one phrase that is repeated often is “Winter is Coming”.   While the true meaning of that phrase will only be known at the time the show reaches its climax, it serves as an ominous warning that change is afoot. The same thing can be said in the banking industry; significant change is coming that will impact the business model of financial institutions.  This will be especially true for community and regional banks and credit unions. There are two forces that are bearing down on the financial services industry that are sure to bring about significant change.  These changes will dramatically impact the role of compliance.

From One Direction- A Significant Market with Needs

The first force that will impact banking is the large number of unbanked and Underbanked people in the united states. There are millions of potential customers who have either a limited relationship with financial institutions or no relationship at all as the FDIC showed inn their 2015 study of Unbanked and underbanked populations.[1]

The FDIC has defined Unbanked and underbanked as follows:

“…… many households—referred to in this report as “unbanked”—do not have an account at an insured institution. Additional Households have an account, but have also obtained financial services and products from non-bank, alternative financial services (AFS) providers in the prior 12 months. These households are referred to here as “underbanked.”[2]

Per the Corporation for Enterprise Development, there are millions of unbanked and underbanked households across the country.  For example, in 2010 the same organization estimated that 20% of the households in New Jersey are underbanked[3].     The number of unbanked and underbanked people that live within the service areas of financial institutions presents both an opportunity and a level of risk.  As the FDIC pointed out in there May 2016 study “Bank Efforts to serve underbanked and unbanked Communities” the whole banking community is better served when the level of trust and participation is increased[4].

Why are so Many Unbanked and Underbanked?

The FDIC asks similar of questions every year and the answers have been consistent.  Here are the key observations:

• The most commonly cited reason was “Do not have enough money to keep in an account.” An estimated 57.4 percent of unbanked households cited this as a reason and 37.8 percent cited it as the main reason.
• Other commonly cited reasons were “Avoiding a bank gives more privacy,” “Don’t trust banks,” “Bank account fees are too high,” and “Bank account fees are unpredictable.
• Perceptions of Banks’ Interest The 2015 survey included a new question asked of all households: “How interested are banks in serving households like yours?”
• The survey results revealed pronounced differences across households.
• Approximately 16 percent thought that banks were “not at all interested” in serving households like theirs, and the perceptions of the remaining 8 percent were unknown.
• Unbanked households were substantially less likely than underbanked or fully banked households to perceive that banks were interested in serving households like theirs. More than half (55.8 percent) thought that banks were not at all interested, compared to roughly 17 percent of underbanked households and 12 percent of fully banked households.

Ultimately, there are well over 50 million households in America that currently either don’t have a relationship with a bank or have only a minimal one.

In many cases, misperceptions from the point of view of customers and financial institutions keep them apart.  For far too long it has been an axiom that the costs of providing banking services for consumer accounts prevents an acceptable rate of return.  However, through the development and use of new technologies, the costs associated with consumer accounts has significantly declined.

Many of the unbanked and underbanked turn to Money Service Businesses (“MSB’s”) to transaction business. Both the check cashing and money remittance industries handle billions of dollars on an annual basis for their customers.  The fees available to financial institutions willing to provide bank accounts to MSB’s present a significant opportunity for income. Unfortunately, too many institutions still feel the sting of “operation chokepoint” a misguided attempt by regulators to drive MSB’s out of the financial services industry. Financial institutions willing to invest in the proper infrastructure to bank these customers have found the return to be worth the investment.

Without significant competition for the unbanked and underbanked households, financial needs are met by businesses that are predatory.  Financial technology (“Fintech”) companies have set out to change the landscape and to fill the need of this massive pool of potential clients. So far, these efforts have yielded products such as digital wallets, person to person networks (such as PayPal and Venmo), fundraising sites and even remote bill paying. Most recently, there are a number of fintech companies venturing in to the consumer and business loan arena.

From Another Direction- Technology

Advances in technology have made it possible for customers to enjoy many of the services of a bank without actually having a banking relationship. Using a smart phone coupled with software programs, from financial technical companies, people can have access to money at ATM’s, pay bills, receive payroll and buy things, all without having a bank account.

The fact that many of the products that are being developed by fintech companies can be delivered to smartphones should not be lost on financial institutions. The unbanked and underbanked may not have accounts at financial institutions, but almost all of them have a smartphone.   A large percentage of the people who fit into this category are millennials who have become accustomed to conducting business on their smart devices.

A growing number of institutions have recognized the potential benefits of working with fintech companies.  In late 2016, the firm Manatt, Phelps & Phillips, LLP, conducted a survey of banks that have engaged in partnerships with fintech companies and the results are enlightening. There were four key takeaways that are useful to everyone in the banking and fintech sectors when approaching the challenges that come with collaboration:

• Banks are on board with fintech. At 81%, the overwhelming majority of regional and community banks are currently collaborating with fintechs. In addition, 86% of regional and community bank respondents said that working with fintechs is “absolutely essential” or “very important” for their institution’s success.
• Lower costs + a better brand = a win-win. For regional and community banks, enhanced mobile capabilities and lower capital and operating costs were highlighted as the benefits of collaborating with fintechs. Fintechs named market credibility and access to customers in regional markets as the main benefits to partnering with banks.
• Data security remains a challenge. Both banks and fintech companies are highly sensitive to the ways in which data is shared and secured. This means extra attention must be paid to cybersecurity when the two sides collaborate—especially given the cultural mismatch that can exist between them. Despite the optimism among banks for collaboration, preparedness is a large concern. Almost half of regional and community bank respondents said they are just “somewhat prepared” or even “somewhat unprepared” for this kind of partnership.
• Regulatory concerns remain paramount. For banks and fintech firms, structuring relationships that are regulatory compliant, including, if required, prior regulatory approval, is critical to ensuring success and the opportunity to change the way financial services are ultimately delivered.[5]
• As partnerships with Fintech firms become more commonplace, so does the need for compliance staff who are fully versed in this area. Compliance staff fully versed in both fintech and regulatory requirements have/will become key figures in an institutions’ ability to offer fintech products that are successful and compliant.

“Winter” is definitely coming- will you be ready?

[1] Estimates from the 2015 survey indicate that 7.0 percent of households in the United States were unbanked in 2015. This proportion represents approximately 9.0 million households. An additional 19.9 percent of U.S. households (24.5 million) were underbanked, meaning that the household had a checking or savings account but also obtained financial products and services outside of the banking system.

[2] FDIC survey of unbanked and underbanked households

[3]See https://cfed.org/assets/pdfs/Most_Unbanked_Places_in_America.pdf  June 2016

[4]Bank Efforts to serve underbanked and unbanked Communities

[5] Fintech comes to Regional and Community Banks- Fintech Finance 2017.