10 Considerations for Fintechs Partnering with Community Banks

As banking and technology become more integrated, banks are increasingly partnering with fintechs to expand their customer offerings. The rapid rise of these partnerships has generated questions for both banks and fintechs on how to manage resulting regulatory and financial risks.

On May 3, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency (collectively, “the agencies”) released final joint guidance for community banks on managing risks associated with third-party partnerships.¹ This guidance builds on previous interagency guidance for all banks entering into third-party partnerships, which we discussed in our June 2023 Fintech Flash.

Herein, we discuss the implications of this guidance for fintechs seeking to enter into partnerships with community banks.

Trends and Challenges for Fintech–Bank Partnerships

Although technology-driven banking services have been prevalent for decades, customer demand for digital access to banks surged during the COVID-19 pandemic. In part to meet this demand, banks turned to fintechs to facilitate digital offerings, commonly entering into banking-as-a-service (BaaS) partnerships, in which fintechs manage user experience while the bank holds the resulting deposits. In April 2024, we detailed considerations for fintechs entering into such partnerships.

These partnerships can blur the lines between fintechs and banks from the customer perspective, inviting regulatory scrutiny. In 2023, banks with BaaS partnerships accounted for 13.5% of prompt corrective action directives, cease and desist orders, consent orders, and formal agreements with federal banking regulators.² As a result, some banks have ended their relationships with third-party partners or more carefully considered fintech partnerships.

At the same time, partnerships with community banks present opportunities for fintechs. Community banks recovered well overall from the COVID-19 pandemic, and they hold a steady deposit base that is largely insured.³ However, community banks often lack the resources and personnel that may give larger banks a leg up in developing digital tools.

Fintechs can bridge this gap by developing these tools at scale and then partnering with community banks to implement them in ways that serve the bank’s needs. The agencies’ joint guidance provides a five-stage road map for community banks seeking to enter into such partnerships: (1) planning, (2) due diligence and third-party selection, (3) contract negotiation, (4) ongoing monitoring, and (5) termination. Below, we provide key takeaways from the guidance that fintechs can use to increase the odds of developing a successful third-party partnership with a community bank, particularly at the due diligence and third-party selection stage.

Key Takeaways for Fintechs

1. Develop a pitch. Before a community bank begins to seek out potential partners, they must define the underlying activity that the partner will perform. Given that some community banks may not have a history of partnering with fintechs or the resources to conduct an extensive search, a fintech can get a leg up by developing a clear marketing pitch for why its product will suit the bank’s needs.
2. Demonstrate expertise in the subject area. A community bank seeking a partnership will look for partners that can show expertise in the given subject area. A fintech should be able to provide a bank with a detailed proposal describing the proposed product, its past implementation (if applicable), and suggested modifications to meet the bank’s needs. A fintech should have experienced staff on hand to help draft these proposals, tailor the proposals to the bank, negotiate appropriate contract terms, and develop an implementation plan.
3. Show an ability to comply with applicable legal requirements. Community banks will look to a potential partner’s ability to comply with applicable legal requirements, including those relating to anti–money laundering and combatting the financing of terrorism, as well as consumer protection laws such as the Electronic Fund Transfer Act, the Truth in Lending Act, and the Equal Credit Opportunity Act. Fintechs should make sure they have relevant policies and procedures covering compliance with all applicable laws and regulations, a demonstrated history of compliance, and the necessary staff for compliance training and monitoring.
4. Demonstrate the ability to recover from disruptions. As part of the diligence process, community banks may investigate the performance of potential partners during past periods of financial stress or operational disruptions. Given that community banks may be especially risk-sensitive, fintechs seeking to partner with them should detail recovery efforts from any past disruptions and have a business continuity plan in place.
5. Seek to minimize, address, and track customer complaints. Community banks may ask potential partners about their customer complaint history, including the volume and nature of customer complaints. Fintechs seeking to partner with community banks should aim to minimize customer complaint volume, address complaints promptly, and track complaint status in a centralized database.
6. Have handy references and be aware of negative PR. As an initial step, community banks may ask for references and conduct internet searches to see if negative information exists about potential partners. Fintechs seeking to partner with community banks should have references on hand and be ready to promptly counter negative information, given that community banks with limited resources may move on to the next candidate if they discover issues.
7. Maintain a robust information security program. As part of a partnership, a fintech operating a customer-facing interface may be tasked with storing and transmitting a bank’s customer information. Given that community banks may be especially litigation-averse and may not have extensive IT resources, fintechs seeking to partner with them should demonstrate an ability to keep customer information secure and integrate their infrastructure with the bank’s.
8. Develop template contract terms. Once they have selected a fintech partner, community banks will seek to ensure that the partnership contract adequately addresses considerations including performance benchmarks, information-sharing, intellectual property, and data retention. Fintechs can simplify the contract-drafting process by having available template contract terms that can be tailored to the specific needs of the community bank partner.
9. Disclose operational changes. Once a community bank has entered into a third-party partnership, it may seek to keep abreast of operational changes at the partner, such as mergers, divestitures, or leadership changes. Fintechs should consider preemptively disclosing such changes to their partners to build trust and ensure a successful partnership.
10. Consider contingency plans. Inevitably, some partnerships will fail. Just as community banks will evaluate the risks of and develop a plan for termination of the partnership, fintechs should similarly plan for termination. Fintechs should consider contractual and legal liability for breach of partnership terms and ensure that termination of the partnership could be done in an orderly manner with limited risk to overall operations.

Conclusion

If you are considering entering into a bank partnership, Goodwin’s fintech team has experience guiding fintechs in all types of bank partnerships, including those involving lending, alternative finance, payments, deposits, insurance, broker-dealers, and investment advisers. For specific recommendations relating to a partnership or if you would like additional information about any of the issues discussed in this Flash, please reach out to Andrew Kliewer or the Goodwin lawyer with whom you typically consult.

Goodwin’s Fintech Team
We practice in every fintech vertical, including lending, alternative finance (e.g., merchant cash advances, earned wage access, and factoring), payments, deposits, insurance, broker-dealers, and investment advisers. In addition to doing product and service development regulatory work, we assist our fintech clients that choose to deliver their solutions through banks in entering into bank partnership and platform agreements.

^[1] Third-Party Risk Management, A Guide for Community Banks, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, and Office of the Comptroller of the Currency, May 2024.
^[2] Yizhu Wang and Thomas Mason, “Small group of bank-as-a-service banks logs big number of enforcement actions,” S&P Global, January 23, 2024.
^[3] Alex Graf, “Community banks’ deposit bases hold steady, seen as ‘safe haven,’” S&P Global, March 24, 2023. 

This informational piece, which may be considered advertising under the ethical rules of certain jurisdictions, is provided on the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin or its lawyers. Prior results do not guarantee a similar outcome.