How will the Fed’s new control rule impact collaboration with fintechs?

FED NOTES: Originally published in the Summer 2021 edition of Bank Owner magazine.

By Linda Anderson

On September 30, 2020, the revised regulations related to determinations of whether a company has the ability to exercise a controlling influence over another company for purposes of the Bank Holding Company Act or the Home Owner’s Loan Act became effective. The Board of Governors of the Federal Reserve System believes that the final rule will increase the transparency and consistency of the FRS’s control framework. As a result, this change should help to facilitate permissible investments in and by banking organizations by providing bank holding companies, savings and loan holding companies, depository institutions, investors, and the public with clarity of the “facts and circumstances” that the Federal Reserve considers critical when assessing control.

Financial technology, commonly referred to as “fintech,” dates back to 1949 when the credit card was invented. The term fintech gained popularity when online banking became mainstream. Over the past few years, the number of fintech startups has nearly doubled, increasing from 5,686 in 2018 to 10,605 as of February 2021. The Covid-19 global pandemic had a significant impact on this increase as businesses, including banks, were forced to embrace financial technology as a means for survival. The consumer’s manner of conducting business changed as shown by the increase in total transaction value of digital payments from $4.1 trillion in 2019 to $5.2 trillion in 2020.

With the increase of online business, Americans were well positioned to move to digital banking. In 2017, Federal Reserve Board Governor Lael Brainard discussed in her speech, “Where Do Consumers Fit in the Fintech Stack?” how advanced technology-enabled tools should help the average consumer manage their finances, particularly through the use of smartphones. A 2016 Federal Reserve survey of Consumer and Mobile Financial Services found that 87 percent of the U.S. adult population had a mobile phone — the vast majority of which were smartphones. The survey also showed that smartphones are being used for banking purposes: 62 percent of mobile customers use their phones for activities such as checking their account balances before making a large purchase.

According to Governor Brainard from a 2016 speech, consumers — particularly millennials —are accustomed to having a wide range of applications, options, and information readily available to them. In 2018, nearly 75 percent of millennials in the United States used digital banking, with an estimated usage increase to 77.6 percent by 2022. A survey from Jumio and Javelin Strategy & Research further showed in their findings that millennials use their mobile banking apps most often to schedule person-to-person money transfers, transfer funds between accounts, and check their transaction history. The same survey also found that millennials are most likely to seek convenience with mobile banking compared to Baby Boomers and Generation X. Based on recent trends, digital banking has reached across all age groups.

With the rise in fintech startups, banks have become concerned that the fintech industry may pose a threat to banking, especially as fintech companies explore ways to simplify banking products and processes for savings and lending. According to PricewaterhouseCoopers, 88 percent of incumbent financial institutions believe their business will be lost to standalone fintech companies in the next five years, primarily due to the speed of technological change. Factors that banks must seriously consider are their customer and the strategy for satisfying their needs, especially millennials. As the forerunners in the digital age, millennials are the generation with the greatest and increasing purchasing power.

The BankDirector 2019 Technology Survey findings showed the necessity for banks to streamline customers’ experience and improve efficiency as key for bank technology strategies. For 78 percent of survey respondents, improving the customer experience was a top objective

in driving their bank’s strategy related to investment, development and implementation of technology. The survey further showed that technology strategic objectives remained key in driving where banks were investing in technology: In 2019, 68 percent invested in automation and 67 percent invested money to enhance the bank’s digital channels.

According to the BankDirector 2020 Technology Survey, findings indicated an increased use of digital banking channels; almost all respondents stated the increase was related to the pandemic.

One way that banks have responded to the risk of fintech companies competing for portions of their business is to use and partner with fintech companies to meet customer needs. When structuring these partnerships, banks must be mindful of requirements in the BHC Act, including restrictions on bank holding company activities and application requirements for companies that control banks. The Federal Reserve’s new control rule will help BHCs and fintech companies understand the regulatory implications of their investments, contractual rights, and business interactions. Consequently, we would encourage organizations to consult

the rule early and often when considering new partnerships.

Linda Anderson is a Senior M&A Analyst with the Federal Reserve Bank of Minneapolis.

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