Podcasts
Podcast: Deep Dive into Depository Services in Bank Partnerships
Read Time: 8 minsIn this episode of our series of Deep Dives into financial services, we’re going to discuss bank programs, but instead of credit, we’re going to talk about depository services.
Rachael Aspery: Hi there, my name is Rachel Aspery. I’m an associate with McGlinchey’s Consumer Financial Services Compliance group. I’m joined today by Aaron Kouhoupt and Brian Fink, who are members of our CFS group here at McGlinchey. We’re excited to talk more about bank partner programs today. So Aaron, to start things off, are there any material differences between a bank partner program that provides credit products vs. deposit products?
Aaron Kouhoupt: No, generally not. Although, the good news is, there is much less in the way of licensing implications when talking about depository services than in the credit world. So if you’ve seen a prior episode of Deep Dives, or if you’ve just worked with us or in this space at all, in the credit side of the house, there are a variety of licenses that can be triggered when you are the non-lending partner. When you’re not the one originating the loan, there could be licenses for facilitation, licenses for servicing, and licenses for pretty much anything that you can think of, depending on the state.
On the deposit side, there’s not the same concept, although there is the same philosophy. From a philosophical perspective, there is still a requirement that the entity that holds a charter, a state or national charter, does the banking activities. So when we’re talking about, which is the same concept as lending, right? In the lending world, you don’t lend for the bank. The bank does the lending, and then the states have some licenses that will sometimes attach for your activities — the same thing here. You’re not going to be the party that actually holds funds, for example. The bank will be the entity that holds deposits.
In FinTech, for example, in a partnership program, the non-depository institution can’t hold consumer funds. Those funds are going to be held at a bank. Banks have a charter to do certain things. Only they can do those things.
Now, you can provide sub-ledgering services or marketing services or platforms just like you might do in a lending product where you are providing access to the funds that are being held by depository institutions. So, the same concept is there. There’s no material difference as it relates to only a licensed entity that can lend on the lending side. Only a chartered depository institution can do depository activities on the deposit side. That includes the advertising, which I think is pretty important. You can’t call yourself a bank unless you are a bank. So, you have to be careful not to hold yourself out as a bank when you’re partnered with that depository institution. It’s just like a loan, where you’ll say loans are made by our partner Bank X.
In FinTech, for example, in a partnership program, the non-depository institution can’t hold consumer funds. Those funds are going to be held at a bank. Banks have a charter to do certain things. Only they can do those things.
Rachael Aspery: So, there are some benefits to offering deposit services through a partnership model like this. Can you discuss more benefits and drawbacks to deposit services being provided via partnerships like these?
Aaron Kouhoupt: Here are the similarities between bank partner programs on the lending and deposit sides, which are similar, right? The idea is to let different parties do what they are best at doing. So banks know how to provide banking services and banks can provide banking services. Often, the non-bank partners are very good at a particular element, whether it’s technology, access to consumers to funds, whether it’s advertising, marketing online, or all of the different things that maybe a bank, especially a smaller bank, right?
It is very similar to lending products. If you’re a smaller bank that doesn’t have the resources to put into the marketing or the technology that would be necessary to compete with larger institutions, for example. Then, that’s sometimes an area where a partner can come in and provide that service. A technology platform that allows a smaller bank to compete without having to build their own internal product or have the resources that are necessary to build that up on their own. That’s a huge benefit, and it’s true for larger banks, too.
Larger banks will be able to focus on what they want to do and what they’re best at and allow the technology company to provide the technology, for example. The benefits are just allowing that flexibility, allowing the two different partners to do what it is they do best. The drawbacks are also similar in that if you’re not the depository, you can’t do the depository things.
We often hear people say, well, one of the benefits is that I can use the charter of the bank, or if it’s the lending product, I can use the license of the bank, whether we’re talking about licenses or charters, that’s not the way it works. You can’t use the charter. A bank can’t lease its obligations out. It can’t say I can do this; therefore, you can do it because I can. That’s simply not the case. The reality is, and this is a pro and a con, that, as I said earlier, the bank is going to do the banking things. You can’t do the banking things for the bank. The bank will do it; they can’t let you do it, but they can contract out to you and say, could you do this particular thing? And you know, Brian will talk in a minute about what that looks like from a compliance perspective.
Only a chartered depository institution can do depository activities on the deposit side. That includes the advertising, which I think is pretty important. You can’t call yourself a bank unless you are a bank. So, you have to be careful not to hold yourself out as a bank when you’re partnered with that depository institution. It’s just like a loan, where you’ll say loans are made by our partner Bank X.
But the tension there is that, as the non-depository, you won’t always have full control of the product. You’re not able to dictate where the product goes, for example, because it’s the bank’s product, and you’re a service provider to the bank. And that will be a lot of conversation and a lot of contract between the parties as to what that looks like. But if nothing else gets taken from this podcast, the most important thing to remember is that you can never borrow the charter. And if you are a bank, you can’t lease your charter out. If you have a charter, you can do certain things, and then you can contract with third parties to do some activities on your behalf. That’s where the compliance obligations will start to kick in.
Rachael Aspery: Brian, I understand that some recent guidance has come out regarding third-party management of service providers. How does that factor into a bank partnership program for depository services?
Brian Fink: Thanks, Rachael. The guidance largely lays out the framework that we are accustomed to and provides some additional detail, but there are a couple of aspects to this. The first is identifying the appropriate partner. Can they do the things that you want them to do? Do they have the technology, the people, the history complying with laws, and all the basics that will allow you to accomplish what you set out to accomplish? But then, once you decide who your partner will be, what will the contract say? Will it provide a way for you to monitor their performance? Will it set clear expectations? Will it have remedies and consequences for issues that may arise? And then a path to resolve those kinds of things. And if that’s impossible, then a way to go your separate ways. So, the contracts will lay out all those expectations and ways to resolve issues.
But if nothing else gets taken from this podcast, the most important thing to remember is that you can never borrow the charter. And if you are a bank, you can’t lease your charter out. If you have a charter, you can do certain things, and then you can contract with third parties to do some activities on your behalf. That’s where the compliance obligations will start to kick in.
Assuming all goes well, then on the bank side, there will be this ongoing monitoring to make sure that the responsibilities from the compliance and regulatory world are met, that the contract expectations are met, and that the services are provided in the way you expect, but also provided in the way that is consistent with the requirements of law. And that will not happen one time. That will happen essentially in a way that is responsive to the risk presented by those laws, the products and size of the customer base, and all those things that factor into risk. However, the monitoring should be consistent so that you can recognize an issue before it becomes a big issue. Technically, the final piece is that if things go poorly, people go their separate ways. Another aspect for both sides is making sure that the compliance management system (CMS) is almost independent of third-party oversight, but there’s a CMS component; we have these third parties. How do we maintain and measure compliance? Or are we doing what we’re supposed to be doing?
So beyond the diligence and the contracts and the monitoring and terminating when appropriate, you must ensure that your processes work. Yes, we are monitoring in a way that makes sense. Yes, we are finding issues when they exist and approaching them in the right way. A partner must understand that these expectations may be rigorous, perhaps even burdensome, and they are part of the deal. You get the benefit of being able to work with a bank to provide services that otherwise couldn’t be provided.
However, it also comes with the additional responsibilities of working with a bank and its charter and intense regulatory scrutiny, you get all of those too. Understanding that there’ll be some contractual requirements imposed on you by your bank, that you will have to demonstrate your compliance, that you’ll have to escalate issues that may exist and communicate those and be prepared to resolve them.
The first is identifying the appropriate partner. Can they do the things that you want them to do? Do they have the technology, the people, the history complying with laws, and all the basics that will allow you to accomplish what you set out to accomplish? But then, once you decide who your partner will be, what will the contract say? Will it provide a way for you to monitor their performance? Will it set clear expectations? Will it have remedies and consequences for issues that may arise? And then a path to resolve those kinds of things. And if that’s impossible, then a way to go your separate ways. So, the contracts will lay out all those expectations and ways to resolve issues.
That’s how this system is supposed to work and this process has to work. No one wants it, but the other side of it is, if these things don’t happen, then regulators have shown very consistently in the last year or so, they’re more than willing to engage in enforcement actions with banks and in respect to their partnership programs when things go awry. And largely, that could be monetary penalties or lots of engagement with your regulator. So it probably is a better option to focus on the not regulatory, not enforcement side of the equation, but focus on the CMS and focus on building all of the third-party oversight processes that are supposed to exist.
Aaron Kouhoupt: Thanks, Brian. Everything that you’re saying reiterates guidance that the regulatory agencies have talked about for a long time recently, reiterated by the banking agencies’ proposal. That’s out for comment right now. That talks about the importance of compliance management systems and third-party oversight and risk management, particularly when it comes to who’s holding the records, who is responsible for the compliance, and how you interact between the bank and the non-bank when regulatory obligations exist. You need to be sure that they’re being done and that access to the records is in the right spot. All these things play an important part in ensuring that the partnership and the program are such that everybody remains in compliance. And you almost can’t do that without a very strong compliance management system on both sides.
And so I know that as a former compliance officer, it’s a sweet spot for me. But those are important. You really need to understand those compliance management programs, and this guidance just reiterates that again, and it’s almost like the agencies are really trying to hammer this fact home. I’m so glad that you brought that up, Brian.
beyond the diligence and the contracts and the monitoring and terminating when appropriate, you must ensure that your processes work. Yes, we are monitoring in a way that makes sense. Yes, we are finding issues when they exist and approaching them in the right way. A partner must understand that these expectations may be rigorous, perhaps even burdensome, and they are part of the deal. You get the benefit of being able to work with a bank to provide services that otherwise couldn’t be provided.
Brian Fink: My pleasure.
Rachael Aspery: So, thank you both for the great overview and discussion of bank programs designed to deliver these types of depository services to consumers. It was great to hear the similarities and differences between typical lending bank partner program structure versus depository, the drawbacks, the benefits, and then also to get into really the expectations from a potentially contractual and regulatory expectations for third party management service providers, and really highlighting the importance of strong CMS between and among these programs. So Brian and Aaron, thank you both so much. Please contact us if you have any questions; we look forward to hearing from you. Thank you.
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