Compliance – Not Technology – Crowns FinTech Champions

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Technology advances have simplified the process to offer digital services through embedded finance. Any company can choose to pivot or complement its core business to become a FinTech, but succeeding takes more than technology alone, writes Vlad Lounegov, CEO of Banking-as-a-Service (BaaS) provider, Mbanq.

The Rise of FinTech

The march of human progress is visible through its technology, and I am privileged to have a close-up view of an industry that is pushing the boundaries of what is possible in business. FinTech is an industry moving at lightning speed, which disrupts traditional financial services through technology to improve the use and delivery of finance to consumers.

Progress and innovation in FinTech is in step with internet infrastructure and increases in computer power. Consumers have benefited from advances – from secure internet shopping and stock investing, to easy and cheap international payments and remittances, as well as blockchain-based smart contracts and cryptocurrencies.

Every aspect of peoples financial lives is in their pockets, on the go, secure, accessible and instant. All because technology has made it so.

It is also much easier and far less capital intensive to set up and operate a digital bank than before. Technology and operational costs have plummeted, and new markets have opened up across the USA and the rest of the peaceful world. Whether it is an unbanked, low-income segment of a nation, or a niche, highly-competitive industry sector, such as transport, music or crypto, a digital bank or Credit Union can step in to provide highly-targeted financial services.

Non-Finance is Waking Up to FinTech

The ease of implementing financial services, especially digitally, is not lost on established non-financial companies and organizations. Today, companies such as airlines, healthcare providers, supermarkets, clothing retailers, fast-food franchises, sports teams and educational establishments are waking up to the possibility of creating new revenue streams through a newly emerging FinTech trend – embedding financial services into existing product offerings.

Finance is a lucrative industry and the advantages of success are a clear temptation. Corporations already have relationships with an existing customer base and plenty of market data and industry knowledge. They can effectively predict what financial services their customers are interested in, and they already have the marketing processes to target consumers effectively.

Types of services they can offer include a mix of traditional and innovative – Buy Now Pay Later, checking accounts and debit cards, payments processing and foreign exchange, crypto investments, various loans such as consumer, automobile or mortgage lending, and bundled products such as insurance, to name a few. All of these are profit powerhouses if implemented successfully.

Technology stacks to offer such services are already mature and accessible, in some cases off the shelf, from FinTechs, so there is no need for a development team or for huge operating budgets. Embedded finance requires relatively straightforward technology to implement and provides a big win if successful.

Regulators Are the Reality Check

However, despite the euphoria, embedded finance is actually far from being the new wild west of business for one simple reason – finance is a highly regulated industry.

All financial services in the USA, including banking and FinTech, are directly or indirectly regulated both at state and at federal level. For a company new to financial services, just making a list of financial regulators and understanding what they require is, quite frankly, a daunting endeavor.

For example, the organizations they need on-side include the Federal Reserve Board (FRB), the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), the Federal Financial Institutions Examination Council (FFIEC), as well as various State Bank Regulators, depending on where they are operating.

Additionally, applying for and being approved for a banking license or Credit Union charter is only the beginning of the journey because compliance is an ongoing process.

Reducing Regulatory Pain

Applying for a bank license or Credit Union charter, complying with laws to prevent money laundering, managing risk of fraud and monitoring lists of entities and individuals who are banned from engaging in financial activities in the USA are all highly specialized processes.

Luckily, just as the technology to create financial services now has a much lighter footprint and can be outsourced, so too can regulator relations and the compliance process as a whole. In some cases licensing itself can be simplified greatly by working with an established bank to provide a licensing shelter. Additionally, external teams of compliance experts can manage the entire day-to-day regulatory and compliance process.

In conclusion, I have observed that being mindful of the compliance process is just as important as choosing the right technology for operational success as a FinTech.

Just as technology has changed society, FinTech has changed the financial world and the businesses and consumers it serves. Businesses themselves are adapting to integrate FinTech into their product offerings as embedded finance. They have a choice of great technology options to integrate into their core offerings. But the real differentiator is the regulatory and compliance aspect. 

Those companies that seek to provide financial services need to be aware they are entering a highly regulated environment which serves as a great filter. Any mistakes are punished harshly – from fines to business closures and even to jail time. But don’t let that scare you, because regulators are a vital part of the financial safety mechanism.

In the spirit of the Financial Policy Council (FPC) insight and outlook – those that get it right will reap the rewards.

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Banks must find their Crypto courage

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Banks that were hoping the cryptocurrency industry might collapse and go away are once again showing concern as digital currencies rocket higher in a new bull market. On January 1st, 2019, the total market capitalization of the top 100 cryptocurrencies was $126 billion, climbing to over $240 billion as of November 1st, 2019. [https://coinmarketcap.com/]

News cycles still love to hype up the crypto industry, just as they did during the previous boom of 2017. And banks are asking themselves – how should we react this time around?

The short answer is that banks need to wake up to the opportunities that digital
currencies and a modern FinTech marketplace offer, rather than react with fear and rejection. Banks should take the initiative and develop a solid crypto strategy for a number of reasons:

  • Сrypto has proved it is not a flash in the pan. Volatility is a feature of the market, and investors show strong appetites in the good times and solid resilience during the bad. Bitcoin and other cryptocurrencies are here for the long term.
  • Numerous crypto businesses have felt the pain of being rejected by mainstream banks but would actually be profitable clients. Previously, banks did not want to get involved because they perceived crypto businesses as being resource-intensive and risky from a regulatory perspective.
  • Lastly, global mainstream interest and acceptance of crypto will continue to grow. Utility payments and coffee purchases can now be done with cryptocurrencies. Crypto ATMs are increasing in number.

Despite this fast-growing and largely untapped market, banks have taken a more nuanced view. Their caution is driven by regulatory uncertainty.

Control over currency circulation and use is an integral part of government monetary policy, providing levers for stimulating spending and investment, generating jobs, managing inflation and avoiding recession. No government will risk giving up these tools. Despite the appeal of cryptocurrency mass adoption, regulators will always act to restrict the amount of money circulating in an economy – virtual and otherwise.

The IRS treats digital currencies as property, but with a degree of suspicion that taxable gains from the growth of cryptocurrencies have been widely underreported. Even though Bitcoin does not currently have legal tender status in any jurisdiction, it may, in the future, make more sense to tax cryptocurrencies like regular money.

The cryptocurrency ecosystem is complex and rather opaque, with masked entities acting in a financial environment that quite often lacks legal recourse. Traditional financial institutions are understandably hesitant to endorse this new market and its technology. So change seems to be gradual and incremental. But modern banks should, at the very least, have these challenges on their radar.

This is because finance and technology are constantly developing to include crypto as part of their service offer. And banks should adapt to keep up with the times. The new cryptocurrency bull market means that banks should develop strategies and offers that welcome legions of new customers from all sectors of the digital currency industry. It is an opportunity too big to miss.

If banks are cautious about publicly endorsing the cryptocurrency industry, one solid approach would be to prepare behind the scenes for future changes, rather than risk getting caught flat footed.

Beefing up security, risk management and compliance is a never-ending arms race – and not just for banks. Big players in digital currencies, such as crypto exchanges and investment brokers also take great care to comply with stringent know your customer (KYC) and anti-money laundering (AML) regulations.

Banks should become comfortable working with the leading cryptocurrency institutions because many have proved themselves adept at dealing with evolved threats and a great number now also have a track record of compliance that is just as robust as that of banks themselves. Banks should examine, integrate and streamline cryptocurrency security and compliance procedures into their own systems.

Lastly, cryptocurrencies and the underlying blockchain technology they are built on can be useful for banks in other ways – such as acting as an asset bridge to quickly resolve cross-border payments. In fact, IBM World Wire recently showed that financial institutions can seamlessly connect existing payment systems to clear and settle cross-border payments in seconds, where previously such a transaction may have taken hours or even days.

Regardless of how the markets will turn in 2020, banks must calmly assess and implement long-term cryptocurrency strategies. Those banks who continue to keep their heads in the sand will be at a significant disadvantage compared to those who embrace the future.

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