It’s no secret that fintech companies can easily get caught between a rock and a hard place when trying to grow their businesses. They know that getting their proposition into a bank is likely to be the only realistic way to achieve mass market scale and, crucially, deliver their backers the returns they expect on their investments. But they also won’t have to go far to find a fellow fintech with grisly war stories to tell about the bitter and brutal experience of trying to navigate a bank’s due diligence process, and demonstrate that they are fully compliant with all relevant regulations.
Some fintechs have been broken entirely by the process, and plenty of others brought close to the brink. But why is the process such a nightmare and what practical steps can fintechs take in order to minimise the risks, maximising their chances of securing a business-defining deal with a bank?
Why banks build barriers
Industry regulation and compliance rules are in a constant state of flux, making it a continual challenge for banks to understand, implement and abide by the latest requirements. Most currently adhere to the ‘three lines of defence‘ approach to defining roles, responsibilities and accountabilities for decision-making in order to stay on the right side of the line by achieving effective governance, risk management and assurance. When it comes to integrating innovation – for which there is genuine appetite in banks, if not always the expertise – the second line of defence, represented by their compliance and risk function, typically constitutes the biggest threat for banks that want to get genuine innovation into customers’ hands.
Distraction can lead to destruction
Of course, it isn’t just banks that are hampered by strict and ever-changing regulation; fintechs trying to provide the innovation to integrate face perhaps an even steeper uphill battle, given the strain that can be put on their resources by their efforts to comply with a regulatory framework often ill-equipped to accommodate them. Banks’ compliance divisions, for instance, are often bigger than the entire team at a fintech, however fast it may be growing. Even if you can successfully identify the right person to deal with about each separate element of compliance – from legal to commercial to personnel – there are often all sorts of other hoops to jump through. These jumps must be cleared in the right order and at the right time.Banks' compliance divisions are often bigger than the entire team at a fintech company Click To Tweet
Going through due diligence process with a bank can be a longwinded process, taking up to two and a half years. This elongated timeframe can be seriously detrimental to fintechs, taking key people’s focus away from their core work within the business. This can in turn create a vicious cycle, stalling the development of the very product they’re trying to sell into the bank, which only further lengthens the processes of brokering the partnership. Meanwhile, with all their eggs in one (admittedly potentially hugely lucrative) basket, fintechs risk letting other more immediately achievable opportunities pass them by.
Potentially the biggest problem created by this slowdown, however, is its impact on a fintech’s investors, who inevitably start to get twitchy about the company’s ability to deliver substantial returns on their investment the longer the process drags on. And with their lack of confidence in banks’ ability to deliver on promises they make about their commitment to innovation, even if a partnership is agreed, investors these days are unlikely to provide additional funding to support the slog through the due diligence process.
Maximising chances, minimising risks
Fortunately, there are several steps fintechs can take to smooth the rough edges of the bank due diligence process and minimise the potential for it to have a damaging impact on their business.
First, fintechs need to ensure that they build the right connections within banks. They must make it their focus to find out early on – if possible, before even embarking on the road towards due diligence and partnership – exactly who is responsible for which areas of compliance. By building solid relationships within the compliance team, fintechs will get a much clearer understanding of the fine details of a bank’s selection processes and red flags, making it easier for them to recognise whether their product is sufficiently relevant, stable and scalable for the bank to prioritise pushing it through due diligence.
Second, as largely unknown quantities, fintechs shouldn’t expect to be able to waltz into partnership with a bank through the front door. A more fruitful approach will be to find a trusted partner – a company, fintech or otherwise, that’s already in some way embedded in or partnered with their target bank – that can provide solid advice and guidance and help shepherd them through the process.Fintechs shouldn't expect to be able to waltz into partnership with a bank through the front door Click To Tweet
It will also be beneficial to find a way to fit their product around that existing partner’s offering and demonstrate the benefit of both solutions in combination. A common problem for fintechs is that they don’t have an end-to-end bank-ready solution in their own right. Rather than going it alone, they need to demonstrate how their product can ‘plug in’ to another solution that the banks are already using and familiar with.
Finally, fintechs with products aimed at selling through banks should aim to be “born ready”, focused on building a product and solution from the ground up with the requirements of the banking industry’s regulation and compliance in mind. Banks are often a fintech’s primary route to scale, so they need to be ready to understand and adapt to their requirements from the outset, as this will save time and energy later.
Winds of change?
Banks have been refining their long-term digital strategies for years, but now more than ever before, they are taking a proactive approach to finding and developing solutions that best serve the requirements and preferences of their customers. Rather than seeing fintechs as a threat, banks are looking at potential allies with the skills to plug gaps in their own offerings.
Much still needs to be done to make the due diligence process more palatable for fintechs, and with the FCA’s support for the introduction of regtech, perhaps we will start to see the hurdles to achieving compliance simplified.
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