Fintech and MSBs: Unlocking Opportunities for Banks

Introduction to Fintech

Fintech, short for financial technology, encompasses a broad spectrum of innovative solutions that leverage technology to improve and automate financial services. In today’s rapidly evolving financial landscape, fintech has become a key driver of efficiency, accessibility, and customer-centricity. From mobile banking apps to digital payment platforms and blockchain technology, fintech solutions are reshaping how people manage and interact with their finances. This transformation is crucial for modern banking, offering banks new ways to serve customers, enter new markets, and stay competitive. By integrating fintech, banks not only streamline operations and improve customer experiences but also enhance their competitive edge by entering new markets and adapting to evolving consumer expectations. Importantly, this transformation enables financial institutions to bolster their compliance frameworks and risk mitigation strategies, ensuring adherence to the increasingly complex regulatory requirements that accompany technological advancements.

The Evolution of Money Transfer

While the concept of fintech feels contemporary, its roots stretch back to ancient times. The earliest forms of financial technology included Rai stones, cowry shells, and early forms of coinage, leading to paper currency. In the 17th century, checks were introduced in America, paving the way for more sophisticated financial instruments. The development of the Federal Deposit Insurance Corporation (FDIC) in 1934 restored confidence in banking during the turbulent times of the Great Depression. Check cashing, which began in the 1930s, continues to be an essential service for many, offering convenience, clear terms, and insurance against potential bank overdraft fees.

Financial systems have evolved from ancient barter systems to modern telegraph-based methods. In the 7th century, systems like Hawala were established, leading to Western Union’s introduction of telegraph-based money transfers in 1851. The digital age brought electronic fund transfers through ACH, wire transfers, and digital payment operators like PayPal, Venmo, and Remitly. In the last decade, cryptocurrencies have emerged, allowing for the transfer of value through immutable blockchain-based systems.

Banking Fintech

With the growth of fintech and MSBs, banks have more opportunities than ever to serve the diverse needs of individual consumers and businesses. However, all these innovations depend on the stability and safety of well-managed banks with robust risk mitigation practices. Banks with excellent boards and strong executive management, supported by effective compliance and operational teams, are well-positioned to capitalize on the opportunities offered by fintech and MSBs. Providing services to fintech firms, many of which are MSBs, can be rewarding for banks that approach it with a well-defined risk management strategy.

Modern Fintechs

Financial technology (Fintech) represents the integration of technology into financial services, offering innovative solutions that compete with traditional financial methods. Fintech companies often lead with innovation, introducing new products and services that improve quality, speed, and accessibility for consumers and businesses. These solutions can be tailored to specific market needs, contributing to the ongoing evolution of the financial sector.

The fintech market is experiencing significant growth. According to Mordor Intelligence, the United States fintech market reached a size of USD 4 trillion in 2023, with a compound annual growth rate (CAGR) of 11% forecasted from 2024 to 2029. This growth underscores the importance of fintech partnerships for banks seeking to innovate and expand their services.

The widespread adoption of digital apps and services — reaching 88% of U.S. consumers — demonstrates the shifting landscape of financial services. The rapid growth in the number of fintech start-ups and the large segment of digital payments — valued at over USD 1.2 trillion — illustrates the market’s potential. However, this growth also necessitates careful oversight and compliance, reinforcing the need for fintech companies to establish and maintain effective compliance programs.

Given the potential for growth and innovation, banks with strong boards, capable management teams, and effective compliance programs can successfully participate in this lucrative market. A key aspect of these partnerships is ensuring compliance and risk management practices align with regulatory requirements, protecting consumers and ensuring stable and compliant operations.

Fintechs and MSBs

Many fintech companies are structured as money services businesses (MSBs), requiring registration with the Financial Crimes Enforcement Network (FinCEN) and applicable state licensing. Compliance with these regulations is crucial for legal operation and helps ensure consumer protection. Fintech companies without proper licensing may face legal consequences, and banks should verify the regulatory compliance of fintech partners and customers before engaging in business relationships.

Under the Bank Secrecy Act (BSA), an MSB is defined as any business engaging in one or more of the following activities:

• • Currency dealing or exchanging

• • Check cashing

• • Issuing traveler’s checks, money orders, or stored value

• • Selling or redeeming traveler’s checks, money orders, or stored value

• • Money transmission

• • U.S. Postal Service operations

The definition of money transmitter, including providers of cryptocurrency services, does not have an activity threshold, meaning that any business engaged in fund transfer, regardless of the transaction volume, falls into this category. Many fintech companies operate as money transmitters and must comply with BSA/AML and OFAC (Office of Foreign Assets Control) regulations.

Fintech Companies and Compliance

Fintech companies must establish and maintain sound risk-based BSA/AML and OFAC compliance programs to meet regulatory requirements. These programs should include comprehensive risk assessment, customer due diligence, effective transaction monitoring, and timely reporting of suspicious activities. Compliance also extends to ensuring strong consumer protection measures, including clear disclosure of terms, secure data handling, and effective dispute resolution processes.

Banks looking to work with fintech companies should assess their prospective customer’s registration and licensing status, their risk assessment and compliance programs to ensure alignment with regulatory expectations as well as their own risk appetite. A robust compliance program can mitigate risks and foster trust between banks and their fintech partners. Additionally, fintech companies operating as third-party service providers to banks must comply with the oversight requirements of their sponsoring financial institution.

Strategic Benefits of Banking MSBs

Banking MSBs can offer significant strategic opportunities and benefits, including:

1. 1. Strengthening Compliance, Risk Mitigation, and Governance:  Successful partnerships with MSBs require banks to rigorously assess risks and strengthen their own compliance, risk mitigation, and governance processes. This leads to enhancements in risk assessment, compliance controls, governance structures, and employee training. The process of refining these areas can bolster the overall operational strength of the bank and drive excellence across various departments.

1. 1. Diversification of Client Portfolio:  By adding MSBs and fintechs to the bank’s customer portfolio, banks can reduce concentration risk and increase the stability of earnings through diversification. This diversification can create a more balanced client base, mitigating risks associated with over-reliance on a single type of customer. However, banks should be selective, focusing on specific MSB types that align with their risk appetite and compliance capabilities.

1. 1. New Revenue Streams:  Serving MSBs can open new revenue channels for banks through transaction fees, float income, cash management, lending, and account compliance oversight. This additional revenue can support the bank’s growth initiatives and provide a competitive advantage in a challenging market.

1. 1. Enhanced Innovation:  Partnerships with fintech-oriented MSBs can bring new technologies and innovative practices to the bank. These collaborations can lead to the development of new service offerings and improved risk mitigation strategies. For example, banks might leverage fintech’s agility to adopt new digital solutions, enhancing customer experiences while maintaining compliance with regulatory requirements.

When considering these benefits, banks should remain cognizant of the risks associated with MSBs and ensure their compliance programs are robust and effective. By strategically approaching MSB partnerships, banks can capitalize on the potential benefits while mitigating inherent risks.

Preparation for Successful Partnerships

Before banks consider expanding their services to markets with non-traditional risks like Fintechs and MSBs, they must conduct a thorough self-assessment. This process involves examining the bank’s compliance and risk management culture, leadership and governance practices, expertise and training, technological readiness, and financial capacity to support such expansions.

Self-Assessment and Risk Evaluation

Banks must recognize that they cannot serve every market or customer segment. It’s critical to define a clear risk appetite and carefully evaluate market opportunities to determine which ones align with the bank’s capabilities. This assessment should consider several factors:

• • Compliance and Risk Management Culture: A strong culture ensures that the bank can effectively handle the compliance requirements and risks associated with MSBs and fintech.

• • Leadership and Governance: The board and executive team should demonstrate a solid understanding of compliance and risk management.

• • Technological Readiness: The bank’s technology infrastructure should support the complexities of MSB and fintech partnerships.

• • Financial Willingness: Adequate resources should be available to invest in compliance, training, and technology upgrades.

Once a bank decides to engage with Fintech and MSBs, it must approach partnerships selectively, focusing on companies that align with its risk profile. Keys to selecting suitable partners include character, compliance, capacity, capital, collateral, commitment, contribution, capabilities, communication, and conduct. These factors help ensure that the bank forms partnerships with companies that meet high ethical and operational standards.

The Importance of Knowledge and Training

Given the risks associated with banking MSBs and fintech, banking staff will likely require additional training to ensure effective compliance and risk management. Comprehensive training programs and resources can help banks navigate these challenges. Recommended sources for knowledge and training include:

• • Professional Associations: Organizations like the Association of Certified Financial Crimes Specialists (ACFCS) and the Association of Certified Anti-Money Laundering Specialists (ACAMS) offer extensive training and certification.

• • Industry Associations: Groups like the Money Services Business Association (MSBA), The Electronic Transactions Association (ETA), INFiN—a Financial Services Alliance, and The Money Services Round Table (TMSRT) provide valuable resources and networking opportunities.

• • Industry Conferences: Events such as CrossTech and those hosted by the Money Transmitters Regulatory Association offer insights into industry trends and best practices.

Banks can also learn from discussions with bankers who have experience in the Fintech and MSB market. Engaging with peers can provide practical insights and help banks develop effective compliance and risk management strategies.

Expanding into Fintech and MSBs: The Way Forward

Expanding banking services to include Fintechs and MSBs presents promising opportunities for revenue growth, portfolio diversification, and enhanced innovation. However, these opportunities come with significant regulatory and compliance challenges that banks must navigate. Establishing stringent compliance measures and maintaining robust risk management practices are critical to success in these sectors.

With meticulous planning and a well-structured compliance strategy, banks can capitalize on the dynamic nature of Fintech and MSBs while ensuring they meet regulatory requirements. It’s essential to maintain a risk-based approach and a commitment to continuous learning and improvement.

Taking the Next Step

To learn more about banking Fintechs and MSBs, consider exploring educational resources that can help you understand the intricacies of this sector. A great starting point is the MSB Banking Certificate Program, offered by the Money Services Business Association (MSBA) in partnership with BankerCollege powered by BankersHub. This course provides an in-depth look at the principles of vetting, underwriting, and onboarding MSB relationships, equipping you with the knowledge to make informed decisions about entering this market.

If you’re a banker seeking to explore new revenue streams and advance your institution in a risk-based manner, this certification course can guide you through the critical steps of establishing and maintaining successful MSB partnerships.

Disclaimer:

This blog post is intended for informational purposes only and does not constitute legal, accounting, or professional services advice. Our team of professionals with expertise in BSA/AML and OFAC compliance uses AI tools like ChatGPT to support our writing process in different ways. Sometimes, AI is used to improve upon a draft we’ve written, while other times, it’s employed to synthesize and combine information from reputable sources, such as FinCEN, FFIEC, CFPB, FATF, and state regulatory bodies, around a concept or idea. In both cases, the final content is shaped and validated by professionals to ensure accuracy, clarity, and alignment with compliance standards. However, since each institution’s compliance needs are unique, we recommend seeking advice from qualified experts in legal, accounting, or compliance consulting. The effectiveness of the strategies and practices discussed depends on your institution’s specific risk profile and tolerance, so customization is advised.

Jay Postma, CAMS, CFCS

President of MSB Compliance Inc.

Associate Member of Money Services Business Association