Banking and Finance Law Daily Bowman explores interaction between innovation and regulation for community banks
Monday, February 10, 2020

Bowman explores interaction between innovation and regulation for community banks

By J. Preston Carter, J.D., LL.M.

The Fed Governor looks forward to a regulatory environment in which guidance is clear, supervisors are appropriately flexible, and due diligence and third-party evaluations are appropriately scaled.

Federal Reserve Board Governor Michelle Bowman presented her "vision for creating pathways to responsible community bank innovation," at the Conference for Community Bankers, sponsored by the American Bankers Association, in Orlando, Fla., on Feb. 10, 2020. In her prepared remarks, entitled "Empowering Community Banks," Bowman discussed the interaction between innovation and regulation for community banks. According to Bowman, "The successful integration of financial technology into the community bank business model is proving to be enormously valuable to enable community banks to enhance the services they’ve already proven they can deliver effectively."

Innovation. Bowman said responsible innovation, especially for smaller institutions, requires two key aspects: a clear idea of how the technology serves a bank’s strategic objectives; and a regulatory environment that supports innovation. Responsible innovation begins with a bank’s strategy, she said. Banks need to identify their goals and then look to identify the kinds of products and services that can help them move forward to implement that strategy. Bowman added that regulators and supervisors can contribute to an environment where banks are empowered to achieve these strategic objectives by simplifying and clarifying the process of third-party selection, due diligence, and monitoring.

Third-party selection. The Fed Governor said the selection of a third-party provider can be challenging for community banks, given a lack of information about potential partners when many firms, and their product offerings, are new. Bowman believes the Fed could help banks make this choice by publishing the list of service providers subject to supervision by the agencies and increasing transparency around the "who and what" the Fed evaluates.

Due diligence. Once banks seeking to innovate have navigated the selection process and identified a partner, they face a complicated due-diligence process, Bowman said. Regulators and supervisors have a role in easing the burden of that process for community banks, she added, by implementing clear third-party guidance that is consistent across all regulatory agencies. That guidance should allow banks to conduct shared due diligence on potential partners. It should also explain what due diligence looks like for a potential fintech partner, because the standards applied to other third parties may not be universally applicable. Bowman believes that to give community banks a better picture of what success in due diligence looks like, and where it begins and ends, the Fed should release more information on its necessary elements.

Monitoring. Once due diligence has concluded, Bowman said, the evaluation of third-party relationships is not over. Monitoring can take weeks of work every year for community bank employees. Regulators and supervisors have a role to play in ensuring that the burden is tailored to bank size, risk, complexity, and capacity. Bowman has encouraged Fed staff to consider options for further tailoring expectations for community banks with assets under $1 billion in this area. "We should be mindful that when we apply the same expectations to banks with starkly different asset sizes, we are creating the same workload for a bank with about 30 employees as for a bank with roughly 180 employees, even though their resources and risk profiles are quite different," she said.

In her concluding remarks, Bowman looked forward to creating "a regulatory environment in which community banks are empowered to innovate, in which supervisors leverage their own knowledge to help banks understand what to look for in a service provider. It’s a regulatory environment in which guidance is clear and supervisors are appropriately flexible, and due diligence and third-party evaluations are appropriately scaled."

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