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The Partnership Series – Volume Three: Fintechs, Big Data, and Third-Party Risk Management

partnerships in financial services

As discussed in previous posts in this series, the degree of collaboration within a financial institution’s technology partnerships will play a significant role in determining future success.

While there are advantages to partnering with fintechs and other third-party vendors, increasing the number of these relationships comes with its own set of strategic, tactical, and regulatory challenges.

How do you overcome third-party vetting challenges and scale your vendor risk management program to accommodate more dynamic partnerships?

Read the Partnership Series - Volume One: Financial Institutions and Technology Firms

Read the Partnership Series - Volume Two: Fintechs Working Hand-in-Hand to Enhance the Small Business Lending Experience

The FI’s Innovation Dilemma

The first challenge faced when considering anything new is cultural resistance to shifts in the status quo. Implementing new innovative technologies with third-party vendors that may not fit the traditional perception of a vendor can be daunting.

Read the Partnership Series - Volume One: Financial Institutions and Technology Firms

Read the Partnership Series - Volume Two: Fintechs Working Hand-in-Hand to Enhance the Small Business Lending Experience

Notice the big sweeping curve in Figure 1 labeled “Disruptive Technology.” That curve has the power to take an organization to new heights while shuttering those who choose to ignore it. The challenge for the financial institution is timing – when to join the disruptive trend. Wait until the curve reaches the upper right-hand corner and you may receive an underwhelming response from your customers. Join the curve too early and you risk putting your financial institution’s capital and reputation at risk with a vendor whose future is in doubt.

The innovators dilemma

Figure 1 - Courtesy of "The Innovator's Dilemma" by Clayton Christensen

Cash Flow Though the Business Lifecycle

Referencing Figure 2 below, notice the typical cash flow situation for a vendor in “Growth” mode. The dip below the “Time” line represents a negative cash-flow situation. This is commonly the stage in the business lifecycle where many vendors reside as they release a disruptive technology. At this stage, the financial fortunes of the vendor can swing dramatically from one quarter to the next.

Cash flow through the business cycle

Figure 2 - Cash Flow Through the Business Lifecycle

If an organization is considering a relationship with a vendor in growth mode, the typical annual vetting will be woefully inadequate and likely to miss key material events. A more effective solution will be to leverage Big Data, analytics, and automation to maintain a constant watch on the vendor’s viability.

Sound Vetting Builds the Foundation for Internal Trust

The #1 reason that a fintech, or any other business, fails is because they run out of money. While the eight reasons listed in Figure 3 are meaningful and valid, they all lead back to cash flow. Therefore, any potential partnership must begin with a robust vetting process. Not only to satisfy regulatory requirements, but to give your internal team the confidence that you are investing time and energy in a worthwhile endeavor.why fintech startups fail

Figure 3 - 8 Reasons Why Fintech Startups Fail

Key Questions of Vendor Vetting

On a high level, the practice of vendor management can be reduced to these pivotal questions:

  1. Is this vendor financially viable?
  2. Does this vendor have the means and resources to fulfill their contractual obligations with our organization?
  3. Will this vendor protect our customer data (if applicable) and our reputation while providing the contracted goods and services?
  4. What significant changes have happened since the last vendor review?

Question #1, vendor viability, drives everything. If a vendor is not viable, they most likely will not have the means to fulfill their contractual obligations. Nor will they possess the technology, people, and resources to adequately protect your financial institution.

Use Big Data and Automation to Solve the Most Common Third-Party Vetting Problem

The most common challenge in third-party vetting is acquiring accurate financials on smaller, privately held vendors. Understanding the difference between vetting a larger, publicly traded company vs. a smaller, privately held one is key.

While an annual vendor review may be sufficient for a company that is (1) regulated by the SEC, (2) closely scrutinized, and (3) mandated to periodically release reams of certified internal and financial information, vetting and monitoring a smaller, privately-held fintech requires a different approach.

From the moment a new company registers with its Secretary of State’s office, it establishes a “data profile.” This data profile is constantly updated with activities related to normal course-of-business events. There are over 30 million business data profiles in the United States, and a typical profile may contain 1,000 to 10,000 data points – depending on the age and type of business. These data points range in scope from a credit score to timeliness of commercial payments, UCC filings, and the presence of lawsuits, liens, and judgements.

As previously stated, in a smaller, growth-mode company, financial stability can fluctuate dramatically from one quarter to the next. An annual review for these types of companies is woefully insufficient and may expose the financial institution to undue operational and reputational risk. Thanks to automation, institutions now have the ability to automate the assessment of the data profiles of these companies daily, with minimal to no effort.

The “Employees’ Journey” Is Just as Critical as the Customers’

The key to leveraging Big Data in your vendor vetting is how it is presented to your internal team members. Most importantly, the data must be presented in a way that is clear to your team and instills confidence when action must be taken in response to warning signals. Many vendor managers are not versed in financial credit risk, so it’s important that key financial concepts are presented with color-coding, scoring metrics, or a combination of both.

Strong Vendor Vetting Creates Stronger Vendor Relationships

The definition of banking has transformed from “the buying and selling of money” to “a collaboration of technologies that facilitate the buying and selling of money.” To remain viable, your financial institution must be able to efficiently acquire, deploy, and support systems that enable customer engagement across an increasingly broad and complex scope of environments and devices. Thankfully, technologies and best practices related to vetting and protecting the interests of financial institutions are evolving just as quickly as customer needs and demands.

Kevin Sasser is the Director of Sales and Marketing for Argos Risk, a Jack Henry strategic partner that provides innovative and affordable subscription services that help companies manage the risks associated with their third-party relationships.

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