Fintech firms, once perceived as ‘disruptors’ of the traditional banking industry, are now increasingly seen as attractive partners for established financial institutions. Partnership arrangements between banks and new financial technology startups have therefore mushroomed over the last several years. Such partnership agreements, which come in different forms and contexts, are usually advantageous for both sides: banks may ordinarily suffer from legacy issues and cumbersome internal processes, and therefore benefit from fintech firms’ superior technology to develop new business ideas. At the same time, a bank’s broad customer base may allow a startup to benefit at an earlier stage from economies of scale and facilitate market entry, while fintechs may also enjoy reputational spill-overs from partnering with an established institution. Most of these arrangements share the goals of outsourcing key banking functions and facilitating market entry for new market players while overcoming relatively tough regulatory hurdles.
Yet such arrangements, while generally to be welcomed, pose a number of regulatory problems, in particular concerning the effective supervision of fintechs that operate outside of the direct purview of regulatory authorities. Our recent paper explores the implications of a growing number of bank-fintech partnerships for the regulatory framework concerning financial institutions.
The various types of partnership arrangements include banking-as-a-service and software-as-a-service frameworks, white-label banking, and front-end neobanks. From a regulatory perspective, all of these arrangements fall under the rubric of ‘outsourcing’ arrangements, where regulated entities outsource some of their functions to third parties, be they regulated or unregulated. The present practice and the relevant regulatory framework raise doubts about the effective supervision of fintechs that operate outside of the direct purview of regulatory authorities. The key downside of the existing collaboration arrangements between banks and fintechs lies in the point that a contractual agreement between the two market participants is a poor substitute for effective regulatory scrutiny. Questions of enforcement and effective supervision emerge, which may ultimately result in problems regarding market stability and systemic risk. The recent downfall of Wirecard, the German payments group that relied on partnering with firms in its Asian markets, put a spotlight on the frailty of such arrangements.
To address these problems, a number of regulatory tools have been put forward, in particular with the objective of facilitating fintechs’ entry into the supervisory perimeter. However, these initiatives are imperfect. For instance, regulatory sandboxes are geared more towards creating and stimulating innovation than towards addressing the regulatory status of fintechs. Other tools, such as fintech charters and umbrella firms, can be helpful in some respects but come with a number of downsides.
We therefore propose an additional, complementary tool to provide for a reliable regulatory framework for partnership agreements between fintech firms and established banks, namely a ‘mentorship regime’. Such a regime would allow for a sort of ‘private sandbox’, where experienced firms could mentor new startups and help them to cope with a complex regulatory process. At the same time, a legally backed mentorship plan would clear up the division of responsibilities and supervisory competences together with the liability questions and thus help to overcome problems of arbitrage and abuse. Ultimately, a mentorship regime may contribute to a new and more reliable system of banking that puts the well-established contractual practice of outsourcing banking services on a more reliable footing.
Luca Enriques is Professor of Corporate Law at the University of Oxford.
Wolf-Georg Ringe is Professor of Law & Finance at the University of Hamburg and Visiting Professor at the University of Oxford.