Michelle W Bowman: Community bank access to innovation
Speech by Ms Michelle W Bowman, Member of the Board of Governors of the Federal Reserve
System, at the Government Relations Council (GRC) meeting sponsored by The American
Bankers Association (virtual conference), Washington, D.C., 9 September 2021.
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Introduction
Thank you to the American Bankers Association for inviting me to address this year's
Government Relations Council meeting. Although we had all hoped that this meeting would be in
person, we will have to settle for the opportunity to convene virtually once again. As we do so, I
continue to reflect on the way the pandemic has transformed businesses and sectors of the
economy, much as it has changed life for all of us. Unfortunately, some aspects of the way we
live and interact may be significantly altered for some time. But focusing on today, I will share
some of my perspectives about the impact of the pandemic on the community bank sector and
the potential of technology to help meet the challenges of this new environment.
The financial services industry has experienced rapid technological change over the past few
years, and there is no sign that this change will slow any time soon. Innovative technologies were
already driving greater efficiency and creating opportunities for banks and their customers before
the onset of the pandemic. In the past year and a half, these trends have accelerated, and I
expect this level of performance to establish a new threshold of industry expectation. Let's look at
education as another example of an industry that has been transformed. We saw schools
throughout the country quickly leverage technology to shift to online learning last year. Schools
implemented innovative technology solutions to continue curriculum, and to creatively engage
students and build virtual student-teacher relationships. While the implications of a period of
prolonged online learning are not yet clear, technology enabled the expansion of the range of
learning alternatives and essentially prevented the American education system from grinding to a
halt. Some of these new tools will likely continue to be used even as in-person instruction
returned this fall. We are seeing service providers in a variety of industries leverage technology to
engage with their customers-from education, to retail shopping, to fitness training and beyond.
In the banking industry, technology continues to encourage new ways of interacting with and
serving customers that can help banks meet the needs and preferences of their customers and
communities. Such innovation creates important opportunities for banks of all sizes and
business models. As regulators, it is also important that we monitor how banks are adapting and
evolving in response to these changes, and that we offer insights and clear expectations to help
banks manage associated challenges.
Broad Innovation Considerations
Community banks continue to play a vital role in supporting local communities. Their ability to
thrive in an increasingly digital landscape is critical to the economic well-being of those
communities. Through my regular engagement with community bank leaders, I do see innovation
thriving. When banks can be agile in developing relationships with third-party providers to meet
unique customer needs, they can find their own paths to innovation. For example, community
banks approach the evolving payment needs of tech savvy customers from many different
angles. Their solutions include partnering with financial technology (or fintech) companies,
developing peer-to-peer payment solutions with their core providers, and even hiring outside
developers to create their own apps that will best serve customers' needs.
While positive trends in community bank innovation are encouraging, I am also attuned to the
challenges community banks face when seeking to innovate. I have heard from many community
bankers about the constraints they face in taking advantage of new technologies-both in terms
of the resources and the expertise required to adopt innovative technologies in a responsible
manner. The cost of conducting due diligence on prospective partners can be high for
community banks already facing capacity constraints. Seeking a partnership with a newly
established fintech company may introduce additional complications. For example, a less
experienced partner may be able to offer a product that fits a community bank's needs but may
not understand the bank's regulatory obligations or have fully developed operational or
compliance frameworks. Gaps in the ability to demonstrate or guarantee compliance can
introduce risk that a community bank will need to fully understand and ultimately to manage.
In December 2020, I spoke about several initiatives being pursued by the Federal Reserve
targeted at promoting access to innovation for community banks and overcoming related
challenges. Today I am happy to provide updates and announcements about those initiatives. I
hope that each provides additional clarity and serves as a valuable resource to community banks
as they pursue their own innovation strategies.
Community Bank/Fintech Partnership Paper
The first initiative is the publication of a paper highlighting some of the promising ways that
community banks are partnering with fintech companies. It lays out some important issues that
banks must consider to maximize the effectiveness of the partnership. This paper is the product
of an extensive outreach effort with community banks, fintechs, and industry stakeholders. It
involved discussions focused on the strategic and tactical decisions that support effective
partnerships in a responsible manner.
Community banks engage in a range of partnerships with fintechs, each pursued for different
reasons, with varying levels of investment of time and resources. The paper describes key
partnership types and the associated benefits, risks, and challenges that community banks
experience with each type. The paper also identifies fundamental considerations for effective
partnerships as described by community bankers.
Some valuable insights emerged from our outreach, which may benefit community banks at
various stages of the innovation process. Two important themes stood out: the first is
establishing trust and aligning with fintech partners, and second, building a long-term culture
committed to innovation. Let me elaborate on each of these themes.
In our outreach, bankers noted that it is critical for partnerships to be built upon a foundation of
mutual trust and alignment of values. In some cases, due diligence efforts reveal that potential
partners do not share the banks' values or objectives. One bank, for example, began discussions
with a fintech company that could assist it with the bank's Paycheck Protection Program loan
originations by providing a customer-facing application portal. After learning that this partner
intended to sell the small business customer information it would obtain, the bank opted out of
the partnership. Instead, the bank looked to other fintech partners with values more closely
aligned with its own.
Harnessing the full potential of technology innovation also requires a long-term, strategic
commitment to innovation. Many bankers spoke of the importance of knowing exactly what new
technology is solving for, building a team they trust, and securing buy-in from both senior
management and the staff responsible for implementation. Bankers who have forged successful
partnerships don't innovate for the sake of being innovative but instead have a clear vision of their
goals. For example, one bank partnered with a fintech company to roll out limited banking
services to teenagers. Its intention was to promote financial literacy among young people in the
community and to prepare the bank to accommodate the preferences of a new generation. The
bank also hired local college students to work with staff, combining the technological expertise of
these more recent hires with the deep compliance background of the bank's long-standing
employees.
Interagency Fintech Due Diligence Guide
In addition to the paper, the Federal Reserve, Office of the Comptroller of the Currency (OCC),
and Federal Deposit Insurance Corporation (FDIC) have recently published a vendor due
diligence guide to assist community banks with their risk assessment when considering a new
relationship with a fintech. I have often heard from community bankers that the manpower and
other costs related to due diligence are formidable barriers for banks seeking to establish new
third-party relationships. A recent survey of community banks confirms that burdens related to
due diligence are indeed an impediment to new third-party relationships, including those with
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fintechs. This guide was developed to help reduce these burdens by providing a practical
resource for community banks when assessing the risks of potential fintech partnerships.
This optional and customizable resource does not establish new regulatory expectations but it
can serve as a starting point for banks in their due diligence process. A community bank can
tailor how it uses the guide to meet its unique circumstances and the specific risk-management
needs posed by each fintech relationship. A community bank can also share the guide with
potential partners to help them understand the bank's risk-management requirements.
Specifically, the guide contains relevant considerations, sources of information, and illustrative
examples within six key areas of due diligence. These include, but, of course, are not limited to,
business experience and qualifications, financial condition, and legal and regulatory compliance. I
hope this guide will encourage responsible innovation that takes into account the range of
potential risks of a partnership in addition to its potential benefits.
Request for Comment on Interagency Third-Party Risk Management Guidance
While the Federal Reserve will continue to focus on developing resources for the community
bank sector, it is also important to ensure that guidance is up to date, it supports the evolving
range of partnerships, and it is consistent across all banking agencies. In July, the Federal
Reserve, the OCC, and the FDIC published for comment proposed guidance for banks
managing the risks of third-party relationships, including those with fintechs. This guidance
should reduce unnecessary burden by eliminating variation in supervisory views. It is also my
hope that this guidance will better address the landscape of the third-party relationships that exist
today. I am particularly interested in hearing from a wide range of community banks on whether
the guidance is clear, helpful, and appropriately calibrated to address the risks associated with
these arrangements.
Use of Artificial Intelligence
The final topic for my remarks today is the use of artificial intelligence (AI). Through clear,
consistent supervisory guidance combined with useful tools and resources, supervisors can
continue to support community banks in their efforts to navigate an increasingly complex world.
In pursuit of this goal, in March of this year, the agencies published a request for information on
financial institutions' use of artificial intelligence. As part of this request for information, the
agencies sought details about banks' challenges in developing, adopting, and using this
technology, including those challenges related to third-party services.
While we are still reviewing and processing the feedback, initial reactions from Federal Reserve
staff indicate that these responses are very helpful in our consideration of next steps. So, I would
like to thank those who provided comments in response to the agencies' request, especially
those pertaining to the use of artificial intelligence by community banks. Comment letters
confirmed our understanding that at times community banks choose to engage with fintech
partners and their models to tap into the benefits of AI. We have also heard loud and clear that
acting on an interagency basis to ensure regulatory consistency is very important. As we
consider the information collected and the potential next steps, I will encourage Federal Reserve
staff to continue exploring opportunities to provide supervisory clarity on this topic and more
generally to consider ways to help community banks innovate in the application of new
technologies.
Conclusion
In conclusion, I welcome comments and feedback not only on the resources the Federal
Reserve and other agencies have published recently but also regarding additional resources that
may be helpful for community banks as they continue to pursue access to innovation. And in the
coming weeks, I look forward to participating in two upcoming innovation-focused programs
oriented toward community banks. The Federal Reserve will host an "Ask the Fed" program later
this fall focused on community banks and service providers, and the Board and the Kansas City
Reserve Bank will jointly host an Innovation Office Hours event later this month.
Frequent and continued engagement with bankers, fintechs, and other third parties has
demonstrated the nuance, complexity, and many considerations involved in promoting
community bank access to innovation. It is my sincere intention that the community bank/fintech
partnership paper, the vendor due diligence guide, and proposed third-party, risk-management
guidance serve as a foundation upon which the Federal Reserve will continue to build.
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Conference of State Bank Supervisors, 2020 CSBS National Survey of Community Banks (PDF), 2020
Research and Policy Conference. Return to text