On Monday a few weeks back, a member of a client’s executive team gave me a call: “We really need to speed up the project to find another bank sponsor.”

That was followed by a call from another client later that day: “We’ve been thinking about what it would take to form a relationship with a second bank.”

On Tuesday, a text came in: “What happens if our bank says that we can’t load crypto wallets anymore?  What would we do?  What should we be thinking about?”

Later that day, I attended a webinar by a law firm that spoke about how fintechs can attract backup sponsor banks.  This was followed by another webinar hosted by a financial technology platform that covered issues related to banking resiliency.

It was only Tuesday afternoon, and I was already a bit tired of the topic, but the message was clear:  Companies were thinking about risks that their bank posed to their business in a way that no one had thought about since 2008.  With the seemingly overnight collapse of Silicon Valley Bank and Signature Bank, CEOs, payments professionals, and treasurers were wondering if something like this could happen to their bank, and how it would impact their business if it did.  And while the government and economists continue to stress that our banking system is resilient, the events of the past couple of weeks have caused many of us to take pause and re-assess the potential risks that exist with our current banking relationships.

Bank Redundancy in Payments – It’s Not a New Topic for Merchants

For those of us who’ve spent a lot of time in the credit card processing space, the concept of backup acquiring banks and processors is not necessarily a new one.  As merchants grow and mature, it’s often quite common to have relationships with multiple institutions and providers.  There are many use cases that can drive this need:

• Provider Redundancy – Probably the most obvious – this addresses the technical or operational failure of one provider as merchant can switch to another.
• Geographic Expansion – Global expansion often drives the need for local acquiring, as cross-border processing volumes can drive up cost and lower approval rates.
• Payments Optimization – Savvy, data-centric merchants often find that some acquirers perform better with certain types of transactions or payment types.
• Risk Distribution – Many merchants employ strategies to distribute transactions across multiple acquires in order to reduce the overall transaction risk profile associated with a single provider.

What Else is Driving Today’s Need for Banking Redundancy?  

• The Rise of Embedded Finance and Fintechs
  While it might be relatively easy to have multiple banking relationships when it comes to card processing, the explosion of non-card use cases in the fintech space has made it significantly more complicated when it comes banking resiliency.  Fintech and embedded finance functionality can include money movement via ACH and faster payments, card issuing, lending, and holding funds in FBO accounts – just to name a few.  The path to bank redundancy for these types of functionally adds significant complexity due to the wide differentiation in products offered by providers, the variation in operational and technical integrations, risk appetites between different sponsoring institutions and basic limitations in how products can be “shared” across multiple providers.For example, what if your business depends on holding hundreds or thousands of FBO (“for the benefit of”) accounts for your customers?  In this case, an operational failure at your primary bank – or worse, the overnight insolvency of your institution – would most likely leave you and your customers without the ability to access your services or their underlying funds.  Furthermore, the migration of FBO accounts, card portfolios and lending portfolios are typically not activities that can be accomplished overnight, even if you did have a relationship with a backup institution in place.

• The Sponsor Bank’s Approach to Risk Management
  While bank failures seem to be top of mind due to their front-page headlines in major media outlets, the chances of bank failure interrupting your business is still quite low. There are several other factors, however, that are causing a lot of headaches among everyone from fintech start-ups to large global enterprises.One major contributing factor to instability among provider relationships comes down to a simple trend:  The continued decreasing appetite for risk among sponsor banks.  For non-licensed entities, their sponsor bank serves as their lifeblood to offering services that only banks could bring to market not too long ago.  This includes the issuing of cards, moving funds between accounts and holding funds on behalf of customers.  But the rise of the fintech has democratized these types of activities, making them available to virtually any organization who can write lines of code – all with the help of their sponsor bank sitting behind the scenes.But a combination of macroeconomic pressures, heightened regulatory oversight, and lessons learned from previous losses has turned sponsor banking into a risky proposition for some institutions, causing them to trim their customer portfolios and, in some cases, exit the sponsor banking business entirely.So, what does happen when you wake up to an email from your sponsor bank stating that that your business no longer fits their risk profile?  Or that many of your customers need to be off-boarded for various risk and compliance reasons?  Those organizations who have a single banking relationship will have no choice but to shut down their activities, which could, perhaps, be their only source of revenue.  This scary proposition is motivating many organizations to look for alternative or “standby” banking relationships in the case that something like this becomes a reality.
   

Approaches to Better Banking Resiliency

When it comes to banking risk mitigation, the first step should, of course, be the most obvious:  Every organization should have more than one banking relationship. I We’ve worked closely with clients to help them achieve success when looking for sponsor banks, as well as setting up resilient banking relationships.  Here’s a few lessons learned along the way:

• More is Not Necessarily Better – While it’s not uncommon for global enterprises to have many banking relationships across geographies, small and medium sized businesses typically do not have the resources to manage more than a couple of banks. Companies should recognize that every new banking relationship adds additional operational overhead, technical integration work and compliance requirements over the lifetime of the relationship.  A single alternative banking relationship is a good place to start.
• Risk Profiles Need Redundancy – In order to achieve true redundancy between banks, you must have redundancy across all risk profiles in your portfolio. For example, it’s often a common practice for ISVs, fintechs, or platforms to route payments to “low risk” and “high risk” acquirers if they have a broad risk profile across their merchant portfolio.  In these cases, we’ll often hear companies assert that they do, indeed, have redundant banking relationships where, in reality, one of their institutions may not be able to process a significant portion of their portfolio should the other institution fail or offboard them as a client.  To be fully redundant, you must have full portfolio processing coverage across multiple institutions.
• “If you build it, they will come” is a good rule for attracting sponsor bank relationships – In the early days of sponsor banking, it was not uncommon for some banks to sponsor clients who did not have fully developed products or operational processes. There were many cases where banks were sponsoring a concept, more so than sponsor an actual functional product or services.  Those days, however, are long gone.  Companies need to ensure that their product, customer service, banking, risk, and compliance operations are fully built out, and that they have subject matter experts who can clearly articulate the company’s practices.  Many organizations have been surprised to find that processes and controls that they had in place when they first struck a sponsor banking relationship are no longer sufficient when they start looking for secondary institutions years later.
• Be open. Be Accurate. Be Honest – I’ll put this very simply: When clients are not honest and accurate with their banks about their customers, funds flow, funding sources or use cases, things will eventually go wrong.  I have personally witnessed scenarios where deception, inaccuracies or sloppiness have caused banks to shut down established relationships very quickly.  Be honest about you deficiencies and communicate a plan to resolve them.
• Use Tech to Your Advantage – Many orchestration, gateway, and treasury platforms have already thought through a number of these issues and offer an easier way for organizations to connect to multiple banking institutions. If you use one of these types of platforms, it’s worth speaking to your provider.  If you don’t, it might be worth investigating whether these providers can help you achieve your goals.

Our Glenbrook Risk Management Practice works with many types of organizations within the payments and fintech ecosystems, including merchants, fintechs, service providers, banks, and payments networks.  We’d love to speak with you about your risk challenges and how we could help partner with you as your grow.