Regulatory Requirements for Sponsor Banks: What You Need to Know

Banking as a Service (BaaS) is a marriage of fintech innovation and sponsor bank regulatory know-how that has fueled digital-forward banking. Through these partnerships, sponsor banks enjoy the increased ability to reach new markets, fintechs flourish providing modern technology, and customers reap the rewards.

The success of this model is proven in the numbers. In 2023, the BaaS market was valued at $15.9 billion, with a strong estimated CAGR of over 17% between 2024 and 2032. No burgeoning industry is without its hurdles, however, and both sponsor banks and fintechs are facing unique challenges as the landscape evolves.

New challenges facing sponsor banks and fintechs

Fintechs, on the one hand, are seeking to diversify their risk by working with more than one sponsor bank. Through this partnership expansion, they can have individual banking partners for each specific offering, like deposits, lending, and international transactions. When looking for partners, fintechs prioritize sponsor banks with substantial risk and compliance resources.

This focus makes sense as, on the other hand, sponsor banks have faced increased pressure from regulators to take more control over their relationships with fintechs. Since the early days of BaaS, sponsor banks have been happy to take more of a “hands-off” approach and let fintechs drive the relationship. But, since the banks carry the risk, failure to adapt to emerging fraud threats and non-compliance with long-standing regulations like AML, KYC, and CDD can bring severe penalties.

That time of compliance complication is upon us. S&P Global Market Intelligence’s recent analysis reveals that in 2023 banks providing BaaS to fintech partners accounted for 13.5% of severe enforcement actions issued by federal bank regulators. That’s quite a lopsided share of the pie, considering there is only a limited number of sponsor banks setting up BaaS relationships with fintechs.

The days of hands-off management and ad hoc compliance are over for sponsor banks. These penalties, along with new regulations, make it clear that sponsor banks need to be in complete control of compliance. Regulators are telling the banks they need to think of fintechs’ actions as extensions of the bank’s actions, not merely those of third-party partners.

What’s stopping sponsor banks from taking more control?

Sponsor banks are aware that because they carry the risk, they need to tighten up compliance and fraud prevention. The issues arise, however, when these banks; 1) rely on disparate data sources, and 2) cannot adapt to emerging frauds because they’re using outdated, non-dynamic prevention methods.

Additionally, managing many fintech partners means protecting customer privacy at multiple institutions. Striking the balance of flexible innovation and cost-effectiveness with robust data security can lead to added friction for customers as banks look to sure up privacy protocols. Losing these customers to a poor experience, especially when they have become accustomed to and expect a smooth one, can mean significant drops in revenue.

Combine all that with the fact that fraud evolves and happens in real time, with new more sophisticated attacks coming at financial institutions every day, and you can see why sponsor banks have a tall task ahead of them.

That’s where having an adaptive architecture centralized in one data orchestration platform comes into play and can act as the central solution to this issue.

How sponsor banks can empower fintechs to take on emerging fraud

The best place for sponsor banks to start when empowering their fintech partners to fight fraud is to centralize the fraud prevention solution’s data sources. Many times, BaaS solutions leverage an unwieldy amount of compliance solutions, fraud prevention tools, and data sources that create silos and cannot communicate with each other. This creates confusion when decisioning on potential fraud scenarios, and indeed even detecting them in the first place with accuracy and speed.

Add to that another pitfall of legacy solutions—slow manual review processes that can’t keep up with modern fraud attacks. Fraud moves in real-time today, so solutions need to unveil and react to fraud attacks in real time before they can harm good customers.

In a common miscommunication scenario, a fintech will send a fraud report to their sponsor bank, but the bank has no way to translate it. This gap creates an attack point for fraudsters to exploit, meaning the bank will face regulatory penalties, complaints from affected customers, and severe damage to its reputation as a result of not prioritizing safety and risk mitigation.

Solutions fintechs can use to better comply with regulations

While fintechs can add more third-party vendors or contract with more sponsor banks to patch over issues, this doesn’t solve their fraud problem on the whole. Using a holistic fraud platform like DataVisor, which has an adaptive architecture that can reduce false positives and prevent fraud, is a growth-minded, future-proof solution.

Through the DataVisor platform, fintechs can leverage a repository for their sponsor banks to send fraud reports to. The DataVisor platform can also absorb fraud alerts for the sponsor bank from the fintech and post them in a single dashboard, giving them a place to track fraud trends all in one place.

Data silos, broken lines of communication, and lack of modern fraud prevention tools can all easily combine to open sponsor banks up to sophisticated new fraud attacks that not only harm their reputation but carry severe regulatory penalties. Prioritizing the installation of a cutting-edge fraud platform capable of unveiling and reporting fraud attacks in real time should be priority one for both fintechs and sponsor banks as they prepare for regulatory requirements on the horizon.