Consumer Compliance Outlook: First Issue 2021

Technological Innovation Is Essential to the Future of Community Banking in America

by Governor Michelle W. Bowman

Over the past year, the COVID-19 pandemic has illustrated the importance of technology across financial services and other industries. In banking, innovation and technology have enabled community banks to continue to meet the needs of their customers during the pandemic and hold great promise to help community banks compete and succeed in the evolving financial services landscape.

Together with the members of the Board of Governors of the Federal Reserve System, I am committed to supporting community bank efforts to implement technology solutions that align with their business strategy and make sense for their customers.

Community Bank and Fintech Partnerships and Challenges

A community bank can provide critical improvements in efficiencies and effectiveness by successfully implementing financial technology. One pathway to achieve these benefits is through responsible partnerships with fintech firms. The fintech partnership model is particularly important for smaller banks, which may have limited resources to develop or implement technology solutions on their own. By obtaining needed technology resources from a third party, community banks can meet their innovation needs and continue to focus on relationships with their customers and communities.

A variety of options are available for fintechs and community banks to partner, including:

While many community banks have successfully partnered with fintechs to meet their needs, I have heard from many banks about the challenges they face in finding the right technology partners and in understanding, monitoring, and mitigating the partnership’s risks. First, with the rapid increase in fintech options, and the relatively limited resources to conduct due diligence on potential fintech partners, some banks struggle to identify a technologically compatible partner that aligns with their overall strategy and risk appetite. And even when a community bank successfully partners with a fintech firm, some banks struggle with the complexities of managing the partnership over time to ensure that the fintech complies with consumer protection laws and regulations and performs according to service-level agreements. Successful management of these challenges is critical, since community banks that fall behind in offering digital banking services to their customers run the risk of being at a competitive disadvantage or of failing to meet the needs of the communities they serve.1

Federal Reserve Initiatives

Over the past year, the Federal Reserve has undertaken several initiatives to facilitate community banks’ technological innovation efforts. In 2020, we launched a series of Innovation Office Hours to promote discussions between Federal Reserve System staff and bankers and fintechs to better understand their use of technology solutions and business objectives.2 Thus far, four of our Reserve Banks (Atlanta, San Francisco, Cleveland, and Richmond) have hosted Innovation Office Hours, and we plan to continue hosting them throughout 2021. These Innovation Office Hours have been productive two-way discussions, with firms sharing information on new business models and seeking feedback and general guidance on a variety of topics. For example, we have received requests from the industry for guidance or regulatory clarity on the use of machine learning for areas such as fraud surveillance and credit underwriting. To that end, the Federal Reserve has been working with the other banking agencies on a possible interagency request for information on the risk management of artificial intelligence (AI) applications in financial services to determine if additional supervisory clarity is needed to facilitate responsible adoption of AI.

We have also established a web page on innovation containing supervisory information, publications, and research related to technology innovation.3 The web page facilitates interaction with Federal Reserve System specialists by enabling bankers and tech industry participants to submit questions about technology issues in the financial services industry or to request an in-person meeting.

We have also convened experts to learn of additional ways and best practices that encourage technological innovation by banks. For example, in January, the Federal Reserve Board hosted a symposium on AI and its use in banking. This symposium featured discussions with leaders in academia on cutting-edge AI topics including fairness, transparency, and accuracy.4

To help increase awareness of the fintech–community bank partnership landscape, we plan to publish a paper in the second quarter of 2021 that describes the spectrum of community bank partnerships with fintech firms and outlines considerations in seeking such arrangements. This paper will describe a range of partnership models, identify potential benefits and challenges of each, and share practices that some community banks are adopting to gain from these partnerships while managing the risk inherent in these arrangements.

To support community bankers in addressing challenges in conducting due diligence on potential fintech partners, I have directed Federal Reserve staff to begin work on two separate initiatives. First, the Federal Reserve is working with our interagency colleagues to develop a vendor due diligence guide. This guide would align with existing supervisory expectations and include sample questions a community bank could pose as it conducts due diligence on a prospective fintech partner, key considerations when evaluating related responses, and examples of documents to collect in support of the due diligence. Second, Federal Reserve staff are working with our colleagues at the Office of the Comptroller of the Currency and Federal Deposit Insurance Corporation (FDIC) to enhance and align interagency guidance for third-party risk management. This guidance would eliminate the need for community banks to navigate multiple supervisory guidance documents on the same issue. This updated interagency guidance, combined with the community bank due diligence guide, should help reduce the burdens on smaller banks in initiating and maintaining partnerships with fintech companies.

The Federal Reserve has also taken steps to improve our own service provider supervision program’s regulatory response to innovation by making reports of supervisory assessments readily available to banks that rely on service providers. These steps will support the banks’ use of the reports in their own third-party risk management efforts. In December 2020, the Federal Reserve coordinated with the FDIC to establish a process for automatically notifying client financial institutions when service provider examination reports are available to download. State member banks interested in receiving this notification should contact their Reserve Bank to participate in this process.

Examination Activities

As a former community banker, I am particularly sensitive to the burden the Fed’s examination activities can have on our member banks. In spring 2020, in response to the COVID-19 pandemic, the Federal Reserve temporarily paused most examination activity for banks with less than $100 billion in assets.5 In June 2020, after banks had time to adapt their operations, the Federal Reserve announced it would resume examination activity, but that examinations would continue to be conducted offsite until conditions improve.6 We understand the greatest impacts of the pandemic reached different regions at different times. Accordingly, we plan to continue monitoring the effects of the pandemic, and we will resume onsite examination activities when the Reserve Banks determine it is appropriate and safe to do so in their District after consulting with the member banks.

We also understand that banks of different sizes have different capacities to handle onsite examination activities. A small community bank may not have the same resources as a large bank does to resume full onsite operations and host examiners. The Federal Reserve will seek to tailor the resource commitments of onsite examinations to the bank’s capacity to manage them.

Additionally, the Federal Reserve has continued to work to refine our Community Bank Risk-Focused Consumer Compliance Supervision Program. We carry out our community bank supervisory function by basing our examination intensity on the individual financial institution’s risk profile.7 We understand the importance of effective communication practices in maintaining an efficient, effective, consistent, and transparent supervisory program. As part of this effort, the Federal Reserve is standardizing its consumer compliance information request process to enhance our examination planning and scoping activities to more effectively communicate with bank management and streamline this stage of the examination. To the extent possible, we will tailor all information requests to fit the character and profile of the institution and to leverage available information sources to avoid duplication in requests needed for effective supervision.

Finally, I believe that open communication and transparency are essential to a strong and innovative banking industry and effective supervision. I am committed to continuing to share our supervisory plans to ensure that financial institutions can maintain effective risk management programs while meeting their mission to serve their customers and support their communities as we all work toward a full economic recovery.


1 The Federal Reserve has published guidance for its supervised institutions on supervisory expectations for vendor management. See SR 13-19/CA 13-21:Guidance on Managing Outsourcing Risk, available at here.

2 Links to prior Innovation Office Hours sessions are available here.

3 The Board maintains an Innovation page on its website.

4 Recordings of the AI Symposium are available here.

5 See the March 24, 2020, Federal Reserve Statement on Supervisory Activities.

6 See June 15, 2020, press release.

7 See CA letter 13-19, Community Bank Risk-Focused Consumer Compliance Supervision Program.