Navigating the Federal Reserve's Novel Activities Supervision Guidance: A Guide for Banks
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In today's dynamic financial landscape, innovation and regulation converge, prompting banks to navigate new opportunities and challenges. To address the evolving terrain, the Federal Reserve Board issued guidance on August 8, 2023 entitled SR 23-7: Creation of Novel Activities Supervision Program.
Understanding the Guidance
The guidance underscores the Federal Reserve's commitment to supporting innovation while addressing associated risks to ensure stability of the banking system. The new program aims to strengthen the board’s oversight of the novel activities engaged in by the banks they supervise, focusing on four primary activities:
1) Partnerships with Non-Bank FinTechs:
Technology-driven partnerships where non-banks collaborate with banks to provide banking products and services to consumers.
2) Crypto-Asset Activities:
Activities related to crypto-assets, such as crypto-asset custody, crypto-collateralized lending, and crypto-asset trading.
3) Distributed Ledger Technology (DLT) Projects with Significant Impact:
DLT projects with the potential for significant implications on the financial system.
4) Provision of Banking Services to crypto-asset related entities and FinTechs:
Banking organizations that concentrate on providing traditional banking services to crypto-asset related businesses and FinTechs.
"While neither prohibiting nor discouraging banks from engaging in novel activities, the guidance makes it clear that the Federal Reserve intends to apply additional scrutiny to those banks who do." - Mike Jones, Chief Compliance Officer & FinTech
The program will work alongside the Fed’s current supervisory structure by adding novel activity expertise to existing teams. Banks engaged in novel activities can expect to be notified in writing if their activities will be examined through the program. The determination of which banks will fall under the scope of the program will be based on the Federal Reserve’s assessment of risk.
FinTech Risk Management
The guidance also underscores the need for comprehensive risk management practices due to the complexities of FinTech partnerships and the crypto landscape.
SRA Watchtower continues to emphasize that banks who partner with or who are considering partnering with FinTechs should enhance their risk management practices to address the unique risks associated with novel banking business models. Managing these risks goes beyond traditional third-party risk management and addresses regulatory expectations by enabling risk monitoring and portfolio aggregation.
A solid novel activity risk management program begins with an evaluation of the bank’s risk maturity to gauge bank-wide competence and fill any gaps. Banks also need to establish evaluation criteria and conduct due diligence to help identify and onboard new FinTech partners. Equally important, banks should establish continuous monitoring and periodic risk assessments, to aggregate and report on FinTech performance to management, boards, and regulators.
Forging Ahead with Wisdom
The guidance from the Federal Reserve represents a pivotal moment for banks to reconcile innovation with regulatory diligence. By understanding the nuances of the new regulatory approach, assessing your bank's risk exposure, and proactively adopting appropriate measures, you can build a resilient foundation for growth in the evolving landscape.
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