Having the proper balance between risk and speed is vital, especially in the fast-moving world of fintech and banking. Getting accounts opened and doing business are crucial, but ensuring effective compliance and fraud prevention measures are fundamental to ongoing operations. One rapidly developing example is the opening and management of For Benefit Of (FBO) accounts.
In general, an FBO account is an account held in the name of a beneficiary. For example, a trust might have an account that names a child as the beneficiary providing a legal way to hold money until they become of age. Or, multiple accounts can be set up where each account is below deposit insurance limits but are all for the benefit of one person. These types of accounts can also simplify various financial transfers such as donations and retirement planning.
FBO accounts and fintech
Innovative use of FBO accounts enables fintech companies to quickly offer banking-like services without the complexities and costs of getting a banking license. The fintech company has a master account with a financial institution that already has the necessary licenses, and then virtual accounts are set up for each client of the fintech.
As each virtual account is for the benefit of a specific client, the fintech has no legal ownership of the account, an important legal distinction, as the bank controls the funds and the regulations fall upon the bank, not the fintech.
For example, consider a U.S. money transmitter, a defined type of money service business. In terms of licensing requirements, they require both federal and state licenses. A federal license requires registering with FinCEN (Financial Crimes Enforcement Network) and following AML (anti-money laundering), KYC (know your customer) and BSA (Bank Secrecy Act) rules. Each state that the money transmitter wants to operate in requires its own license, which is a costly and time-consuming process, taking up to two years to register in all fifty states.
An alternative to registering as a separate money transmitter in each state is setting up an FBO account from a licensed, nationwide, chartered U.S. Bank.
The quicker go-to-market opportunity is enticing for fintech companies focused on rapid growth. From the bank’s point of view, they can increase their amount of funds and the associated fees, or investment profits, without customer acquisition costs.
FBO risk considerations and controls
Of course, these are complex legal arrangements, and careful attention to the exact relationship and structuring of accounts is necessary
An increase in the risk profile for the bank is possible. With one bank account for the fintech to cover all of their accounts, the bank relies on the fintech to have an effective customer identification program and perform proper due diligence. If those procedures are robust and sync with the risk-based approach of the bank, then the risk profile can be similar.
The bank needs to be very careful about its fintech onboarding procedures using this approach. The fintech does need to ensure that its clients are legitimate, as problematic accounts or transactions can tarnish the whole relationship. But for the bank, all the fintech activities are under one account. So, clarity from the beginning on acceptable accounts and behaviors and ongoing transparency into transactions is vital.
On the fintech side, compliance procedures echoing the bank requirements will help establish the account and keep it in good standing. There’s also the need to have strong ledger controls to ensure that accounts are precise and reconciled correctly.
The relationship can benefit both parties if the fintech has equivalent procedures, tools and risk-based approaches as the bank. The FBO fintech model should not bypass any risk and compliance controls but rather is about having the proper controls in place for the partnership.
To that end, any fintech that wants to get an FBO account needs to have its compliance measures in place. Some KYC and due diligence procedures that would be commonly required include:
- Ascertain the identity and location of the customer and gain a good understanding of their business activities.
- When authenticating or verifying a potential customer, classify their risk category and define what type of customer they are.
- Ascertain whether Enhanced Due Diligence (EDD) is necessary. EDD checks can be an ongoing process, as existing customers can transition into higher-risk categories over time. In this context, conducting periodic due diligence assessments on existing customers can be beneficial. Factors one must consider in determining whether EDD is required include, but are not limited to, the following:
- Location of the person
- Occupation of the person
- Type of transactions
- Expected pattern of activity in terms of transaction types, dollar value and frequency
- Expected method of payment
- Keeping records of all the CDD and EDD performed on each customer, or potential customer, is necessary in case of a regulatory audit.
- Transaction monitoring to detect and understand spikes in activities, exceeding thresholds, out-of-area or unusual cross-border activities, the inclusion of people on sanction lists or other suspicious activities
A fintech that wants to speed up the FBO account creation and build a successful long-term partnership should have compliance best practices such as:
- Robust corporate governance
- Clear management oversight
- Effective employee training
- Proper internal controls
- Accurate reporting
FBO accounts are a deep connection between a bank and a fintech requiring ethical operations and careful implementations to justify the efforts.
FBO as a critical fintech innovation
Another fintech model that can prove insightful when considering FBOs is the payment facilitator (PayFac) approach. By using sub-accounts of the PayFac merchant account, businesses don’t need to go through rigorous onboarding and operational processes for electronic payment and processing services. The results are massive transaction volumes (estimated to be over $4 trillion by 2025) and the creation of payment giants such as Stripe and Square (now Block).
Simplifying the onboarding of other financial services via the FBO model might prove to be as successful and lucrative as the PayFac approach. With proper customer onboarding, due diligence and risk management procedures, the FBO approach can drive success for banks, fintechs and their customers.
How can banks vet UBO integrity?
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