Regulators crack down on Minnesota community banks over fintech partnerships

A tiny Iron Range bank is at the heart of a global financial revolution — one that has increasingly drawn scrutiny and enforcement action from financial regulators.

Chicago finance entrepreneur Brian Barnes snapped up the First National Bank of Buhl a few years ago and rebranded it B2 Bank. Barnes aims to make B2 the engine behind fintech (financial tech) apps, including his own, M1 Finance.

M1 is one of thousands of digital financial applications that have cropped up in recent years, giving consumers a new platform for managing their money. But fintechs must partner with banks to actually deliver many of the financial services they offer.

Yet fintech customers can be inherently riskier than traditional bank customers. And over the past year, the burgeoning market for fintech-bank partnerships has been rattled, as regulators have hit several banks — including B2 — with a disproportionately high number of enforcement actions.

“Regulators are intently focused on leveling up risk management practices in this space,” said Patrick Haggerty, a senior director at Klaros Group, a California-based banking and fintech consultancy. “It tells me there is some clean-up to do.”

Federal banking regulators found “unsafe or unsound” banking practices at B2 in November 2023. Three months later, another set of financial regulators — in a landmark action — fined M1 Finance $850,000 after its paid social media influencers made misleading claims.

Also in December, bank regulators targeted Fargo-based Choice Financial, which partners with fintechs and has four Choice Bank branches in the Twin Cities. Choice allegedly violated the U.S. Bank Secrecy Act and was ordered to improve its money laundering detection program.

The Federal Deposit Insurance Corp. (FDIC) in September proposed a new rule requiring banks to improve recordkeeping rules for deposits from fintechs. It’s a response to the collapse this spring of San Francisco-based Synapse Financial Technologies, a software middleman between several banks and fintechs.

After Synapse filed for bankruptcy and closed, thousands of fintech customers were frozen out of their accounts. A bankruptcy trustee found that $85 million in fintech-related bank deposits had gone missing.

The Synapse collapse “is a huge problem for this space — a giant black eye,” Haggerty said. “It realizes the major risks that people have been worried about, and in a spectacular way.”

The 122-year-old First National Bank of Buhl was one of the nation’s smallest federally chartered banks when Barnes bought it in 2021. With offices in its namesake town and Mountain Iron, the bread-and-butter bank catered to locals.

“A unique opportunity presented itself for me to buy an already running, nationally chartered bank,” Barnes said on an M1 Finance blog entry titled “So … I bought a bank.”

Barnes, who didn’t respond to requests for comment, said in the blog that he would continue supporting the Iron Range bank’s local mission. The bank’s Penny the Pig mascot still stands as a sentinel to savings outside its Buhl branch.

But Barnes said he would also bolster B2′s capabilities to become “the premier banking as a service (BaaS) bank, primarily serving fintech customers such as M1.”

BaaS is industry lingo for banks that partner with fintechs. By buying the First National Bank of Buhl, Barnes went about creating a BaaS bank in a relatively novel way.

For the most part, fintechs — including M1 — partner with existing community banks across the country. The banks take deposits, lend money and process payments.

The allure for community banks is simple: Growth.

“Community banks are generally shrinking,” said Jesse Silverman, an attorney with Troutman Pepper in New York who works with banks and fintechs. “The shape of competition has changed so much in the last 10 years. It is getting harder to be a community bank.”

Community banks, generally those with less than $10 billion in assets, are hemmed in by geography compared to banking goliaths like Minneapolis-based U.S. Bank. Meanwhile, online finance — which requires significant tech investments that smaller banks can’t always muster — is growing quickly.

St. Paul-based Sunrise Banks has successfully partnered with fintechs for 13 years, helping to boost its assets from $1.18 billion in 2019 to $2.32 billion last year. Fintech services made up 39% of the bank’s 2023 revenue.

Sunrise uses its fintech business to boost lending to traditional community customers and has had no regulatory issues over those transactions, said Teri Hodgett, the bank’s chief risk officer.

But working with a fintech business “definitely increases the risk profile” of a bank, Hodgett said.

“We are very selective with the fintechs we work with — they have to share our core values and care about [regulatory] compliance as much as we do,” Hodgett said. “As a bank, we are ultimately responsible for what happens to fintech products.”

The risk is higher because fintech customers generally don’t have to divulge as much information as traditional bank patrons. Yet banks are extensively regulated under the Bank Secrecy Act to sniff out customers and transactions involving money laundering and other criminal activities.

Banking regulators — in their enforcement actions against fintech banks — have been commonly concerned with weaknesses in anti-money-laundering programs, analysts say.

Choice Financial Group, which owns Choice Bank, was told by regulators in December to “immediately improve” oversight of its programs to detect money laundering and terrorist financing — and to “eliminate and correct” all law violations involving each.

The Federal Deposit Insurance Corp. and the North Dakota Department of Financial Institutions also directed Choice Financial’s board to “at least monthly” discuss “customer identification” requirements and the bank’s ”relationship with third party providers of financial services and products.”

Choice Bank, which declined to comment, has 20 branches in North Dakota and Minnesota, and several of its executives are based in Golden Valley.

Federal regulators have hit banks that partner with fintechs with a higher rate of enforcement actions over the past year.

Of the roughly 4,500 banks in the U.S., about 150 partner with fintech firms, estimated Haggerty, of Klaros.

Yet fintech partner banks were the target of 35% of all enforcement actions in the first three months of 2024, and 11% and 19%, respectively, in the second and third quarters, according to a Klaros analysis.

“The numbers are pretty staggering,” Haggerty said.

Many enforcement actions against fintech partner banks cite “a breakdown in third-party risk management,” he said.

For instance, the U.S. Office of the Comptroller of the Currency (OCC) ordered B2 Bank to quantify risks associated with “affiliated companies and/or financial service partners” and to develop a comprehensive “risk management program” that covers third parties.

The OCC also ordered B2 to develop a “comprehensive” Bank Secrecy Act and anti-money-laundering risk assessment program, and it criticized the bank’s internal controls and its “less than satisfactory management.”

B2 Bank didn’t respond to requests for comment. Despite its regulatory issues, B2 is not financially troubled, according to the OCC’s enforcement action.

Fintechs have a broad reach, particularly through social media, that community banks don’t.

“The fintechs that are successful at customer acquisition are more creative in their use of modern marketing tactics, and social media is a huge part of that equation,” Haggerty said.

But if not managed properly, social media can present new risks, as M1 Finance discovered.

M1 Finance paid social media influencers — “finfluencers” as they’re known in the financial industry — for promotion, according to the Financial Industry Regulatory Authority (FINRA), a federal government-authorized organization that enforces rules for brokerage firms.

M1 chose its finfluencers based partly on the size of their social media following, and it paid them a flat fee for every new account opened.

Between January 2020 and April 2023, M1 shelled out over $2.75 million to about 1,700 finfluencers influencers who brought in nearly 40,000 new accounts, according to FINRA’s disciplinary action.

But M1′s finfluencers made claims that were “exaggerated, unwarranted” or “misleading,” FINRA found. For instance, one influencer touting M1′s margin lending program falsely stated that customers can pay back margin loans “at any given time; … there is no set time period.”

FINRA fined M1 Finance $850,000, its first enforcement action against a fintech over the supervision of social media influencers. M1 Finance consented to FINRA’s findings without admitting or denying any charges — and it agreed to remedy the problems.

There is no evidence M1 Finance’s finfluencer fiasco had an effect on Barnes’ B2 Bank — or any other bank.

Still, it should ring an alarm bell for banks that partner with fintechs, said Sarah Beth Felix, owner of Palmera Consulting in Texas, which works with banks on anti-money laundering programs.

Banks should be reviewing their fintechs’ marketing programs, Felix said. And if a fintech uses influencers, banks should know what those influencers are allowed to say.

“This is something that banks should be fully aware of. It is a risk that has to be identified and controlled — but it is not even being identified.”