Majority of US banks struggling with embedded finance compliance

By Gloria Methri

In Alloy’s recently released 2024 State of Embedded Finance Report, a striking 80% of U.S.-based sponsor banks reported facing challenges in meeting embedded finance compliance requirements. Despite this, embedded finance programs are driving substantial revenue for these institutions, accounting for over 50% of their income.

This survey, which gathered insights from more than 50 decision-makers, underscores the critical yet complex role of compliance in the growing field of embedded finance.

The Embedded Finance Report comes at a time when sponsor banks in the U.S. face drastically increased regulatory scrutiny. According to data from Klaros Group, 25.6% of the FDIC’s formal enforcement actions have been directed at sponsor banks since the beginning of 2024.

“Running a sponsor bank program is inherently complex because you have banks who are highly regulated working with companies that are often new, fast-growing, and creating entirely new ways for consumers to interact with money,” said Tommy Nicholas, CEO and co-founder of Alloy. “Despite the challenge, we are already seeing sponsor banks respond to regulatory developments by investing in better controls, training, and adding to their compliance tech stack.”

These recent compliance violations have resulted in financial consequences for sponsor banks: 75% have lost $100k or more due to compliance violations, while 39% reported losses of $250K and 6% lost $1M or more. However, financial losses are far from the worst consequence of regulatory violations: decision-makers at sponsor banks rank reputational damage as the top consequence of mishandling FinTech partners’ compliance.

Alloy’s report found that sponsor banks’ top barriers to maintaining a compliant embedded finance program are 1) a lack of control over their FinTech partners’ policy controls and 2) a lack of auditability of their FinTech partners’ policy controls.

Earlier this year, the company launched Alloy for Embedded Finance, a product that allows sponsor banks, electronic money institutions, and program managers in the U.S., U.K., and E.U. to oversee the compliance policies of their FinTech partners.

This addresses embedded finance providers’ need to have greater control and visibility into their FinTech partners’ compliance programs. Today, Alloy also announced a new module within the product, Audit Access. Tools like Alloy for Embedded Finance are becoming more widely adopted by sponsor banks. The report found that sponsor banks’ most likely course of action in response to regulatory scrutiny is investing in new compliance technology.

“Using Alloy for Embedded Finance has been a game changer for our team,” said Teddy Gordon, Director of Data at Grasshopper Bank. “We can easily set KYC requirements for our fintech partners and then roll those policies out to our entire program all at once. We ensure we’re compliant across the board, and our fintech partners still get to manage their risk tolerance.”

The report was fielded from May 30th to June 5th, 2024, and includes respondents from sponsor banks in the U.S. with at least $2 billion in assets under management (AUM).