Fintech Risk Management: Common Due Diligence Package Red Flags
Note: This article is the first in a 4-part series designed to help fintech companies forge lasting relationships with financial institutions and build trust with consumers.
Fintech regulation has been significantly tightened. Companies like yours are now subject to many of the same standards as traditional financial institutions (FIs), though some differences may remain in specific regulatory requirements. Regardless of your stage—whether you’re a start-up or post-IPO—or your industry be it insurtech, payment processing, crypto, or others – you must demonstrate a commitment to implementing robust controls and addressing the most critical risks.
Common Due Diligence Package Red Flags
Potential banking partners will scrutinize your due diligence packages for signs of risk or inadequate controls. But a thorough package can set the foundation for a strong relationship with a well-known institution. From identity theft to data protection and cybersecurity, here are some common risk management faux pass that could discourage your prospective partners.
Manual risk assessments
In many cases, tech-savvy Fintechs will be using some sort of risk assessment technology. However, you might be surprised at the number of companies relying on manual methods, such as spreadsheets, to conduct their internal risk assessments.
When a FI sees a potential partner using manual methods to track risk assessments, it often indicates potential for error or inefficiency. While spreadsheets may be acceptable for certain operational tasks, relying on manual processes for risk assessment introduces greater risks compared to using integrated risk management software. Key drawbacks of overreliance on spreadsheets include human error, data accuracy issues, limited visibility, and lack of version control.
From Risk to Reward: A Due Diligence Playbook for Fintech Trust 
Out-of-date risk assessments
Many banking partners will offer up a due diligence checklist to be considered to work with them. Failing to keep an updated due diligence package, including an enterprise-wide risk assessment mapped to the latest compliance and regulatory standards – may delay potential partnerships or disqualify your Fintech for potential partnership.
Stay vigilant about the latest policy updates on the BSA, AML, OFAC compliance, and Fair Lending regulations. Ensure that your SOC 1 and SOC 2 reports are current. Also, consider any relevant examinations your partner may provide, such as National Automated Clearing House Association (NACHA) audits, especially if you’re involved in the payments industry.
WolfPAC’s Integrated Risk Management solution automatically displays the dates associated with your risk assessments and alerts you when they should be updated
Insufficient controls for identity verification and fraud prevention
Identity-related fraud accounts for more than 40% of all suspicious banking activity. Due diligence packages that lack clear identity verification and fraud prevention protocols may signal to banking partners that a Fintech is not fully equipped to handle high-risk scenarios.
Red flags include outdated or ineffective identity verification processes and the absence of advanced fraud detection tools, such as biometric authentication or behavioral analytics. Strong Know Your Customer (KYC) and AML practices are crucial for building trust with partners
Poor data privacy and consumer protection measures
Similar to identity theft, data privacy is another hot-button issue in terms of building trust with banks and their customers.
Compliance with data privacy regulations is crucial. It’s especially important to have a grasp on the regulations in the geographic areas you do business. This includes measures such as GDPR (if you’re operating in Europe) and the California Consumer Privacy Act (CCPA). Personally identifiable information (PII)
should be held in the highest regard. Potential banking partners will tend to look for gaps in your data security protocols and consumer notification procedures in case of data breaches.
Lack of demonstrated ransomware preparedness
Ransomware attacks are growing increasingly sophisticated. Naturally, potential banking partners will want to see evidence that your Fintech is prepared to prevent and deal with cybersecurity incidents.
You’ll want to prepare clear action plans; for example, what are the top three steps you’d take in response to a data breach or leak of customer information? The more specific, the better. Demonstrating regular data backups and encrypted storage practices will show that you’re prepared to mitigate loss in case of a ransomware event
Failure to show a track record of routine cybersecurity testing
Routine cybersecurity testing is a lot like preventative maintenance on a car; changing your oil frequently will help deter serious engine damage. Conducting regular tabletop exercises with key team members will help ensure your controls are in place before a cybersecurity incident occurs.
Banking partners expect Fintechs to demonstrate a proactive approach to security. Additionally, failing to document and remediate issues identified during testing can indicate that a Fintech is not fully invested in maintaining a secure environment, which could compromise the integrity of financial transactions and sensitive data.
Inadequate model validation
Reliable financial models are essential for streamlining financial reporting, ensuring regulatory compliance, and enabling proactive, data-driven strategic decision-making. As regulatory requirements become more complex and technology continues to evolve, maintaining the accuracy and reliability of these models can be increasingly challenging.
Thorough, ongoing testing of your models is critical to uncover potential gaps, mitigate risks, and identify areas of enhancement. This process not only strengthens model resiliency but also helps prevent issues such as technical glitches, calibration errors, and inaccuracies arising from manual data input. By continuously refining your models, you can better safeguard against operational disruptions and ensure that your financial reporting remains both precise and compliant.
Could your Fintech use some help navigating the alphabet soup of regulatory demands? Contact us today, and one of our Fintech risk management experts will guide you every step of the way.