Key risk areas for internal auditors
If your financial institution is already engaged in BaaS or contemplating entrance into the space, internal auditors should be alert to the following risk areas:
Compliance and regulatory risks
BaaS involves multiple parties, including the bank providing the infrastructure and the non-bank entity offering the services. This complexity can lead to challenges in ensuring compliance with regulatory requirements, such as KYC, AML, general consumer compliance, and data protection laws. Internal auditors need to ensure that all parties involved are complying with relevant regulations to avoid regulatory penalties and reputational damage.
Banks must ensure that their BaaS offerings comply with consumer protection regulations, including transparency requirements and fair treatment of customers. This includes providing clear and accurate information about fees, terms, and conditions associated with BaaS services. Additionally, marketing materials including social media must comply with all relevant regulations.
Information security, cybersecurity
In fintech and bank partnerships, critical information security risks must be managed to safeguard sensitive data and maintain trust. These risks include data breaches, cyberattacks, third-party vulnerabilities, failure to meet related regulatory requirements, insider threats, mobile security concerns, identity theft and fraud, and API vulnerabilities. To mitigate these risks, robust cybersecurity measures, regular risk assessments, employee training, clear security policies, and open communication channels are essential. Ongoing security audits and penetration testing can help identify and address vulnerabilities proactively.
It is recommended that a data flow is mapped. Data flow mapping is an essential process that helps in the understanding and visualization of data's journey within various systems and can help stakeholders understand who is doing and responsible for what during each stage of the data journey.
Third party risk
Banks must effectively manage the risks associated with their BaaS partners, including operational, compliance, and reputational risks. This requires thorough due diligence when selecting BaaS partners and ongoing monitoring to ensure that they comply with regulatory requirements. To learn more about third party risk and the role of internal audit, I recommend the following articles and reports:
Reputational risk
Reputational risks in BaaS partnerships arise from the potential for negative perceptions or damage to the reputation of a bank due to the actions or failures of its fintech programs. These risks can stem from various sources:
- Data breaches or security incidents
- Service disruptions to end users
- Regulatory compliance failures
- Quality or performance issues
- Regulatory enforcement actions
Financial risk
BaaS providers are exposed to financial risks, including liquidity and market risks. Auditors should assess the financial health of BaaS partners and ensure they have adequate capital and liquidity to support operations. BaaS banks should also ensure they have appropriate contingency plans in place in case they need to wind down a fintech program.
An opportunity for internal audit
In conclusion, as BaaS continues to reshape the financial landscape, it presents a rapidly evolving space for internal auditors tasked with safeguarding their organizations. While BaaS offers unparalleled opportunities for expansion and innovation, its inherent complexities introduce a spectrum of risks, from regulatory compliance and data security to reputational vulnerabilities. By comprehensively understanding these risk areas and implementing robust auditing practices tailored to the unique challenges of BaaS, internal auditors can play a pivotal role in ensuring the resilience and success of their organizations in this rapidly evolving ecosystem.