Challenges to Digitalization for Mission-Driven Banks

Banks with a mission give money and credit to people and places across the country that need to be served by the rest of the financial system. These banks, which include minority depository institutions (MDIs) and community development financial institutions (CDFIs), help more people buy their own homes, help small companies grow, and ensure every consumer has a safe place to save money. The locations of these institutions show how much they want to help more people access banking services. For example, 25% of MDI branches are in zip codes with no other bank, and more than 3 million people live in these zip codes. However, because technology is changing quickly and business models are changing, the long-term future of these mission-driven banks is still being determined.

In the last few decades, the banking industry has become more competitive, and mission-driven banks face several long-term threats to their very existence. These threats include the recent explosive growth of fintech (financial technology) firms, the entry of big retailers like Walmart into the market, the ongoing consolidation of the banking sector through mergers and buyouts, and the recent sharp outflow of deposits after some big bank failures. Mission-driven banks also face risks from broader changes in finance, such as the rise of decentralised networks that can take over the role of banks in storing deposits, making payments, and giving credit; this will force all financial institutions to rethink their missions and business models altogether.

Mssion-driven banks must use digitalization in every part of their businesses to stay financially stable in this competitive and changing world. Digitalization is often used as a shorthand for specific features like automated lending, chatbots, remote check-deposit capabilities on mobile apps, and interaction with third-party web applications to link bank accounts with mobile payment services. But, digitalization uses data to simplify business processes, cut costs, improve efficiency, make better decisions, improve customer experiences, and personalise products. In its most advanced form, personalization turns banking from a set of financial products that can only be accessed at physical places into banking as a service (BaaS), which can be integrated into all parts of a customer's social life.

Digitalization allows banks to offer better goods and services, reach more places, and get more out of economies of scale while making them more competitive. A recent study, for example, shows that financial technology has actively lowered the costs of financial intermediation, which has led to more efficiency. In the context of the pandemic, an FDIC (Federal Deposit Insurance Corporation) study shows that banks with more advanced financial technology were better prepared than their peers to give small businesses emergency capital through the Paycheck Protection Programme (PPP). In a positive feedback circle, each of these good things can make the others better: By using data, banks can find more efficient ways to put more resources into new loan products with better terms in new places. Even though size is essential for economies of scale, even the smallest organisations can gain significantly from these steps.

When viewed positively, digitalization gives mission-driven banks a chance to grow their loan footprints and make a more considerable difference. For example, Texas National Bank, a Hispanic MDI and CDFI mainly serving the Rio Grande Valley, has used digitalization to improve its relationship banking model and credit people and small companies with bad credit or no collateral. Through partnerships with digital companies, the bank uses the monthly inflow, outflow, and overall balance of personal and company checking and savings accounts to check the ability to pay back; this lets the bank give loans that it might have turned down before because they were too risky. Importantly, this work gives consumers alternatives to predatory payday lenders, which often charge interest rates as high as 600 per cent, by letting households deal with cash flow problems without falling into debt traps.

Digitalization has clear benefits for banks with a mission and the communities they serve, but getting there is hard. Unfortunately, there are a lot of big barriers that make it hard for many mission-driven banks to adopt strong digitalization strategies. In our report, we talk about a few of these problems, such as prohibitive upfront costs for platforms and services, implementation problems like the current staff's skills and abilities, increased risk management and regulatory compliance requirements, and a greater reliance on core providers and other third-party vendors who may not put the needs of smaller clients first. Mission-driven banks need help from the public, private, and charitable sectors to deal with these problems.

To help MDIs and CDFIs on their way to digitalization, regulators and politicians need to eliminate the things that slow down growth. The most important thing for regulators is to know what they should think are safe and sound practices regarding partnerships with fintech companies and other relationships with third-party providers. Similar rules are needed to define "reasonable" due diligence so that banks are not left open to regulatory actions or other measures when unexpected problems arise. Also, bank supervisors and regulators should let MDIs and CDFIs spend more of their capital on technology and digitalization, including in partnerships with fintechs and other third parties.

Policymakers can help mission-driven banks by changing the rules for bank holding companies so that publicly held companies can invest in these banks without causing ownership to change. In turn, these purchases can make it easier for banks to lend more money. Policymakers should also look for new ways to get money into MDIs and CDFIs, such as through investment and grant programmes, tax credits, and yearly appropriations. Lastly, policymakers should put mission-driven banks at the centre of future programmes like the Paycheck Protection Programme; this will ensure that emergency help goes to the places that need it the most.

Mission-driven banks can also get help from business and philanthropic partners and the government. These stakeholders can give equity investments and technical help, loan their executives to mission-driven banks for set periods to help oversee the adoption of new strategies or technologies and give access to software or other forms of technological support. In addition to paying for specific deliverables, philanthropic support can pay for building capacity and teaching skills so that mission-driven banks can grow their workforces and make them better. Companies and nonprofits should look for ways to work together long-term instead of making one-time promises since this important work takes time to develop.

In the end, mission-driven banks can lead the banking industry in using digitalization strategies to meet the complex needs of customers in the 21st century, especially those in the Millennial and Gen Z generations who grew up with digital technology. The path to digital change will ensure that mission-driven banks stay strong as anchor institutions that can do more to close the wealth gap between whites and people of other races.