Article

Evaluating the sponsor bank relationship is critical for ATM deployers

Many service providers don't take time to critically evaluate their sponsor-bank relationships. Service providers that don't look both ways before walking into a sponsor-bank relationship could be heading for disaster.

February 16, 2010 by Susan Kohl — President, ThoughtKey

Susan Kohl will be speaking during this week'sATM Industry Associationconference in Miami.See details about the conference here.

Banks evaluate their critical partner relationship continuously. They know that the dynamics of relationships change, especially when economic times are tough. Evaluating partnerships regularly mitigates risk and keeps business on track. Like someone crossing a street without looking for cars, service providers that don't look both ways before walking into a sponsor-bank relationship could be heading for disaster.

When was the last time you, as a service provider, questioned whether your business partners still align with your strategy? Is something missing in the partnership that could significantly impair the business portfolio you have worked so hard to build? The time to address these questions and opportunities is now, and quarterly for as long as you are in business. If you think this is overkill, allow us to elaborate on the service provider/sponsor-bank partnership process.

"Service providers" in the payment industry are entities that have access to cardholder data, solicit card brand activity, and/or perform certain supporting services for the payment industry. Service providers can operate in both the issuing and acquiring sides of the industry including, but not limited to:

Independent sales organizations (ISO)s
Encryption service organizations (ESO)s
Payment call centers
Payment processors
Payment gateways

These entities are required by the card brands (i.e., Star, Pulse, NYCE, CU24, Visa, MasterCard, etc.), to have a bank "sponsor" their payment activities. In order to be a sponsor, the bank must be a member of the card brand(s) and must ensure proper registration of each service provider they choose to "sponsor" as defined in the card brand(s) operating rules and regulations.

These operating rules and regulations also define what level of due diligence the sponsor bank must perform to ensure that a service provider is eligible to participate (aka be "sponsored") in payment activities. Eligibility criteria vary slightly for each sponsor bank, but most diligence guidelines require:

Validation of ownership and business license
Evaluation of financial status
Background checks (credit, criminal, company D&B, etc.)
Adequate insurance coverage
Review of business strategy/plan

TIP: A great resource to review publicly available information on banks is theFDIC Web site. Just click on "Last Financial Information," then under the "ID Report Selections" select "All Summary Information."

The due diligence that sponsor banks must perform can be painfully long. Often, demanding paper flow requests are submitted for the service provider. Throughout this process, service providers are put under a microscope to ensure they do not introduce risk into the sponsor bank and/or the card brand. But what about the sponsor bank? Who is asking if it is a viable, stable partner?

Unfortunately, all too often the answer is no one. Any service provider walking into the lengthy sponsor bank partnership process should have evaluated the sponsor bank and confirmed it as a viable, stable partner. If a service provider has not performed enough due diligence to know, at a bare minimum, whether the sponsor bank is stable, consider the consequences. The service provider may be subjecting itself to the painful evaluation process with the possibility that the bank may be sold, merged or fail – meaning the painful process must start over with another sponsor bank. That relaxed approach to critical partnerships can result in months of wasted effort.

Have the roles now reversed? Does the sponsor bank now present a greater risk than you as a service provider? We don't think so, but certainly risk scales have shifted, placing the burden of due diligence more evenly on both parties.

Consider the current state of the financial sector:

2009 — 140 banks failed
2010 — 15 banks have already failed, hundreds under review as of the date of this article
Sponsor banks were among those that failed
Sponsor banks have reported negative earnings, diminished capital, large loan charge-offs, and increasing REOs.
Several sponsor banks have been forced to acquire additional capital, require buy-outs or additional funding from other sources to survive.
Some sponsor banks are considering canceling their sponsorship programs or scaling back on their number of sponsored service providers.

There is no denying that the financial sector downturn worsened over the past year, resulting in a catastrophic impact on many financial institutions. This downturn is expected to continue through 2010. To protect their businesses, service providers must "look both ways" — at their own financial stability and that of their sponsor banks — before moving forward with a sponsor-bank relationship. And the scrutiny shouldn't stop there.

Just as service providers must review their own financials quarterly, they should also take time each quarter to verify that their partners have financial strength and mutually beneficial business goals. Then, ensure your funds at the sponsor bank are protected (FDIC insurance caps at $250,000) and have a backup plan in the event that the sponsorship relationship is abruptly terminated.

Susan Kohl is CEO of ThoughtKey, a payment industry boutique consulting firm focused on PCI, regulatory compliance, risk management and expert testimony. Marilyn Kilcrease, CEO of Creative Card Solutions, a payment industry financial consulting company, contributed to this article. To submit a comment,please e-mail the editor, Tracy Kitten.