Banking-as-a-Service (BaaS) is the latest in a long line of technology-enabled trends that purports to save the traditional banking sector, specifically smaller banks and credit unions. Like most trending topics, BaaS has become a bastion of technical jargon that often skews its origin, purpose and nuance. Despite its somewhat confusing and evolving definition, there is no question that Banking-as-a-Service is here to stay and opportunities abound for banks, fintechs and non-financial companies alike.
When defining BaaS, there are a few key elements to include: a technology stack, a chartered financial institution, an audience or focus and a set of desired functionality. These two definitions help further define what makes up BaaS today:
- The end-to-end process, ensuring the comprehensive completion of a financial service, provided via the Internet on-demand and managed within a specified timeframe, according to Dr. Ulrich Scholten.
- Another way we might update Dr. Scholten’s definition is to say that BaaS is a technology stack that allows brands, fintechs, or anyone who desires to embed financial services in their company to tap into modular banking specialties via licensed banks and deliver a specific set of functionalities to an audience.
Popular fintech consultant and blogger, Chris Skinner, noted that one of the reasons BaaS is so misunderstood or misrepresented is the fact that “it’s not open banking and it’s not APIs.” He continues, saying “it can include both of these things.” Banking-as-a-Service may include APIs from popular fintechs but for it to be the purest form of BaaS today, it must be backed by a licensed bank.
A Charter Comes In Handy:
Banking-as-a-Service can only go so far with just API technology. At the end of the day, it takes a bank license for it to be true BaaS.
How Banks Can Use BaaS
Banks regularly see scary statistics about their future. Surveys have shown that 90% of Gen Z respondents would consider a banking account with a nonbank. Additionally, 53% of all people would choose Amazon, PayPal and Walmart as their top three non-bank financial services providers. While some bank executives may feel the threat is exaggerated, there is no denying consumer awareness and sentiment have shifted away from a singular financial partner. Banking-as-a-Service offers both direct and indirect connections to these new customer groups looking outside the traditional financial system.
It’s common for older financial institutions to suffer from legacy technical debt and lack of technology resources and capital to indirectly connect and benefit from customer relationships that would otherwise be expensive or unlikely to attract.
“Smart financial institutions will find a way to enable embedded finance, and think about their balance sheet as their superpower.”
— Simon Taylor, Head of Ventures for 11:FS
So how do traditional financial institutions leverage Banking-as-a-Service to their benefit? Simon Taylor, Head of Ventures for 11:FS, says “the smart financial institutions will find a way to enable embedded finance, and think about their balance sheet as their superpower.”
But for many smaller banks and credit unions, their legacy technology stack doesn’t offer the highest degree of flexibility to allow brands or fintechs to attach their services seamlessly. Fortunately, technology providers like Nymbus are giving banks and credit unions a means to run a more modern, flexible environment that brings the full stack of financial product capabilities to fintechs and brands that want to embed and scale financial functionality.
While core financial products haven’t changed in the traditional system due to regulation, the way these services are delivered is the difference between customer acquisition at scale and stagnant customer retention exercises. The next decade of customer growth may depend on using technology to enter into new ecosystems, many of which may fall outside of traditional geographic footprints.
Some community banks and credit unions are already taking action while others seek more traditional means of growth via M&A and de novo expansion. Given margin pressures for both small and midsize financial institutions, there is no question that connection into new customer environments will be critical going forward.
A community bank with an open and API-driven architecture can power some of the most progressive fintechs across the country because the charter is still the most powerful, defensible asset a regulated financial institution has today.
Becoming an enabler of fintech could protect and pad the bottom line.
The Promise of BaaS for Fintechs
The fintech community has seen explosive user growth over the past 18 months and venture capital continues to pour into the space at an unprecedented rate. But sustainable growth of these new financial tools is being tested. High-growth fintechs who saw interest surge as the world went all digital during Covid, experienced a number of growing pains due to infrastructural challenges with bank partners and operational challenges given the lack of established, scaleable banking servicing operations.
HM Bradley’s capacity via partner Hatch Bank was tested as demand increased and they shifted back to an invite-only model temporarily. Chime, in the midst of a soaring valuation, faced deposit operations challenges this year and more questions about how future neobanks will be regulated.
The good news for fintechs is the growing customer interest in and usage of non-traditional banking tools. With users comes the desire to “supersize” apps, adding new functionality across different financial areas (payments, lending, treasury, payroll, crypto, cash flow, etc.). And while the desire to add features may be tempting, a key component of expansion will be the use of the Banking-as-a-Service.
Separating Winners from Losers:
How fintechs choose BaaS partners and approach integration will separate them from the pack over the next decade.
As seen at HM Bradley and Chime, complexities have already proven difficult for some neobanks and B2C apps as they begin to rely on different technology and financial providers while trying to maintain the pristine user experience that attracted many users in the first place.
How fintechs choose BaaS partners and approach integration will separate them from the pack over the next decade. Others will fall into the same traps the legacy financial industry experiences today, with a stagnant reliance on a few providers that prevents seamless and successful customer experiences.
Non-Financial Brands Tapping Into BaaS
The latest entrants — and most likely the fastest growing segment of BaaS users in the coming years — will be non-financial brands. You may have heard “every company is a fintech” and in many ways that is true, but the next generation of embedded financial services inside other companies will be much more complex. You’ve already seen mainstream examples in Apple Pay and Google Plex as they embed BNPL and various payment options into their commerce ecosystems.
Embedded finance companies are predicted to reach a market cap of $7.2 trillion globally by 2030. Additionally, the embedded finance market will reach just under $230 billion in terms of new revenue volume by 2025 in the U.S., versus $22.5 billion in 2020, an increase of 922%, according to Business Insider. This growth signifies two key trends:
- Retailers want to own more of the financial enablement within their company (and benefit from it). Whether companies embed new payment options or short-term lending functionality, more companies recognize they need great partners to improve how their customers “bank with them.”
- The “Great Opening of Finance” is slowly taking place. As more universal APIs gain traction, consumers will expect seamless integration and connectivity between their financial services providers and preferred brands.
Embedding financial services presents a number of integration and customer experience challenges for non-financial companies, but the access and ease of integration will continue to improve over the coming decade. Already reliant on a variety of payment tools via companies like Square, Shopify, Apple and Google, many companies will need to hire stronger financial product strategists to truly build the best and most profitable financial solutions inside their services.
What’s Next For BaaS?
The outdated concept that fintechs would end the traditional financial services sector was quickly muted the past five years. Financial institutions and fintechs still need each other to provide the most secure, compliant and successful customer experiences today.
In the coming years, more banks and credit unions will enter the BaaS landscape via technology partners and some will directly acquire fintech offerings that can attach to their BaaS offering. Fintechs will continue to seek out BaaS partners that can demonstrate scalability as users young and old seek better digital experiences.
Additionally, non-financial brands see a growing window of opportunity to embed financial capabilities in their services, as BNPL, short-term financing, credit and other digital payment opportunities appear in non-traditional places. Banking-as-a-Service is clearly redefining when and where companies provide financial services. The implications for bankers, fintechs and brands are enormous.