Put five bankers and five fintech players in a room and have each write out what “banking as a service” and “embedded banking” means to them. You’re likely to have ten sets of definitions that don’t agree with each other.
“People are jumping into the business and using terms like those and assuming we’re all using the words the same way,” says Jason Henrichs, CEO of Alloy Labs. “But we all actually have different definitions. It’s pretty frustrating when you think you’re in alignment, as a bank, with a fintech partner, only to discover, a few months later, that you’ve been using the same terms to describe different things.”
Henrichs’ company works with about a third of the banking as a service providers, by volume of activity, he says. He says the opinion developed among members of Alloy’s “BaaS Center of Excellence” client group that as BaaS matures, a consistency in terminology will be essential to avoid problems. Aside from contractual issues arising from misunderstandings over terms, says Henrichs, members also saw risks relating to compliance and treatment of consumers, among other issues.
The solution: A glossary that attempts to bring clarity to BaaS by defining a dozen terms.
“It’s written ‘in pencil’ right now, but pretty firmly,” says Henrichs of the new glossary. “But as this circulates around it’s intended to be a living document that will continue to be updated.” He adds that this effort is intended to be an open process and that he doesn’t see the project as a competitive advantage for any of the participants.
‘BaaS’ Versus ‘Embedded Finance’
Some might think practitioners would agree on what key terms mean, but that’s not actually the case. Conversations about “BaaS” and “embedded banking,” or even “embedded finance,” may begin with one party asking the other where they draw the line between the two.
“Banking as a Service” has tended to be used as something of a catchall term, but the group’s white paper, “The New Nomenclature Behind the BaaS Partnership Boom,” makes a clear distinction.
BaaS, in part, is defined as follows: “A partnership model in which a financial institution leverages its bank charter to enable one or more non-bank financial services companies to offer deposit accounts directly to consumers.” [Emphasis added.]
Some readers may be surprised to see the stipulation about deposits in the definition of banking as a service. After all, aren’t some bank-fintech deals based on use of payment rails?
Payments are addressed through a separate definition, “BIN Sponsor.” (BIN stands for “bank identification number.”) The paper defines this as: “A partnership model in which a financial institution leverages its position as a member of one or more payment card networks to enable non-bank financial services companies to issue debit, credit, or prepaid products directly to consumers.”
Linked to these two definitions is a third, “Embedded Finance.” The paper defines that term as follows: “Refers to payment or lending services that are provided directly to consumers by companies that are not financial services firms.” [Emphasis added.]
The definition continues: “Embedded finance tools are typically used to help consumers complete checkout experiences or access credit quickly. These experiences are often instant and can be invisible to the consumer. In most cases, the consumer never encounters the financial services brand that facilitates these transactions in the background.”
Among other terms set forth in the white paper are: Marketplace Lending, Issuing Bank, Middleware Provider, Program Manager and Sponsor Bank.
As noted, the document is intended to evolve. Already, some providers have pointed out that the definitions lean toward consumer financial services and have suggested revisions to make them cover both consumer and commercial banking arrangements.
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How a Central Set of BaaS Definitions Could Help
Henrichs says the idea for the glossary gained momentum as bank members in his company’s banker group began to realize they weren’t always using terminology consistently among themselves. As discussions progressed, they realized that fintechs, especially startups that are completely new to banking, had even more variation in what they understood key terms to mean.
Ideally, the white paper can serve as a resource both parties to a contract can use as context for negotiating contracts. Henrichs says this would be especially important when a fintech is going to operate with multiple banking providers. Chime, for example, works with two organizations, The Bancorp Bank and Stride Bank.
Henrichs says there has been a “gold rush” mentality to BaaS deals that practitioners think needs some control in the form of agreed-on usage. In the absence of that, he says, some fear regulatory issues will come. Alloy’s group includes some longtime BaaS providers, including Cross River Bank, Lincoln Savings Bank and Choice Financial Group.
Of course, BaaS is not solely an American phenomenon. It’s used in other countries as well. In the U.K., for example, Starling Bank, a new player itself, has been successfully offering access to banking for nonbanks as a business line.
So far the glossary is a U.S. arrangement. Henrichs says the plan is to get it solidly going here and then to expand usage to other regions. Some companies participating in the effort, such as Currencycloud and Railsbank, work in other countries as well. Henrichs says their guidance has helped develop definitions that could work in other markets.