A thirst for deposits has made the concept of banking as a service hotter than jalapeños. The thing of it is, many institutions should just stay out of it.
At best, they’ll waste resources they can’t spare. At worst, they could end up running into regulatory trouble.
This advice comes from Ahon Sarkar, general manager of Helix by Q2, which provides core systems that connect banks and credit unions with fintech partners.
A long line of institutions now aims to raise deposits through partnerships with fintechs and other nonbanks, Sarkar says. But “it’s like a long line at a roller coaster,” he says. “There’s a sign up front that says, ‘You must be this tall to ride.’ And of the folks in the would-be BaaS line, more than half of them are not tall enough.”
BaaS truly is a partnership, and it is critical for new players to recognize that many of the fintechs seeking their services aren’t tall enough to ride the roller coaster either, he adds.
The motivation to jump into BaaS is strong. “Every bank wants deposits; every bank wants distribution,” says Sarkar. “And so they are sitting there thinking that BaaS is the ‘easy button’ for the bank to go get new deposits.”
It isn’t, he warns, and any institution unwilling to sweat the details of a serious BaaS program should save themselves the trouble now. In this interview with The Financial Brand, he shares a process for making a sound decision.
Think of a BaaS Relationship as a Bank-Fintech Marriage
Many view banking as a service as little more than a “rent-a-bank” strategy — lend some fintech your charter and just keep harvesting deposits.
But this deposit option is never as cheap as they think.
“Yes, you are not going to have to spend a bunch of money on marketing,” says Sarkar. “And yes, you are not going to have to spend a bunch of money on additional branches. All that stuff goes away.”
But after you take those costs off the scale, you have to add some other ones, he says. “You are going to have to scale up your compliance team and your fraud monitoring team. In a lot of cases, you are going to have to scale up your legal team, too.”
Many would-be BaaS players forget that ultimately the institution’s reputation and its standing with regulators is on the line with every fintech partnership. Due diligence is required not only up front, but on an ongoing basis.
“Vet it and forget it” won’t work.
To think that banking compliance, for example, will be handled by the fintech is a big mistake. Experience with that and much more is what the bank or credit union brings to the table.
Any newbie in the BaaS business must have sufficient resources to ride herd on its first partners and be prepared to add incrementally to that spending as its cohort of partners grows.
“Ultimately, a good partnership between a bank and a BaaS client looks like a marriage where both sides are deeply involved.”
— Ahon Sarkar, Helix by Q2
When a bank or credit union ventures into “the fintech Wild West,” some would-be partners are in a big hurry to sign a contract and get moving on their pet idea in a month, Sarkar says.
But fast BaaS — much like an elopement — can be dangerous. It often becomes apparent months later that the institution and the fintech never built a common understanding of relative roles and responsibilities, he warns.
Establish a process that will ensure each partnership is set up appropriately. Then refine as needed. After that, “rinse and repeat,” Sarkar says.
Need Deposits Now? Get Real About the Time BaaS Takes to Set Up
Understanding the nature and depth of the commitment is just the first part of this adjustment. Banks and credit unions need to have a realistic view of the timeframe for getting any banking-as-a-service program up and running.
If deposits are the motivation behind your interest in BaaS, Sarkar advises taking a hard look at the calendar.
• A few weeks — Let’s say the bank wants new deposits to flow in three weeks. Don’t even finish reading this article. Sarkar says the solution is to either pay up with a high rate locally or pay the premium demanded by a deposit network or by a provider of brokered deposits.
• Months — Do you have six to nine months to build up deposits? Consider establishing a digital bank, a separate online-only brand that can gather deposits from outside the branch footprint. These typically target a particular niche, such as Owners Bank, which is pursuing small business customers. Owners, a division of Liberty Bank in Middletown, Conn., launched in spring 2023. An earlier entry, Ivy Bank, is taking more of a generalist approach. It launched in 2021 as a division of Cambridge Savings Bank in Massachusetts. “Be prepared to spend a little bit of marketing money on it because you are going to have to fuel the engine of your brand,” Sarkar says.
• A year or more — BaaS is a viable answer only when you have the luxury of time, according to Sarkar. He suggests a comfortable timeline of about 15 months to set a program up properly and get a partner onboarded.
It also could take longer, depending on the type of program that a fintech partner wants. A savings account offering is the simplest type of product, because it’s an account and a statement, essentially. But as soon as a debit card gets added to the package, add more time. The extra steps include getting the card certified on Visa or Mastercard, getting card art approved and more.
Once a BaaS program is established, “you can launch a very standard product in a month or two,” says Sarkar. “But the winners are going to be the ones that have some unique value. And if you want to win, you’re not going to launch in a month.”
Sarkar also stresses that top management must be committed to the BaaS strategy. While that’s a standard proviso for every new thing banks and credit unions want to get into, he says it’s especially true in this case.
- How to Get the Best Results from Bank-Fintech Partnerships
- What Regulators Say in Their New Guidance on Partnerships
Assessing Potential BaaS Partners
Sarkar warns that there are many “me-too” fintechs that bring nothing unique to the market. A banking-as-a-service provider, especially a newcomer, must be careful to choose partners that have the potential to grow.
Not long ago, fintechs had plenty of venture capital funding to pour into marketing. Now capital is tight, and investors favor a focus on profitability over growth. Banks and credit unions should understand how a potential BaaS partner intends to achieve both of those goals.
So Sarkar recommends asking fintech founders what their story is. “Sometimes companies have great answers and sometimes companies have awful answers,” he says. “And when they have awful answers, you just know they are going to fail.”
It’s also important to assess how well the founders understand what they are doing and why. The standouts typically can get by without having to pay maximum rates on deposits because they are solving their customers’ problems in some unique way.
Winners Know Their Goal:
What makes fintech survivors successful is that they have a crystal-clear understanding of who they are serving and what problems they are solving for.
A standard fintech account offering isn’t going to draw lots of deposits today, Sarkar warns. “Unique value takes time,” he says. “The reality is that a lot of those companies’ customers are going to have $30 average balances, because they opened an account and put a little bit of money into it. Cost but no usage means no revenue.”
This should eliminate a potential BaaS partner from consideration early on. But even when a fintech makes it past that hurdle, more analysis awaits.
Sarkar says that the demographic a fintech serves will determine the balance per customer. A mass affluent customer may have a couple of thousand dollars in an account, while a recent college graduate may have just a few hundred dollars. The fintech has to have a plan for attracting enough of either base to have a viable start.
After that, income strata makes a difference.
“The math comes down to, how many active users will the fintech have? What will be the average balance of the users? How sticky is your product? How many people will actually be using it?” says Sarkar. The result of the computation has to be high enough to make the BaaS deal worthwhile for the bank or credit union.
Other questions to consider are: Is the offering unique and do enough people need it to make the fintech profitable and a viable source of deposits?
What Newcomers to Banking as a Service Say
FirstBank in Nashville, Tenn., and Legend Bank in Bowie, Texas, launched a BaaS initiative this fall, after taking about a year to get things underway. Both cited deposits as one of their goals. (Get more detail about their approach here.)
“The ability of nonbank entities to gather deposits and originate credit is quite shocking when you begin to see the actual numbers generated” — and it’s all from customers who might otherwise be getting those services from a traditional financial institution — says Wade Perry, the chief innovations officer at the $12.9 billion-asset FirstBank.
“My guess is that most banks don’t realize the silent competitor that is eating away at the fringes of their deposit base.”
— Wade Perry, FirstBank
Regulators expect “a high degree of rigor” in vetting fintechs and in operating a BaaS program, Perry adds. FirstBank invested in technology and talent to ensure its risk and compliance framework is “best in class,” which it now touts as a selling point with potential fintech partners.
“I think fintechs are becoming very sensitive to the fact that a bank partner’s regulatory issue could have catastrophic consequences to them,” he says.
Jared Robinson, the fintech program manager for the $1.1 billion-asset Legend Bank, says it has settled on its first fintech partner — “a consumer fintech in the deposit account and debit card space” — and expects to have a few others by the end of 2024.
He says its BaaS initiative has been a bankwide effort and describes the support of an “adventurous” executive team as key. “Every department — including compliance, operations, finance, risk and more — have played a crucial role at every step of the journey.”
In an analogy similar to one from Sarkar, he likens BaaS to a “thrilling roller-coaster ride” for community banks. “It’s tempting because it promises new deposits, fresh customers, impressive shareholder returns, and the chance to keep up with the fast-paced digital world,” Robinson says. “But let’s be honest, it’s also a daunting challenge.”
Check out The Financial Brand’s List of Digital Banks.