Banks’ interest in expanding into “banking as a service” is soaring. Many institutions latch onto the idea as a way of achieving digital transformation or to make up for a shortfall in their current operation.
A cadre of firms has emerged to help them find suitable fintechs and other partners and to make the deals work technologically. But the leader of one such firm suggests that for many institutions “BaaS” is either not the right move at all or that they simply aren’t ready for it.
In fact, Chris Dean, CEO of Treasury Prime, says some would-be BaaS providers who come to the firm wind up being turned away.
“They may even be willing to pay us a consulting fee up front,” says Dean. “We say, ‘Well, no thank you. We like you, but your bank isn’t ready’.”
He explains that in some ways his company is the “Airbnb of BaaS.” On one hand sits a nonbank company that wants to add banking powers to its operation in some way. On the other, there’s a bank that wants to expand into BaaS to add to its business lines. Treasury Prime’s main role is to evaluate partners on both sides and then provide the tech connection for those that fit the requirements.
Interest Isn’t the Same as Readiness
Dean says that only about one out of three banks that are interested in BaaS have a clear idea of what they want to do in this field. And only one out of ten has worked out how they will accomplish it.
“Many come to us because they want to be turned into a fintech bank,” says Dean. “And community banks are often feeling the squeeze because the national brands are invading their territory in one way or another. For example, deposits might be getting sucked away.”
However, interest doesn’t equate readiness. “Our model is based on usage,” says Dean, “so we can’t spend two years holding their hand until they figure things out.”
A BaaS Deal Killer:
Without CEO support, Banking as a Service will fall apart due to departmental infighting.
Dean explains that BaaS requires the internal cooperation of many functions in the bank. As a result, someone with broad authority, such as the CEO, has to champion BaaS.
“The most junior person on the leadership team may really want to do BaaS because they see that it’s the future,” says Dean. “I think they’re right — that’s why I started the company. But if the risk management staff is arguing with the operations staff you need someone to broker the peace there.” The junior staffer can’t do that.
The other make-or-break point is not size or financial strength, but operational ability. “Can they execute on it?” is the key question, according to Dean.
Read More: The Future of ‘Banking as a Service’
Understanding How — and Why — BaaS Works
Many BaaS newcomers don’t understand the fundamentals of banking as a service.
One key point many would-be BaaS players don’t appreciate is that financial institutions are actually in the driver’s seat.
“Despite all the noise from the fintech side, banks hold most of the economic cards, especially in the U.S.,” says Dean. “Banks have a charter, which is a monopoly. And the fintechs can only do what they want to do when they can get a bank on their side. In fact, I tell fintech clients all the time that their most important partner is the bank, not Treasury Prime.”
Many candidates also don’t fully appreciate what makes the usual BaaS arrangement work. Dean says it is a matter of each side doing what they do best.
“Chime is a great example of fintech success. What does Chime actually do? Chime is a marketing company. That’s what they are good at, customer acquisition.”
— Chris Dean, Treasury Prime
Marketing and product development, he continues, are not skills that banks handle well. “Banks are great at tasks like risk management and they are great at customer relations, especially for commercial clients,” Dean explains.
When two partners can bring such skills to the table and make a good match, a deal can be done, so long as the bank is operationally ready.
However, Dean says there have been surprises when Treasury Prime is in matchmaker mode. Sometimes the company has a fintech on one side with a specialty or angle that Dean feels may not be strong enough to succeed, or may even entail reputation risk. But the bank on the other side of the pending deal really likes the fintech and wants to do the deal. So Treasury Prime lets the deal proceed.
Ultimately, so long as things work technically, it’s up to the players.
“We’re a software company. I’m not going to tell someone they can’t write a bad novel on Microsoft Word,” says Dean.
Dean adds that the bank ultimately has the upside if the potential they saw plays out. “The downside,” he notes, “is that they’re holding the bag if anything goes wrong.”
Something that has surprised Dean is that large banks have had virtually no interest in BaaS arrangements, though some of the largest banks, like JPMorgan Chase, have been gobbling up fintechs to become part of their own organizations.
Dean says he once thought the big banks would roll into BaaS, but “they’re never going to do it. They just don’t care about this strategy. They see fintechs as competitors. They don’t want to power them. They want to take all their business.”
Goldman Sachs, working with the likes of Apple and GM is one exception, he notes.
How Far Can BaaS Go As the Industry Evolves?
Dean says a good ballpark figure for the amount of U.S. deposits that fall under BaaS arrangements is about $30 billion. He believes the influence of BaaS will continue to grow and that by 2032 roughly $1 trillion in deposits will be controlled by fintechs and other nonbank players.
Driving much of the interest will be embedded banking, the incorporation of banking and payment functions into many websites and other company venues.
Even having once started a successful dotcom years ago, Dean admits to surprise how things have evolved.
“If you had told me that every pizza place would have an internet presence, I would have laughed at you,” says Dean. “But now that nearly every company has a website, they will be internet companies, and in that way, they will all be fintech companies.”
A good company that Dean recommends watching to see how roles develop is Toast, which provides restaurant management and point of sale payment software. While the software is a fee-based business, Dean says Toast makes much more from payment services.
“A penny here and a penny there, over many transactions actually works out to be a lot of money,” says Dean.
He says much of the BaaS action in the future will be with companies doing things like Toast is doing that require a banking partner.
“Something like starting a neobank for Millennials is last generation now,” says Dean. “Now the market is becoming companies that want to monetize their client bases.”
Though there will be industry consolidation over that decade, Dean doesn’t think the fundamental structure of banking, in terms of the range of sizes of institutions, will change much. He says banking as a service has grown in part as a substitute for the moribund fintech charter developed by the Comptroller of the Currency. Somewhat wistfully, Dean says he wishes the U.S. had taken a page from the U.K. strategy, which created the opportunity for challenger banks like Starling to start up on a limited basis, graduating in time to full charters. However, the relatively high numbers of U.S. banks appears to have precluded that.
Many BaaS Partners Serve Business Banking Needs
One misconception that Dean says persists is that all BaaS arrangements consist of retail banking services.
“Many journalists focus on the big retail brands like Chime and Affirm, but most of our fintech clients are on the commercial side and they don’t make that radar,” says Dean.
Often they are serving market segments that don’t have the headline appeal of consumer services. An example that Dean thinks has good long-term potential is fintechs using BaaS arrangements to serve landlords.
“It’s a great business and they’re making a ton of money,” he says, “but it’s not something that’s going to make the front page of The New York Times.”