As 2023 drew to a close, many banking executives and thought leaders threw up their hands in despair at the apparent death of Banking as a Service (BaaS). An anticipated hot market has failed to live up to expectations, and countless financial institutions have seemingly thrown in the towel on BaaS as the industry grapples with the disruptive forces reshaping financial services on the road to The banking sector in 2035The bell has tolled. Or has it?
Rumors of the demise of BaaS have been greatly exaggerated. The BaaS model still retains enormous advantages, but market turbulence and organizational and technical challenges continue to thwart financial institutions’ efforts to create a successful BaaS offering. Redefining BaaS for 2024 and understanding the challenges ahead can illuminate the path forward.
Redefining BaaS in 2024
The concept of Banking as a Service (BaaS) and BaaS models took root as the banking industry evolved digitally via APIs, wrapped in the cloud. The popularity of the BaaS model and acronym reached the mainstream in July 2013, when Gartner released its landmark report Open Banking hype cycle. He describes open banking (aka BaaS and embedded finance) as “…the provision of services in the context of users via API platforms, app stores and applications.” More than a decade later, BaaS capabilities extend beyond new transaction channels to encompass complex financial operations, fraud and risk management, and regulatory compliance.
BaaS is the bridge between traditional banking and the tech ecosystem. It’s a lucrative business model in which banks provide white-labeled core financial products, via a few lines of code and APIs, to a myriad of payment front-ends and industries: communications, hospitality, retail, airlines, energy, card processing, and payments, among others.
BaaS, as I have already mentioned, has enormous potential. As a new, low-margin, high-volume business for banks, it could reverse the decline of banking into a deposit-taking and lending business. The key for banks is that they hold the banking license and, therefore, all the regulatory obligations. Typically, the third-party partner never touches the customer’s money: they simply provide the bank’s white-label products and deliver them into the customer’s app. So the bank is at the mercy of the baby.
High odds from top to bottom
Financial firms, of course, face many obstacles to BaaS adoption. The difficulty of developing fintech partnerships while retaining intellectual property, particularly given the bank’s lack of technical expertise, is a real challenge. Realistically assessing the time, money and resources required (while adequately preparing for the high level of operational and technical integration at hand) requires a series of change management exercises and upfront investments. Without adequate capital, it will be nearly impossible to create a unique offering amidst 30,000 startups jumping on the fintech bandwagon.
From a leadership perspective, BaaS initiatives require significant commitment to the broader IT ecosystem and strategic alignment of business, technology, and ideological strategies. Add to that the challenges facing giant financial institutions with the recent decline in FinTech funding and an unstable macroeconomic environment, and leaders face many hurdles in delivering what is needed to successfully mount a BaaS offering.
A BaaS impulse control
2023 has been a particularly challenging year for bank-fintech partnerships, with several banks finding themselves in regulatory hot water. Among them, Evolve Bank & Trust and BaaS platform provider Synapse are in a dispute over liability for an alleged $13 million theft. “deficit” in Synapse client funds held in “for the benefit of” accounts at Evolve. The The breakdown of the partnership led Synapse to lay off 40% of its employees of its workforce.
Increased surveillance of US banking agencies — described in the Interinstitutional guidelines on relations with third parties: risk management Guidance issued jointly by the Federal Reserve, the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC) last June imposed new requirements on bank-fintech partnerships. The guidance emphasizes that a bank must align its risk management practices with the nature and risk profile of its relationships with third parties, including partnerships with fintechs. This is prompting bank executives to think twice before engaging with fintechs.
However, the many benefits of BaaS and the potential for an expected (and tempting) service A market of 7,000 billion dollars in the coming years, The question for banking executives is: How can an institution with a historical culture focused on governance and risk management adapt to a culture of innovation? And focus on customer engagement, while remaining constrained by compliance?
A Recent study of the US banking sector by CCG Catalyst A study found that among 122 senior banking executives surveyed, 21% said they were interested in leveraging fintech but didn’t know where to start, compared to just 3% in 2022. Those who said working with fintech was an integral part of their business strategy fell 4%, from 43% to 39% year-on-year.
This suggests that while the industry may be struggling to quickly realize its promise and potential, BaaS as a business strategy is far from dead. Quite the opposite. While banks still have much to think about about the future of the model in this changing regulatory landscape, the benefits and opportunities remain – and they will likely be significant. They will just materialize at a slower pace than expected.
More haste, less speed — at least at first
While it’s tempting to chase the next viral app, banks should view BaaS as a longer-term strategy. They should work with partners to help strengthen existing relationships and expand their capabilities. Another compelling option is to look beyond fintechs to more established tech companies with a proven track record of AI innovation and execution. Regardless of the path chosen, success will require due diligence and data-driven decisions.
When it comes to regulation, partnerships must foster a strong culture of compliance. This is based primarily on two things: compliance officers must 1) have sufficient oversight of fintech operations, and 2) have sufficient decision-making authority. Overcoming these hurdles will require reporting, reporting, and more reporting, all tailored to each stakeholder’s role and delivered in real time.
The BaaS model could well be a game changer in the financial services sector. The question remains whether traditional players will rise to the occasion and make it a reality.
Author: Joan McGowan, Head of Consulting for the US Financial Services Industry at SAS