Redefining BaaS in 2024
The concept of Banking as a Service (BaaS) and BaaS models took root as banking digitally morphed via APIs, enveloped by the cloud. Popularity of the BaaS model and acronym hit the mainstream in July 2013, when Gartner published its landmark report Hype Cycle for Open Banking. It described open banking (aka BaaS and embedded finance) as “...the provision of services in the context of users through API platforms, app stores and apps.” 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 link between traditional banking and the tech-driven ecosystem. It’s a lucrative business model where banks provide white-label core financial products, through a few lines of code and APIs, to a myriad of payment frontends and industries — communications, hospitality, retail, airlines, energy, card processing and payments, among them.
BaaS, as I explored previously, has tremendous potential as a low-margin, high-volume new revenue business for banks. Critically, it could reverse the decline of the banking industry into a deposit and lending utility. The crux for banks is that they hold the banking license and, therefore, all of the regulatory obligations. Typically, the third-party partner never touches the customer’s money — it simply white-labels and delivers the bank’s products into the customer’s app. The bank is left holding the baby.
Steep odds from the top down
Financial firms, of course, face many hurdles that have hindered BaaS adoption. Difficulties in scaling fintech partnerships while retaining intellectual property — particularly amid a lack of technical competency on the bank’s part — is a distinct challenge. Realistically assessing the amount of time, money and resources required (while adequately preparing for the high level of operational and technical integration at hand) demands an array of hefty change management exercises and up-front investment. Without adequate capital at the ready, building a unique offering amidst 30,000 startups hitching to the fintech bandwagon will prove nearly impossible.
From the C-suite's perspective, BaaS initiatives require enormous commitment to the broader IT ecosystem and strategic alignment of business, technology strategies and ideologies. Add to that the difficulties behemoth financial institutions face with the recent plummet of fintech funding and a roiling macroeconomic environment. Leadership fights long odds in delivering what’s required to successfully mount a BaaS offering.
A BaaS pulse check
2023 was particularly testing for bank-fintech partnerships, as several banks found themselves in regulatory hot water. Among them, Evolve Bank & Trust and BaaS platform provider Synapse are in a dispute over responsibility for an alleged $13-million “deficit” in Synapse client funds being held in “for benefit of” accounts at Evolve. The partnership's breakdown led Synapse to lay off 40% of its workforce.
Increased scrutiny by U.S. banking agencies — outlined in the Interagency Guidance on Third-Party Relationships: Risk Management jointly issued by the Federal Reserve, Office of the Comptroller of the Currency (OCC) and Federal Deposit Insurance Corporation (FDIC) in June — has placed further obligations on bank-fintech partnerships. The guidance emphasizes that a bank must align their risk management practices with the nature and risk profile of their third-party relationships, including partnerships with fintechs. This has bank executives thinking twice about leveraging fintechs.
Still, the many benefits of BaaS, and the potential of an anticipated (and tantalizing) $7-trillion market in coming years, means the stubborn question remains for banking leaders. How can an institution with a historied culture, focused on governance and risk management, adapt to a culture of innovation and focus on customer engagement, all while still shackled to compliance?
A recent U.S. banking study by CCG Catalyst showed that, among 122 C-level bank executives surveyed, 21% professed interest in leveraging fintech but weren’t sure where to start, up from just 3% in 2022. Those who said working with fintechs is an integral part of their business strategy slipped 4%, from 43% to 39% year-over-year.
This indicates that, although the sector is struggling to quickly tap its promise and potential, BaaS as a business strategy is far from dead. To the contrary. While banks still have much to consider about the model’s future in this shifting regulatory landscape, the benefits and opportunities remain — and they will likely be significant. They will merely be realized at a slower pace than once anticipated.
More haste, less speed — at least to start
Alluring as it is to pursue development of the next viral app, banks should consider BaaS as a longer-term strategy. They should work with partners to help build on existing relationships and increase capacity. Another salient option is also to look beyond fintechs to more established technology firms that are proven in AI innovation and execution. Whatever path they choose, success will entail doing the necessary due diligence and making data-backed decisions.
As for regulation, partnerships must foster a strong culture of compliance. Critically, that hinges on two things: the chief compliance officers must have 1) sufficient oversight of fintech operations and 2) sufficient decision-making power. Clearing these hurdles will require reports, reports and still more reports — all written for each stakeholder’s role and delivered in real time.
The BaaS model could prove a real gamechanger in financial services. The question remains, can traditional players rise to the occasion to make it a reality?
Author: Joan McGowan, Head of US Financial Services Industry Consulting at SAS
-->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