Banking as a Service has exploded in popularity as a result of the push for open banking (BaaS).
Indeed, according to recent study, Open Banking and Banking as a Service would be worth USD 43.15 billion by 2026. Yes, we understand that there are several jargon definitions for Banking as a Service (BaaS) on the internet.
What exactly is Banking as a Service (BaaS)?
Banking as a service, or BaaS, enables non-banks to provide fundamental financial services to their consumers through API integration with banks. Non-banks (such as fintech and even non-fintech companies) create products on top of existing banking infrastructure.
Here’s a BaaS example:
Assume you run an online ticketing service. Naturally, you want to boost revenue and customer retention. So, here’s what you’ve decided:
These approaches will now result in an increase in sales and customer satisfaction. Furthermore, you can analyze consumer purchasing habits and tailor offers to them in order to enhance customer loyalty.
- Customers will appreciate personalized cards.
- Each purchase earns you loyalty points.
- Loans are available with a single click.
Isn’t it simple enough?
That’s not the case.
Offering customers financial services comes with a lot of stipulations. In fact, in order to provide banking services such as depositing and lending assets, you must obtain a banking license or other associated permits.
For example, you’ll require:
PPI (pre-paid instrument licence) for issuing pre-paid cards
A license from the National Bank to provide loans for upcoming performances.
Licenses are, without a doubt, exceedingly difficult to obtain. Especially for enterprises who do not engage in banking activities or collaborate with financial institutions.
Non-banks (like the ticketing platform in our example above) can interact with banks using Banking as a Service (BaaS). They will be able to provide digital banking services to their consumers as a result of this.
All of this without the burden of obtaining a bank licence.
Banking as a Service (BaaS) Players
BaaS usually involves three major players:
Traditional Banking as a Service Platform, New-Age Banking as a Service Platform, and Fintech or a non-fintech company looking to integrate fintech services into their offering. Let’s take a closer look at each player to see what they do and how they do it.
Traditional and New Age Banks
What are their responsibilities:
The physical infrastructure, also known as “Infrastructure as a Service” (IaaS), is provided by the banks. The server and communication devices are examples of basic infrastructure services.
Banks have the necessary licenses to provide core financial services. They allow BaaS suppliers access to their main banking system.
These IaaS services may now be accessible on-demand and have a non-fintech focus. After launching an app, for example, servers can be rented via Amazon Web Services (AWS). IaaS services can also be rented on demand from traditional banks.
A classic bank, for example, might be Goldman Sachs or ICICI Bank. Solaris Bank is an example of a new-age financial institution.
Platform for Banking as a Service
The Banking as a Service (BaaS) platform offers software that ensures secure data transfer between a traditional bank and a business/fintech firm. The ‘middleware’ or ‘banking as a service’ layer is another name for this layer.
As if it were a Lego set, fintech companies and businesses connect to the BaaS platform. Interestingly, several BaaS platform vendors also have bank licenses. They may not, however, have the same underlying basement as a regular bank. Chris Skinner, a well-known financial thinker and expert, refers to these BaaS platforms as ‘decomposed banking services’.
The BaaS platform is based on APIs. Consider it a back-end for a variety of Fintech companies and non-bank businesses. To ensure secure functioning across the domain, the BaaS layer requires continual monitoring. Furthermore, secure authentication is crucial.
Example: Various BaaS providers may provide different banking services. Services such as card issuance, personal finance, quick lending, and payouts, for example.
Fintech and Non-Fintech Businesses
Finally, there are companies that communicate directly with customers. The BaaS platform’s customers are these businesses.
It’s vital to note that these businesses might be either fintech or non-fintech. Anyone who wants to incorporate these financial services into their offering is a consumer.
The BaaS platform is typically used by fintech and non-fintech companies to deliver financial services to their own consumers. Because fintech services are delivered via a BaaS platform, they must adhere to the platform’s rules.
Example:
Remember how we used an online ticketing platform as an example in the first section of this article?
That’s an example of a non-fintech company using the BaaS paradigm to provide financial services to customers.
A fintech company, on the other hand, may employ the BaaS architecture to provide loan services. Take, for example, Early Salary. User onboarding, loan disbursement, and payment collection are all handled by Cashfree (a BaaS provider).
While these are just two examples, the BaaS paradigm has a wide range of applications. Let’s see if we can find some of them.
Online Banking
BaaS can assist fintech and non-fintech businesses in providing online banking services to their clients. They may concentrate on improving their offerings rather than worrying about bank licences and integrations.
For their customers, these user-friendly and technologically advanced products may be a better option than traditional banking.
They can also design apps for their consumers to keep track of their daily transactions, account balances, and savings. Aside from that, they can provide superior client service by ensuring faster access to funds and no hidden fees.
Cashfree Payments, for example, provides account creation services to neobanks and NBFCs. Their end-customers can create and link accounts as a result of this. They can also use it to check their balance, accept, and make payments. Surprisingly, all of this is made feasible by simple APIs.
Offer Debit and Credit Cards
Non-banks can offer credit and debit cards to their consumers using the Banking as a Service (BaaS) paradigm. Consider the Apple Credit Card.
Through an app, customers may obtain real-time updates on all of their transactions. The account information and payments for the customer are shown in a user-friendly manner.
Additionally, firms might entice clients by providing reduced interest rates.
Surprisingly, many businesses provide rewards on their credit and debit cards. This cashback can be assets with no expiration date that can be used to purchase any goods or service in stores, online, or apps for customer happiness.
Offer Loans
Businesses can also use BaaS to lend money to their clients. For example, an airline might provide consumers with one-click loans to guarantee that their travel plans are not disrupted and that they have a better customer experience.
Furthermore, companies can provide customers with Buy Now, Pay Later choices. The customer has the option of choosing their payment schedule in advance. They might use an app to keep track of their monthly EMI payments.
Investment Services
Non-bank and fintech businesses can also leverage the BaaS concept to assist customers automate their finances and invest their assets. They can assist customers in creating a customized investment plan using low-cost index funds. They can also automatically rebalance the portfolio in accordance with the customer’s investment strategy.
They can also fit the consumers’ investment requirements.
Verify the customer’s identity
Failures in payment transfers might jeopardize an organization’s reputation. Furthermore, it is possible that a company’s merchant account will be labelled as a “high-risk merchant.”
Payment transfer failures can be reduced with bank account verification. Before beginning the payment process, BaaS platforms can assist fintech and non-fintech organisations in verifying their beneficiary’s bank account. This is possible in the case of mass payment transfers across several payment modalities, such as net banking and UPI.
This section discussed how BaaS can aid in the advancement of financial services.
But what are the benefits of implementing the BaaS model?
Let’s find out.
Benefits of Banking as a Service for Banks
Increased Revenue Streams
BaaS enables banks to share data with third-party financial institutions via APIs. BaaS provide new revenue sources for banks as open banking becomes the norm.
In fact, 43% of banks want to operate under a model that permits them to charge a fee every API transaction.
Fintech and IT firms are ahead of the curve in terms of innovation and speed. Banks, on the other hand, have the trust of their customers and a vast amount of funding capacity at their disposal. Both sides can work together to find new revenue streams.
For example, JP Morgan Chase partnered with On deck, a fintech firm, to expedite the processing of small business loans.
Initiative to Save Money
Banks can benefit from BaaS not just in terms of income generation, but also in terms of cost reduction. Banks are not required to invest in technological advancement.
As a result, they may benefit from third-party partnerships because they already have ready-made solutions. In reality, this can assist banks in making additional investments and earnings estimates.
It’s no surprise that 77 percent of banks want to invest in open banking efforts for their corporate clients.
Increased Customer Insights
When a bank works with a third-party provider, it gains additional consumers. Not only that, but they also learn about the tastes of their customers. For example, their purchasing habits and financial needs.
Banks can now utilise this additional information to generate tailored offers for their consumers. After all, individualised offers are more likely to be accepted by 80 percent of customers. They can also use a more targeted multi-channel marketing approach. This may assist companies in reducing their reliance on above-the-line spending.
Advantages of BaaS for Non-Banks and Fintech Players
Non-banks and third-party suppliers have limited access to client information and banking capabilities. As previously stated, obtaining a banking license implies significant capital requirements. Furthermore, not everyone has the resources necessary to maintain legacy systems and comply with regulatory laws.
To put it another way, being a banker is not easy.
Furthermore, most firms cannot afford to obtain a banking licence because it will take attention away from their core business. The speed to market and product innovation will suffer greatly as a result of this.
The BaaS approach comes in help in this situation. It allows fintech companies and individuals to sidestep banking licencing rules by interacting directly with a bank. Financial startups may get off the ground much faster without having to deal with a bank’s IT infrastructure.
Increased Customer Trust
Banks don’t just have a lot of money to play with. They have the customer’s trust as well. In reality, 43% of customers believe banks will look after their financial security in the long run.
Businesses can use that trust to grow their customer base by collaborating with banks.
Furthermore, when firms interface with banks, they gain access to a wealth of client data. Long periods of usage have yielded this awareness. As a result, it may assist consumers in developing new and tailored services to address unique concerns. Automatic reconciliation, for example, for small and medium-sized business transactions.
These arguments demonstrate that both banks and non-banks stand to benefit greatly from using the BaaS model.
But how does the customer come out on top? So, let’s see what happens.
Advantages of Banking as a Service for End-Customer
Banking has traditionally been a regulated but privileged sector.
BaaS promotes financial services competition by allowing non-banks to provide fundamental banking services. As a result, innovation is pushed forward, and customers have access to more user-friendly products. Furthermore, it leads to increased financial transparency.
Customers’ individual pain areas are the focus of third-party players. For example, a fintech company may solely specialise on business payouts. A neobank, on the other hand, might concentrate on making the process of lending money to customers as simple as possible.
This helps them to concentrate on the task at hand rather than worrying about obtaining a banking licence and everything that entails.
As a result, a frictionless and personalised financial solution is created. This solution would be simple to use, appealing, and relevant to today’s increasingly tech-savvy customer base.
Superior Customer Experience
Customers have always taken out loans and paid them back.
So, what makes these financial solutions based on the BaaS paradigm so unique?
It’s about the customer as much as it is about the product. Customers today are digital natives. Customers of corporations such as Apple, Facebook, and Amazon have been trained to anticipate immediate satisfaction.
Customers, understandably, demand the same degree of service from their financial institutions. This pressure has only begun to rise as more and more technology businesses enter the banking sector.
The client demographic is another facet of this problem. The new consumer base is technologically sophisticated and expects real-time access to financial data and products. Surprisingly, countries with a young population had the greatest fintech adoption rate. In fact, in India and China, the incidence might be as high as 50%.
At the end of the day, the customer emerges victorious.
However, getting to that stage of client satisfaction is a huge accomplishment in and of itself. After all, connecting with a bank and developing financial products on top of that necessitates stringent data security and compliance protocols.
Yes, there are numerous benefits to using BaaS. What, on the other hand, are the market developments that have contributed to the rise of the BaaS model?
What’s the future of Banking as a Service?
Here are four reasons why BaaS has grown at an exponential rate in recent years. And why it doesn’t seem to be slowing down.
Customer Demand
Customer desire for integrated financial services is the first and most evident factor. After all, customers are becoming increasingly tech-savvy. The desire for comprehensive, user-friendly financial products will only increase.
Customers are also searching for seamless experiences. These merged experiences are referred to as “ecosystems” in the commercial world. In simple terms, an ecosystem is an end-to-end solution that eliminates the need for the customer to use any additional services to complete their purchase. In fact, ecosystem companies generate two times the income of other businesses.
A financial offering will, of course, play a significant role in this ecosystem.
Let’s look at an example. Let’s pretend you’re the owner of an online supermarket. You’d like to allow your consumers to shop using pre-paid debit cards. You might also want to offer services like instalment finance and money transfer. (Walmart recently tried something similar.)
Customers will have a better experience and be more loyal as a result of this. Most significantly, it will build an ecosystem in which your customers will not need to look for another solution to meet their financial requirements.
Furthermore, many fintech companies are focusing on small enterprises as possible consumers. They provide them user-friendly online banking services as well as low-interest loans. However, when dealing with traditional banks, 70% of small and medium businesses (SMEs) are unable to meet their financial needs.
Naturally, they are giving traditional banks a run for their money in this previously unbanked segment.
As a result, banks and private financial institutions must work together to provide relevant services to this group.
Growth of Fintech Industry
Fintech is booming all around the world, but especially in India. In fact, India has an 87 percent fintech acceptance rate, compared to a global adoption rate of 64 percent.
For their product offerings, fintech companies need to integrate with banks. As previously stated, most businesses are unable to obtain a bank licence. A banking license’s capital and compliance requirements ensure this.
What’s the end result? For fintech startups, the BaaS model becomes the only way to break into the market.
Regulatory Requirements
Open banking and the usage of APIs across the banking infrastructure are being promoted by organisations such as PSD2 and the Open Banking Working Group. In many countries, banks are required to make their APIs public in order to comply with the new legislation.
This measure is intended to maintain robust competition in the banking sector. Traditional banks, on the other hand, will face competition as a result of the open API.
As a result, in order to assure client happiness, banks must adopt the BaaS model. Integrating with fintech companies and non-banks also allows businesses to gain access to cutting-edge technology to meet client demands.
Banking Revenue
We all know how important bank interfaces are for fintech companies.
Recent reports, however, suggest that banking income and profitability may be on the slide in the foreseeable future. Traditional banks must maintain profitability in order to stay in business.
Integrating with non-banks can help them generate new revenue sources and expand their product offerings. They will be able to serve a larger number of consumers and meet their technological needs. Collaborations with businesses that have a highly scalable business plan would be the most profitable.
The dramatic rise of the BaaS model in recent years can be explained by these market dynamics. What about the future, though? What does the future hold for BaaS and what obstacles does it face?
Challenges faced by Banking as a Service
The challenges of implementing a BaaS strategy are plenty. Thankfully, the accompanying solutions pave the way for user-friendly financial products and solutions.
Let’s dig deeper.
Traditional banks are being modernized. Most traditional banks’ basic systems are obsolete. They don’t work with today’s technologies. This can be a major concern when deploying the BaaS model because third-party integrations will be hampered.
Traditional banks would benefit from modernised design in the future of Banking as a Service. This would help expose APIs, services, goods, and processes.
Players’ roles in the Finance Industry are changing. According to recent study, traditional banks are gradually losing their “customer trust” advantage over fintech businesses. Many tech businesses, on the other hand, are entering the financial sector because they have a high level of customer trust ( Eg. Apple Card)
Furthermore, BaaS necessitates collaboration with third-parties. There are a number of overlaps in functional capabilities, which is to be expected. Furthermore, many businesses utilise white-labelling to market their products. Customers may become perplexed as a result of this.
With these considerations in mind, the future of BaaS indicates a significant shift in player obligations. Banks may be reclassified as “assemblers” rather than “manufacturers.” This implies that they will not be only focused on their core banking services. Banks will instead package the services provided by their partners as value-added services.
It takes a lot of effort to set up a bank or a business (middleware) using APIs. Operational processes and business capabilities must be exposed to their full potential. However, most businesses confront challenges while developing an API strategy.
The simplicity of integration should be the primary goal while developing an API strategy. It should be able to provide maximum business value while keeping integration to a minimum. Global API strategy standardisation could be a part of the finance industry’s future.
Taking into account all relevant elements. The BaaS industry is showing no signs of slowing down. It will be fascinating to see how the BaaS model evolves over the next decade as technology advances.
Banking as a Service FAQs (Frequently Asked Questions)
What’s the difference between Open Banking and Banking as a Service (Banking as a Service)?
Open Banking introduces the concept of banking as a service.
The term “open banking” refers to the sharing of client information. Non-banks, on the other hand, can use BaaS to integrate financial services into their own product offerings. It focuses on providing essential banking services to customers.
The term “open banking” refers to a much broader concept. It enables third parties to gain access to customer financial information via banks.
What is White Label Banking, and how does it work?
White labelling is a method of putting a company’s own label on third-party made goods and rebranding them as their own.
When a Software as a Service (SaaS) provider puts their label on a BaaS provider and provides a front end for the customer, this is known as white label banking. A grocery store, for example, will be able to integrate financial services into their ecosystem by white-labeling the services of a BaaS platform.
Do you recall the website pets.com? The late-’90s pet products e-commerce site became shorthand for one of the dot-com bubble’s most important lessons: what sounds great doesn’t always earn money.
But it wasn’t the concept behind pets.com that was the issue. As e-commerce grew in popularity, the concept gained traction. Chewy, which debuted more than a decade after pets.com, is essentially the same premise — albeit a more profitable one.
The actual lesson here is that nothing can be predicted. There are wonderful concepts that fail due to a lack of customer readiness or poor execution. Fintech, for example, is a fast-growing business with plenty of opportunities for both development and mistakes.
Do you recall the website pets.com? The late-’90s pet products e-commerce site became shorthand for one of the dot-com bubble’s most important lessons: what sounds great doesn’t always earn money.
But it wasn’t the concept behind pets.com that was the issue. As e-commerce grew in popularity, the concept gained traction. Chewy, which debuted more than a decade after pets.com, is essentially the same premise — albeit a more profitable one.
The actual lesson here is that nothing can be predicted. There are wonderful concepts that fail due to a lack of customer readiness or poor execution. Fintech, for example, is a fast-growing business with plenty of opportunities for both development and mistakes.
So, what does the fintech crystal ball have in store for the year 2022 — and beyond? What can the industry fairly foresee, and what does it currently need knowledge about?
- Capital will continue to flow.
The record-breaking startup funding rounds of 2021 weren’t a fluke; they were just the beginning. In 2020 and 2021, venture capitalists raised unprecedented amounts from their limited partners, and they’ll be putting that money to work for years to come. That means that even if the bigger economy lags and individual consumers have less money to deposit into fintech-branded bank accounts, fintech growth should be fueled by investment.
Fintechs have shown to be a good investment. While fintech investments soared in 2021, exits also increased. As of October, more than 700 Fintechs have shut down, up 25% from the previous year. According to PitchBook, VCs gained more than $134 billion in aggregate value from fintech exits in the second quarter alone.
- Embedded finance will gain traction.
Banking on your phone is more convenient than going to the bank. What could be more convenient than mobile banking? Financial tools are available wherever you need them, even non-financial apps. According to estimates, the embedded finance business would be worth over $138 billion by 2026, and maybe trillions by 2030. Companies that embed financial products start with user bases that already require them, which is what makes embedded finance so popular (apart from the convenience for users).
- Fintech will pull ahead in the U.S. and then face more scrutiny.
There are about 10,000 depository institutions in the United States, many of which are community banks. This has resulted in a very fragmented financial system, which has hampered innovation. It’s more difficult to create a simplified digital experience for all depositors when there are so many banks, each with its own old technology. That is beginning to change. Consumers are more comfortable with mobile banking than they have ever been, and investors are loaded with cash and eager to invest in fintech businesses.
Because of this confluence of movements, there are now more fintech possibilities than ever before. More activity equals more visibility, both from regulators and the general public.
“By holding SBPs to banking norms, we may eliminate the discrepancy between the rights and obligations of banks and those of synthetic banking providers,” Michael J. Hsu, acting US comptroller of the currency, said during a conference of industry group American Fintech Council in November. To put it another way, he believes fintech should be more regulated. Fintechs and integrated banking firms must prepare for this by expanding their compliance services.
- Banks will dip their toes into BaaS.
Banking as a service, the fintech industry’s back-end expertise, has long been the domain of tech businesses. With fintech expanding, I expect banks to want to go beyond being a bank partner and become a BaaS provider as well. At least one big bank is expected to dabble in developing its own banking application programming interfaces. As of October, HSBC has taken this step, which could signal the start of a trend.
- Banks and fintechs will need each other more than ever.
The financial system in the United States is still based on banks. They have an oligopoly on charters, which allows them to control the conditions of their agreements with fintech firms. Banks have the authority to terminate fintech collaborations if they believe the agreement to be too hazardous or unproductive. They also have the cash on hand to keep lobbying regulators. None of this is likely to change anytime soon.
Larger fintech firms are gaining traction, but only to a point. They add significant value to their bank partners by facilitating new account openings, and as a result, they have negotiating power in their contracts. Even so, they’ll have to haggle hard with banks to get what they want out of the partnership. They must also be careful not to misrepresent themselves as banks, as regulators are increasingly calling for fintechs to be regulated more strictly. In my perspective, the function of BaaS companies in connecting fintechs to multiple banks and compliance providers will only rise in 2022.
Finally, banks, fintechs, and BaaS firms are most effective when they collaborate to reduce risk, maintain compliance, and provide the modern financial solutions that consumers demand.
