Digital transformation is democratizing data across all industries, enabling richer features, greater transparency, and a better customer experience. As new technologies allow fintech and other companies to access legacy systems, Banking-as-a-Service (BaaS) solutions have emerged as an important component of open banking, with an increasing number of businesses and ecosystems embedding financial services into their offerings.
BaaS is transforming the banking value chain by providing banking products and services through third-party vendors across multiple sectors. Based on specificity and agility, these new offerings are displacing existing ones and fragmenting many profitable elements of the traditional banking value chain.
In this article, we highlight how BaaS is reshaping finance, the benefits and challenges this model poses for banks, non-banks, and customers, and take a look at the foreseeable future.
Banking as a Service (BaaS) Explained
What is BaaS?
BaaS is an end-to-end model that allows the delivery of banking products and services to non-financial third parties through an application programming interface (API). By integrating non-bank businesses into the regulated financial infrastructure, BaaS enables new, specialized offerings and brings them to market faster.
Banks integrate fintech or other financial service providers’ products into banking operations, while non-financial companies embed banking products into their own services. BaaS enables non-banks to offer financial products where and when they are needed directly to their customers, with minimal investment.
How Does BaaS Work?
The BaaS model starts with a fintech, digital bank, or other third-party providers (TPPs) paying a fee to access the BaaS platform. Retail or wholesale banking products and services are delivered as a service through an existing licensed institutions’ secure, regulated infrastructure using modern API-based platforms. The financial institution opens its APIs to the TPP, providing access to the systems and information needed to develop new banking products or offer white-label banking services.
Key Use Cases
Fintechs, non-bank, and even small businesses can use BaaS models to improve the banking experience they offer and, in turn, their customers’ user experience. BaaS models are considered a better alternative to traditional banking mainly because they can help companies offer technologically advanced services to their customers through user-friendly products. Organizations can easily bring new products to market and incorporate banking services into their business without major investments. They can create apps for their customers to ensure more efficient tracking of daily transactions, account balances, and savings. Apart from that, they can ensure quicker access to funds and no hidden fees for a better customer experience.
Credit and Debit Cards
Non-banks can offer credit and debit cards to their customers through BaaS; thus helping organizations attract customers by offering lower interest rates and cashback offers on their cards. This cashback usually comes in the form of credits with no expiration date and can be used to purchase products and services in stores and on websites or apps.
With Apple Credit Card, for example, the company uses BaaS capabilities to offer customized financial products, and further engage its customers in its ecosystem.
According to an Oliver Wyman analysis, a non-financial company can market financial products or services under its own brand—the customer feels like they are buying them from that brand, even though a financial institution actually offers them.
In retail, this is already a reality. Embedded financial solutions have led to companies offering interest-free installment loans, driving the disintermediation of the banking sector, and directly threatening traditional banks’ revenue streams. A good example is Amazon, which has recently invested in payments infrastructure and services, according to CBInsights. Over the years, Amazon has used a variety of techniques to improve its payments experience—introducing digital wallets through Amazon Pay, acquiring tech talent, and building various technologies in-house. From payments and loans to insurance and cash deposits, the e-commerce giant is approaching financial services from all angles, without advertising itself as a traditional bank.
Advantages & Opportunities
So far, the BaaS model has proven revolutionary for the financial sector. It can lead to tremendous growth for both banks and non-banks, while the customer emerges as the winner in both cases. These are the key benefits and opportunities of BaaS for all stakeholders:
There is no doubt that the BaaS model is customer-centric and can successfully meet the needs of the new generation of customers—tech-savvy individuals who expect access to customized financial solutions. Consumers increasingly use digital platforms to access e-commerce, travel, retail, healthcare, and telecommunications services. By implementing the BaaS model, companies can find new ways to add value for their customers.
Innovation is promoted by enabling non-banks to provide core banking services, giving customers access to smarter and more convenient products. The result is an enhanced customer experience, through richer functionality, and access to a broader range of products and services.
With the rise of innovative online and mobile payment options and open access to customer and transaction data, more industries are beginning to take control of their financial processes.
As noted earlier, fintech companies and other new entrants can bring products to market and incorporate BaaS into their business without major technology investments. Because fintech and non-bank organizations can work directly with licensed banks to access their core financial services through APIs, they can offer new solutions to their customers without holding a banking license. Thus, companies can accelerate their operations, efficiently enter new markets, and innovate products without spending huge costs or using resources maintaining legacy systems, resulting in a major competitive advantage, a strengthened market position, and increased customer loyalty.
While banks are concerned that distributing their products through partners will jeopardize their customer relationships, if end users start using embedded finance in significant numbers, banks may have little choice but to adopt BaaS models. The good news is that BaaS is an increasingly viable option for banks because of its simplified compliance, speed, security, and cost efficiencies. BaaS brings revenue to the banks and helps them cut down on huge costs. Banks would no longer need to invest a lot of resources in technology development or infrastructure. Instead, they can take full advantage of the existing service platform that the partner company provides, and focus on expanding financial products to increase revenue and access new sources of growth.
In addition, working with third parties allows banks to gain insights about customers, such as payment habits or financial needs. On this basis, the bank can improve its services, develop highly personalized products and offer packages tailored to individual consumer needs—attracting more potential customers.
Potential Challenges for Businesses
BaaS offers great growth potential for businesses. However, the long-term success of the offering depends on the digital banking platform’s sustainability, scalability, and flexibility. What looks less expensive now could turn out to be far more costly in the years to come.
The biggest issue surrounding BaaS is the fact that integrating with a bank and building financial products on top of that require robust data protection and compliance measures, which can be challenging for many organizations. Another issue that can arise is the lack of geographic coverage—tapping into the global market is the most common goal of many fintech companies. Still, only some BaaS providers can offer this kind of geographic coverage.
According to McKinsey, to limit or overcome these challenges, companies should ensure they have the technical and operational capabilities to partner with a bank and build on its BaaS offering. In addition, the integration of banking services into the user experience must make sense for the business model. Ultimately, the embedded financial offering should reach the necessary volume to justify the cost of implementing and developing the BaaS model.
Predictions for 2023 and Beyond
There’s a strong chance BaaS will become as ubiquitous as online or mobile banking in the coming years. A financial IT group Finastra survey found that an overwhelming majority of executives are implementing BaaS solutions or plan to do so within the next 12 to 18 months. According to the report, one of the key drivers for BaaS market growth is that consumers are increasingly transacting through non-bank channels. As consumer demand for customized and integrated digital experiences rises, awareness of BaaS will surely grow in the coming years. Demand from fintech companies, banks’ and non-banks’ search for new revenue models, and consumers’ changing trust in financial services are other major drivers for market growth.
An analysis by Stellar Market Research projects that the BaaS market will reach $1.2 trillion by 2027, suggesting that the financial services industry is moving toward an era in which shared data and infrastructure will become consumers’ new expectations. The BaaS model will be able to serve the future of financial services by bringing API-led, transparent, and customer-centric alternatives to the forefront.