Banking as a Service Explained: Turning Competition into Collaboration
Open banking APIs have unlocked a host of banking capabilities over the past several years, connecting core bank processors with external technologies and enabling secure data transfer.
Banking as a Service (BaaS) is one of the most exciting opportunities created by open banking APIs. Across a range of financial services, including payments, lending and insurance, embedded finance (closely related to BaaS) is predicted to generate 230 billion dollars in total revenue by 2025, a 10x increase since 2020.
BaaS involves a bank enabling another organization to offer financial services or offering a new and innovative product alongside a technology company. Through collaboration, everyone wins.
This blog unpacks the essentials of BaaS. For a deeper dive into the intersection of Open Banking and Banking as a Service, be sure to refer to Open Banking and Banking as a Service: Opening Opportunities.
What is Banking as a Service?
The open banking and BaaS landscape is complex and diverse, but the general premise is simple – a financial institution and its core provider collaborate to enable another business to offer financial products.
This strategic model uses APIs to connect financial institutions to other institutions, fintechs or non-financial organizations so that all parties can work together. Rather than delivering individual banking products to a consumer, BaaS ultimately delivers financial services in new and novel environments.
In many cases, partnerships involve a third-party fintech sharing profits from their unique and innovative financial products in exchange for using a financial institution’s regulated infrastructure. For instance, a bank might partner with a fintech to create purpose-driven cards or health savings accounts.
In others, BaaS involves nonbanks providing financial services like point-of-sale loans, payment plans and compliance tools. Embedded finance is one subset of such a strategy and includes financial institutions “embedding” their services into another company’s application or platform, typically in conjunction with consumers purchasing goods or services. While that third-party business improves its customer experience, the participating bank makes additional revenue each time the business’s customers use their products.
Regardless of which unique BaaS strategy your institution favors, the end goal remains roughly the same. By enabling fintech and core providers to collaborate, all participating parties can seek new revenue streams and give consumers broader access to financial services.
The Opportunities for Banking as a Service Participants
For years, financial institutions saw emerging technology companies as competitors. BaaS turns that dynamic on its head to leverage each party’s strengths. Here are the most common personas and what they stand to gain through connection:
- Financial Institutions: Brick-and-mortar institutions that want to adopt a digital strategy often need more time and resources to organize, execute and distribute innovative offerings. Core vendors and specialized fintechs help build custom interfaces, products, analytics and security services for the bank. In so doing, financial institutions can provide the latest technology with faster-to-market solutions. Banks can realize additional revenue streams through these increased lines of business. They can also use integrators and vendors to help automate manual processes and workflows, especially with data exchange. BaaS also connects institutions with brands that already have high engagement. Finally, a vendor or fintech provisioning a white labeling service to banks allows them to place its branding on the provider’s interface, improving its brand reputation as a forward-looking institution.
- Core Vendors: Core technology providers serve as BaaS facilitators and can help vet other third-party technology partners. In addition, core vendors enhance data sharing security and assist in data privacy. While core vendors already offer open APIs to share their technologies, BaaS takes the next step by allowing the bank to provide that capability elsewhere or collaborate more effectively with third-party fintechs. Under the larger open banking model, core providers offer embedded financial services to fintechs or banks, often through digital and mobile applications. These services complement and enhance the institution’s offerings, driving additional revenue for both parties. Some examples of vendor applications include advanced profitability analytics, embedded credit score reporting and monitoring and specialized account onboarding services.
- Other Third-Party Fintech Companies: Fintechs aggregate core vendor and bank services for customers through open APIs, creating value by driving financial product innovation and often focusing on product ease of use for the end user. Fintechs benefit by freely innovating on unique products for customers while receiving regulatory and risk guidance from their partner bank, which is often highly valuable and sometimes critical to the longevity of the fintech. In addition, fintechs may even diversify their holdings across institutions to mitigate exposure. Entry into a highly regulated space also appeals to many neobanks (defined in detail below) and emerging fintechs. Obtaining a bank charter has a steep barrier to entry in terms of cost and time. BaaS solves the dilemma by enabling nonbanks to use a bank’s existing regulated infrastructure. In so doing, fintechs can expedite their entrance into the marketplace, and neobanks can gain customers while ultimately working toward a charter.
- Integrators: Integrators are the party integrating into and accessing the open banking platform to facilitate seamless data exchange between parties. Depending on the case, this can be a bank with a development team integrating directly or a third party building integration between its application or another third party. Integrators assist with integration between banks and third-party technology companies. By connecting to open banking APIs and pushing and pulling data on behalf of the provider (usually banks or fintechs), integrators help expand the open banking network and provide billable technical resources to institutions. These entities benefit from recommended lead generation in exchange for delivering fast integrations.
- Consumers: Customers can benefit both directly and indirectly from the BaaS model. In addition to the many benefits of open banking at their financial institution, BaaS enables consumers to use the industry’s latest financial technology. Alternatively, it can make life more convenient by incorporating financial services into products and offerings with which they are already engaged.
What’s a Neobank?
Neobanks, sometimes called challenger banks, are specialized fintechs, typically online-only and without a banking license. Generally, they provide specialized financial services like high-yield savings accounts, loan refinancing and cards with cash-back rewards. Some well-known examples of neobank companies include Chime, Current, Aspiration, Acorns, Varo, and even Uber debit and Spotify balance.
Although these firms are skilled in innovation and creating new technologies, they are still subject to regulatory compliance, which can be expensive and drain resources. To offer solutions sooner, neobanks often partner with traditional financial institutions as their “sponsor bank.”
Sponsor banks typically charge neobanks to use their charter and balance sheet. In exchange, neobanks use the sponsor bank’s regulated infrastructure and put their offerings on the market, sometimes working toward a charter through petition or acquisition.
Typically, collaboration is much simpler than working toward a charter. For instance, it took neobank Vara over a hundred million dollars and five years to obtain its charter. Even better, a good relationship between banks and fintechs may allow best practice sharing for regulatory and risk requirements.
Preparing for a Banking as a Service Future
Collaboration with technology providers empowers traditional financial institutions to enhance the user experience and tailor innovative banking products to new customer segments and markets. This can bolster the bank’s brand, diversify its customer base and create additional revenue streams.
That may be why over 50% of traditional financial institutions are very interested, and 14% have already established a BaaS relationship. Banks with fewer than 10 billion dollars in assets that are exempt from the Durbin amendment are ideal for partnering with debit card-focused fintechs, as they stand to grow interchange revenue. Ultimately, those new revenue streams could change the game for smaller community banks.
To learn more about Banking as a Service, its essentials and the opportunities for your institution, don’t miss our white paper, Open Banking and Banking as a Service: Opening Opportunities.
Derek Murray is a payments technology and Product Management professional who brings experience from merchant payments and fintech neobank organizations. As Strategic Product Manager of Open Banking at CSI, he helps bring the needs of banks and fintech partnerships together as part of CSI’s Open Banking Initiative, which enables banks and partners to connect their current applications with Fintechs and solutions of their choice, helping them stay relevant and competitive in the financial industry.