BaaS: Banking as a Service

BaaS is a topic receiving more attention and making more headlines than ever before. In the first quarter of the year, two providers made different announcements that perfectly encapsulated the confusion surrounding the subject. Metropolitan Commercial Bank announced it will exit all BaaS relationships, with the process expected to be completed throughout 2024. Later the same week, Synctera announced it raised $18.6MM for an international expansion to sign on overseas firms looking for US-based services. BaaS has faced a number of regulatory inquiries and disciplinary action, which industry leaders approach cautiously. A 2023 survey found that 27% of respondents who have not implemented BaaS cited compliance and security concerns as a barrier to adoption. With BaaS facing more regulatory oversight, reactions have been mixed as the future of the service remains unclear.

Decision-makers in the industry believe that BaaS will achieve mainstream popularity and adoption within the next five years. In 2022, Finstra found that 85% of senior executives were either implementing BaaS solutions or had plans to do so within the next 12-18 months. SME and corporate banking will be the focus of over 70% of BaaS providers as the market grows. Small and medium-sized businesses can struggle to find financing and maintain a healthy cash flow. Of the businesses distributing financial products, over a third expect a revenue growth of over 15%. Current products are mainly geared towards retail banking customers, who have embraced BaaS solutions. Consumers are not picky about which bank is providing the services; they are more focused on the capabilities that come with the offering. However, an extended chain link can confuse end users if incidents take place.

Disciplinary action has been aimed at BaaS providers, while enablers do not seem to be reprimanded as harshly. In 2023, 13.5% of severe enforcement actions issued by federal bank regulators were against banks providing BaaS to fintech partners, up almost 10% from 2022. Financial technology has grown expeditiously in terms of product offerings and capabilities, and regulatory oversight has not kept up with the demand. Bank providers are facing scrutiny for a lack of risk management. The FDIC and OCC have issued consent orders related to banks not conducting due diligence, not establishing compliance procedures, and not vetting board committee members for appropriate experience. Certain banks have been ordered to terminate their relationship with their fintech partner. While a few providers have exited the space due to the enforcement, numbers grew from 116 in 2022 to 136 in 2023. 50% of BaaS enablers anticipate increasing their partnerships with distributors and providers, and it is expected that regulators will provide best practices and compliance outlines for BaaS players to follow. Although rules and regulations have not been fully established, trends point to all parties finding benefits in pursuing BaaS as an option.

As it exists, the current BaaS playing field is unstable. Yet despite the increasing penalties and disciplinary action providers have faced, embedded financial solutions are proving to be beneficial for all parties involved, bringing opportunities for community banks to build relationships with demographics they would not usually access. Generations bank differently, with younger age groups choosing fintechs at an increasing rate. Digital options are going to meet the demand as younger generations enter adulthood. Mergers and acquisitions among financial institutions are pushing out community and regional banks, making it harder for them to keep their market share. Regional banks are entering the market as well, eliminating the need to partner with a fintech. Santander Group announced the expansion of its digital bank to the United States and Mexico later in 2024. Openbank, developed in-house using proprietary technology to provide, “FinTech pricing and the trust of a global bank.” Rather than compete, smaller community banks can partner with a fintech to access newer technologies, and fintechs will be backed by stronger institutions. Banks offer a full suite of services under one license, while fintechs face limitations in holding customer funds, making payments, and performing cash transactions. Fintechs can enhance banks’ digital offerings and capabilities, making it cost-effective to partner rather than develop. The end customer will experience better customer support while accessing innovative financial products. Banking and banking as a service are ever-changing and expanding. The boom in financial technology will only continue to be implemented and offered. There is a reckoning for traditional banks to update their systems and processes to compete with fintechs. Limitations prevent fintechs from starting up efficiently; there are only so many products they can offer without the proper licensing. Within any ecosystem, symbiotic relationships exist. Banking as a service can be the bridge for traditional banks and fintechs to continue to exist within their field of expertise, together and separately.