The dynamic, emerging expectations of end-users is constantly reshaping the financial services landscape.
But against a backdrop where innovation moves faster than ever, many traditional financial institutions (FIs) have found it challenging to quickly stand up the type of services, products and digital experiences that their customer base expects.
Enter the advent of Banking-as-a-Service (BaaS).
This innovative model allows non-banking entities to offer financial services by using the infrastructure of traditional banks. It has transformed the landscape of banking — but it comes with its own risks. Take, for example, the ongoing fallout from the chaotic bankruptcy of former BaaS darling Synapse.
Still, the BaaS model offers numerous advantages. These include increased innovation, market reach and cost efficiency. It also presents various risks, including operational, regulatory, reputational, financial and strategic challenges. Both banks and FinTech companies need to carefully navigate these benefits and risks to ensure successful and sustainable partnerships.
That’s why PYMNTS sat down with three financial services executives for “What’s Next in Payments: The Future of Banking-as-a-Service.”
What we heard was threefold. Regulatory scrutiny is at an all-time high, making compliance crucial. For BaaS to succeed and deliver on its promise of embedded convenience, there must be a renewed focus on the “banking” part of BaaS. And, the contemporary turmoil facing the space today will ultimately end up being positive for the sector as a whole as the BaaS cream rises to the top.
Regulatory Scrutiny Moves to Forefront of BaaS Space
By providing the necessary infrastructure and regulatory framework, BaaS enables FinTech innovators to offer a wide range of financial products and services without the need for a full banking license.
This synergy fosters innovation, expands market reach and enhances the customer experience. However, as with any disruptive model, BaaS comes with its own set of risks and challenges. The relationships between FinTechs, banks and neobanks is under a harsh spotlight with the recent revelations around the Synapse bankruptcy.
“The regulators are now awake,” Thredd CEO Jim McCarthy told PYMNTS. And they are awake to the vulnerabilities as well as the potential of BaaS. No matter their focus, companies are going to invest more in regulatory and compliance technologies and processes, and compliance will wind up being a key differentiator, McCarthy said.
The reliance of BaaS solutions on third-party service providers can lead to operational disruptions if the service provider encounters technical or financial difficulties.
“I hope we find some middle ground in terms of expectations … especially around fund segregation, account keeping and data flows,” Amias Gerety, a partner at QED Investors, said of the inevitable meetings between regulators, FinTechs and banks. “And we’ll make these best practices … this will actually increase the confidence of both banks and FinTechs coming into the market, which will make everything better.”
After all, regulators are just now creating additional frameworks governing how FinTechs — and partnerships with financial institutions — need governing, Ingo Payments Chief Revenue Officer Lydia Inboden told PYMNTS.
“There needs to be more scrutiny and oversight of these partnerships — bi-directionally,” Inboden said.
Putting the Banking Back Into Banking-as-a-Service
The BaaS industry might be going through a period of upheaval — but there’s long-lived staying power. One of the top advantages of BaaS is its ability to accelerate deployment of new financial products and services. FinTech companies, often characterized by nimbleness and innovative approaches, can use the infrastructure and regulatory licenses of established banks to bring solutions to market quicker. This rapid deployment is particularly beneficial in a competitive landscape where speed to market can be a critical differentiator.
But it also means that firms should prioritize the “banking” in Banking-as-a-Service going forward.
More firms are moving, or should move, to a direct business model, said Ingo Payments’ Inboden.
She said these are relationships “where the FinTechs have direct relationships with the FIs holding consumer funds. I also think the commingling of consumer funds within these tech platforms has got to stop and there needs to be more of a one-to-one correlation between the FinTech program and the financial institution.”
“Too many people are focused on the ‘as a service’ part — but have ‘minored’ in the banking part, if at all … if you’re going to play in that space, I’d argue that if you fail at the banking, the service piece doesn’t matter,” Thredd’s McCarthy stressed.
The Cream Will Rise to the Top and Define the Future BaaS Landscape
The BaaS model holds immense potential to transform the financial industry by fostering innovation, expanding market reach and enhancing customer experiences. However, firms must carefully weigh the benefits of BaaS against the associated risks. Both banks and FinTech companies need to navigate these challenges strategically to ensure successful and sustainable partnerships.
As the financial landscape continues evolving, the key to using the BaaS model lies in fostering strong, transparent and mutually beneficial relationships between banks and FinTechs. By doing so, they can collectively drive the future of banking toward greater inclusivity, efficiency and innovation.
Looking ahead, over the short term, McCarthy noted that banks may shy away a bit from embracing BaaS partners. The result? The list of BaaS providers will be winnowed down through consolidation — and an ultimate flight to quality.
“At the end of the day, it’s the banks that sponsor these Banking-as-a-Service programs that will be the ones that are impacted … so they will take this all quite seriously,” McCarthy told PYMNTS.
QED Investors’ Gerety said he believes we’ll see the consolidation of stronger BaaS players.
“If you want your business to survive, you have to figure all this out,” he said.
“[The Synapse situation is] very messy and it’s not good for the industry … but for those of us who have been paying close attention, the news that Synapse is going out of business comes as a relief,” he added.
Echoing that sentiment, Ingo Payments’ Inboden said, “as the tea leaves ‘fall,’ I think we’re going to have a better framework for operating [these partnerships].”
As all the executives emphasized, while the contemporary environment presents challenges, market disruptions can ultimately foster a more robust and healthier ecosystem.
