Leading The Next Financial Revolution: Banking-as-a-Service
BaaS will play an important role in the future digital transformation of banks and serve as a revenue-driving business model.
Imagine that you are the CEO of one of the leading e-commerce companies in Indonesia. Your company is facing stark competition and you are finding ways to boost customer loyalty. If you were to offer your customers, for example, a credit card, you could award them loyalty points whenever they pay with the card. Then, each time your customers use their card, they would interact with your brand. By analyzing your customers’ spending behavior, you could understand them better and offer them more tailored services. Or what about if you could offer your customers an online loan for their purchases directly on your map? This way, your customers could finance their products immediately without ever having to disrupt their customer journey. You could boost your sales and directly influence the amount your customers spend.
Many of these ideas require your company, as a non-bank player, to start offering banking services. That said, every government in the world would require you to own a banking license before you could offer these services and such licenses are relatively difficult to obtain. Now this is where Banking-as-a-Service comes in.
What is Banking-as-a-Service?
BaaS is an end-to-end model that allows digital banks and other third parties to connect with the banks' systems directly through APIs to build banking offerings on top of the providers' regulated infrastructure, as well as unlock the open banking opportunity reshaping the global financial services landscape. This way, a non-bank business, such as your e-commerce company, can offer their customers digital banking services such as bank accounts, debit/credit cards, loans, and payment services, without the hassle of of acquiring a banking license of their own. This type of service is often referred to as white-label banking, since the banking services are delivered through the branded product of the non-bank player.
On the other hand, tech-savvy legacy financial institutions also benefit since this model enables them to fend off the threat of upcoming fintech players by working together—sharing their data and infrastructure—instead of competing with one another. In a matter of years, ease of online access to financial-related information will become critical for digitally native customers and as such it is essential for banks to start developments now. Banks that are ahead of the curve through advanced tech offerings and strong partnerships with leading fintech players are likely to be rewarded with high demand.
What are the benefits for 3rd party providers?
Faster speed to market
Banks put in a ton of investment and constitute necessary infrastructures to develop their many functionalities – from holding money to payment processing. By accessing a bank’s functionality, third-party providers can bypass major development hurdles and go to market much quicker than if they were to build their own functionality from scratch.
Overcome regulatory complexities
Acquiring a license imposes not only significant capital requirements, but more importantly, compliance with strict regulations. Due to the systemic relevance of banks to the functioning of the economy, such licenses are relatively difficult to obtain. By partnering with banks, they can circumvent this by piggybacking onto the banks’ license.
What are the benefits for banks?
New revenue streams
Banks need to navigate more competitive markets and find ways to drive profits while keeping costs low. Creating a BaaS platform and allowing third-party providers to access it for a fee can inject fresh revenue into the bank. The main monetization strategies for BaaS include setup charges, recurring monthly fees for access to the platform and/or revenue sharing agreements based on service used.
New customer bases
External providers may potentially have huge customer bases that are currently not bank customers. By providing BaaS to third parties, banks can reach new customer bases with much lower acquisition costs, leading to the beginning of anew, potentially profitable, relationship between the bank and the customer.
Improve the overall customer experience
BaaS allows banks to integrate external parties’ products and services into their own offerings allowing them to provide their customers with an end-to-end customer experience without having to build new products.
How does BaaS work?
BaaS allows third party organizations to draw off of the existing banking services through APIs that communicate between banks and third parties. These APIs would then enable the use of these banking services by fintech companies, programmers and developers, and other non-financial companies. This allows them to build their own features as a layer on top of the existing banking services. In exchange these fintech, digital bank, and other third-party providers (TPP) pay a fee to access theBaaS platform.
In the US, this model is becoming increasingly common with several banks even pivoting to solely focus in this BaaS space, partnering with notable tech giants to offer their banking services to a wider set of customers. In fact, these BaaS providers are specializing in different forms of partnerships: Bancorp and Green Dot focus on consumer banking experiences, Sutton Bank focus on card issuance, and Celtic Bank, Cross River Bank, and WebBank pursue partnerships with lenders.
Green Dot provides banking services to some of the most well-known brands in the US. Retailers like Walmart to tech players like Uber use Green Dot Bank to offer payment cards to customers. Apple Pay and Apple Cash both run on Green Dot’s banking platform. TurboTax also utilizes Green Dot Bank’s services to offer debit cards to customers.
Sutton Bank mostly partners with big fintech players to issue debit/credit card players to both individuals and businesses. Their partners include CashApp, Robinhood, Monzo, Brex and Marqeta. Notably, they launched an enterprise B2B solution with Marqeta in 2013.
Cross River Bank on the other hand primarily offers direct lending and marketplace lending processed through different P2P lending portals. They have a large roster of clients in the fintech sector, including Affirm, UpStart, Stripe, Ripple, and Coinbase.
Even notable banks such as Goldman Sachs are venturing in the space. In late 2019, they partnered with Apple to launch Apple Card and by March 2020, over 3 million Americans hold the card with 60% using it as their primary credit card. They offer various deals and installment plans with no fees aside from interest fees when carrying a balance and interchange fees to the vendor. This partnership has allowed Goldman Sachs to lend billions of dollars to Apple users.
In Asia, there are similar interests from tech giants to tap into the banking space but instead of partnering with existing banks, Asian companies typically acquire or establish their own banks and obtain their own licenses if necessary. This is evident from the likes of Alibaba with Ant Financial and Korea’s Kakao with KakaoBank.
Both trends are evident in Indonesia. Well-established banks have initiated partnerships with local startups. Travel tech startup Traveloka partnered with Bank Mandiri to launch its own credit cards in early 2020, allowing users to collect Traveloka points for card transactions. Bukalapak also recently partnered with Standard Chartered following the unveiling its new banking as a service venture ‘nexus’. On the other hand, some startups are raising money to acquire their own banks. Gojek and Sea Group are paving the way through their recent investments in local banks Bank Jago and Bank Kesejahteraan Ekonomi respectively. That being said, it is still unclear whether partnerships or acquisitions is the better move as we are still in the early stages of the BaaS adoption.
What are the risks and challenges associated with BaaS?
With so much access to personal information, the first threat that comes to mind is of course cyber-crime. The introduction of additional entrance gateways through increased amounts of composite online services does increase the risk for cyber-crime and as such presents a challenge on how BaaS providers can create a satisfactory user experience that is also properly firewalled and ready to handle malicious intrusions.
Another big issue within the BaaS space is the lack of regulatory oversight. As in the case of many new lines of businesses, regulations may not have fully caught up yet with BaaS as an offering. This is evident in the case of Wirecard, once one of the leading white-label providers in the world, that became insolvent in June 2020 after auditors EY discovered fraudulent activities and discovered that €1.9 billion of alleged reserves, supposedly held in Asia, were non-existent.
Investigations have made it rather obvious that Wirecard’s default had little to do with the technological complexity of its operations and instead resembled a typical accounting fraud of the more classical type. This has raised many concerns on the lack of adequate oversight of Fintech companies as the inability of authorities to detect the fraud in any prominent company is, to a significant extent, the result of regulatory loopholes. Germany’s BaFin, the markets regulator in Wirecard’s home country, has taken a barrage of criticism for its seemingly intentional ignorance of Wirecard’s fraud.
The final challenge here is ensuring that BaaS itself does not become a commodity. This means ensuring differentiation within companies offering BaaS product offerings will become increasingly important. Today BaaS companies typically choose a layer of the banking stack (e.g., compliance, card issuing or payments), and provide that layer “as a service” through full-stack applications that are bundled and often coarse-grained. They support standard use cases but limit customization, modular development or an ability to plug into legacy environments. This is similar to building houses faster and cheaper while choosing from a small set of pre-configured floor plans. The perfect world requires a programmable inventory of every type of brick, tile and fixture that may be combined in any permutation seamlessly.
So where do we go from here?
Overall, the BaaS sector will achieve mainstream adoption in the next decade as consumers demand the best from financial services providers. Traditional banking models are being challenged and modern banks will need to become modular and platform-based to effectively collaborate with players in the financial services ecosystem. BaaS will play an important role in the future digital transformation of banks and serve as a revenue-driving business model that banks can adopt to reach new customers and improve the overall customer journey.
Players within the BaaS industry will start to overlap as banks become more “fintech-like” and fintechs build the same banking capabilities from a less regulated landscape. New competition will come from tech giants that have established customer groups who would benefit from the same brand of innovation, but in their financial lives, as we are seeing from the likes of Gojek and Shopee here in Southeast Asia through their acquisition of Bank Artos (Bank Jago) and Bank Kesejahteraan Ekonomi respectively.
Consumers will consolidate their deposit balances with companies that are able to deliver a full ecosystem of financial services customized and adaptable to their continuous changes in life — whether it be banks, fintechs, tech giants, or some hybrid-mix of these firms that is delivering the solution. Banking-as-a-Service will continue to make banking widely available to any company capable of delivering valuable services to customer or market segments around the world.
Risk and controls will continually evolve, protecting critical customer data but also enabling a smoother business process overall. The Wirecard affair has undoubtedly left a stain on the global fintech sector and further illustrates just how difficult regulating emerging global digital players with new operating models can be. Regulators need to work with fintech industry leaders to remediate existing regulation and ensure a healthy fintech ecosystem for customers, employees, and shareholders alike. With a looming economic crisis deepening a result of the Covid-19 pandemic, the growth of BaaS and its fintech peers is critical to ensure financial access for the mass.