Banking as a Service (BaaS) is a business model that allows banks to offer white labelled banking processes to fintechs and other corporations through the bank’s secure and regulated infrastructure.

It empowers these companies to provide seamless financial services to their customers without having to obtain a banking license, or to build up the substantial balance sheet and reserves of an established financial institution.

In a sense, BaaS is simply the natural next step in the evolution of open banking infrastructure:

• Pre-2000 was the era of branch banking, where bank products were developed in-house, and distributed to customers via a physical branch network.
• The 2000s ushered in the age of web banking, where many of these services became digitized and offered to customer via a desktop web browser.
• The 2010s saw a leap to mobile banking, where the smartphone became the dominant distribution channel.

Now, the 2020s are giving rise to API banking, where banking products are often developed in tandem with external fintech partners, and distributed to third-party customer bases via open APIs. BaaS is one of the most common forms of API banking, and also one of the most important.

Trends driving the rise of BaaS

There are several key reasons for the increasing importance of BaaS:

1. Growing demand for integrated customer experiences

Customers are increasingly seeking out holistic multiproduct experiences from brands with cohesive multi-product ecosystems. According to a McKinsey study, 70% of customers value ecosystem purchases that simplify their buying journey, which explains the appeal of consumer companies with a wide range of integrated offerings, such as Apple, Amazon and Microsoft.

Since financial services are integral to so many buying journeys, offering these services can make the customer experience much more seamless. For example, IKEA’s recent acquisition of Ikano Bank would potentially allow them to offer financing solutions for furniture purchases at the point of sale, hence making it much more convenient for customers to shop at IKEA stores.

2. The rise of fintechs

The fintech industry continues to grow from strength to strength. While the pandemic took a toll on many sectors in 2020, fintechs actually came out ahead, with global investments in the industry growing by 14% from 2019.

Fintechs excel at technological innovation, marketing and digital distribution, but what most of them lack is the ability to provide standard banking services such as bank accounts, payments and large-scale lending. Even big tech companies are unable to earn banking licenses themselves, especially in the US and other developed markets where the regulatory bar is high.

As a result, their best option is to partner with BaaS providers to access existing banking infrastructure, which results in growing demand for such solutions.

3. Compelling customer acquisition economics

While non-financial companies can clearly benefit from the ability to provide financial services, what’s in it for the banks themselves?

The answer is simple: efficient customer acquisition.

From a marketing perspective, banks that provide BaaS solutions are in a similar position to Original Equipment Manufactuers (OEMs) who rely on a network of partners to embed their solutions into marketable products, then sell those products to their existing customer bases. This is a simpler, faster and more economical approach than attempting to acquire those customers directly.

Research from Oliver Wyman shows that the cost of acquiring a banking customer directly ranges from $100 to $200, but by offering a BaaS technology stack and acquiring those customers via partners, that cost can be reduced to $5 to $35.

By establishing BaaS partnerships with five major non-financial companies, one specific Asian bank with $300 to $400 billion in assets stood to gain 50 million active customers, amounting to $200 to $500 million in revenues over three to five years. That would grow its Asian revenues by 2-5% – a remarkable increase from a single strategic initiative.

4. The modernization of bank IT infrastructure

Regulatory trends such as PSD2 and open banking are encouraging the modernization of bank IT infrastructure and the development of bank APIs for universal access. In order to comply with these new regulations, banks are required to make heavy IT investments, which is causing many of them to consider BaaS business models as a way to recoup those costs.

Apart from regulatory pressures, emerging technologies are also accelerating the modernization of bank IT. Financial service aggregators like Plaid are changing customer expectations for the portability of their financial data. And bank platform providers like Fintel Partner Finzly are making it easier than ever to modernize core systems and develop open APIs.

Consequently, banks are becoming increasingly well-positioned to deliver BaaS offerings.

BaaS Spotlight: Payments

BaaS opportunities exist across the entire spectrum of banking services, but one category stands out as being especially ripe for disruption.

In a 2019 Aite-Novarica study, the majority of digital bank executives ranked payments as their top priority for API monetization, with regulatory compliance being the primary trigger:

This emphasis is supported by the rapid growth in revenues of global payment facilitators like Stripe, Paypal, Shopify and Square, which are expected to increase at 31.8% annually through to 2025:

While regulatory pressures might have catalyzed the focus on payments, this type of service is also especially tangible to customers because of its prominent position in the buying journey. By offering services at the point of sale (POS), banks can build trust with consumers and expand into other complementary services.

Square’s newly unveiled checking and savings account are a great example of this. The company recognized that small businesses could benefit from bank accounts that are seamlessly integrated with their POS system, and has developed an offering which leverages their core strengths. Notable features include:

• Instant cash flow. As soon as a Square sale is completed, the cash is immediately available in their checking account, as well as their linked Square debit card – for both digital and in-person purchases.
• Easy signup. Since Square already has significant data on their customers, the signup process takes less than two minutes. Square does not require any credit checks or banking history to set up an account.
• Simplified financial management. Businesses have one integrated ecosystem for accepting payments, storing their cash and managing their finances through a streamlined SaaS platform.
• Native automation. A certain percentage of sales can be automatically transferred into the savings account, and business owners can easily edit their savings goals and monitor their financial progress.

The Future is Open

Like many other fintech innovations, BaaS presents an exciting opportunity for incumbent banks to grow their digital portfolio. Instead of trying to go it alone, banks may do much better by focusing on their unique strengths and outsourcing distribution to the right partners instead.

If you’re looking to chat more about BaaS and how your bank can leverage the opportunities its presents, get in touch with us. We’d love to chat!