Banking is no longer just for banks, and that’s no longer a problem for financial institutions that have embarked on a bank as a service (BaaS) strategy. BaaS continues to blur the lines between what is – and what isn’t – a bank.
Although there are many variations, in a BaaS model, regulated institutions provide their charter to unregulated companies that wish to offer financial services without the need to acquire their own banking license.
The most notable examples are now familiar to anyone interested in fintechs and neobanks: Chime in partnership with The Bancorp Bank and Stride Bank; Acorns in partnership with Lincoln Savings Bank; Venmo is also a partner of The Bancorp Bank, and many others.
Less often discussed, but increasingly important are BaaS technology vendors that work with both financial institution and fintech. These “intermediaries” help manage BaaS operations, notes Kate Drew, director of research for CCG Consulting. The main players are Galileo, Marqeta, Q2 and Synctera.
“BaaS” is a new name for an old concept: “the white label”. Banks and credit unions have white-labeled their credit card products for years, but what’s changing is the breadth and depth of those partnerships – and the volume. In a detailed report, CCG Consulting predicts that the number of financial institutions partnering with more than double by 2030.
BaaS against open bank
Do not confuse BaaS with open banking. Although open banking also connects financial institutions with non-banks using APIs, this is a totally different model than BaaS. In an open banking model, third parties access a financial institution’s data (when the customer has given permission to do so) and load it into their own applications, such as a personal financial management (PFM) tool aggregating from from several sources. The data flow is one-way.
In a BaaS model, non-banks integrate banking services into their own products, such as the home buying app of a fintech offering a mortgage or a neobank offering a debit card. The data is shared between the financial institution and the non-bank.
Compensation for diminishing returns
BaaS is hot for several reasons. First, the banks earnings growth has stalled. The problem, 11FS note, is that the traditional banking business model offers diminishing returns. Net interest margins are reduced by perpetually low interest rates, competitors with lower overheads, and commoditization of products.
Regulatory and compliance costs continue to rise, and many banks and credit unions have invested heavily in high-cost in-branch distribution channels as the preferences of today’s customers shift in favor of retail channels. digital distribution.
Since a BaaS model can be a low margin but high volume business structure, it can increase the bottom line of a regulated institution. There are many variations of the model, so it is difficult to generalize, but the income often comes from debit card fees, program management fees, revenue sharing agreements and, of course, the benefit of additional deposits. BaaS is an opportunity for financial institutions to reach more customers at a lower cost, notes Oliver Wyman.
36% of the heads of financial institutions say they are increasingly using multi-partner agreements, heralding a new banking model.
Second, the global disruption of Covid-19 has caused many changes in business models – including the way banks and credit unions view partnerships. According to Accenture, nearly a quarter (24%) of banking executives experience multi-party systems and 36% are expanding multi-partner systems as a result of the pandemic. The vast majority (91%) agree that multi-stakeholder systems will allow their institutions to build a more resilient and adaptable base and create new value with partners.
According to a report by Transcard and Pymts.com, 80% of executives at global financial institutions believe banks will benefit from adopting platform business models. By 2030, Transcard estimates that the size of the integrated finance market will reach $ 3.6 trillion.
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A match made in heaven?
A BaaS model has many benefits for financial institutions, in addition to the fee agreements put in place: the most compelling is that the bank’s partner seeks out and brings together clients, which fintechs and other tech companies do very well. Banks and credit unions can focus on operations and compliance, while partners focus on acquisition and customer experience.
Regulated institutions, however, are still subject to compliance and risk management.
Traditional institutions fear losing control of customer relationships by embracing BaaS, but at the end of the day, they can still lose them.
Banks and credit unions need to determine where they need to lead the interaction and customer experience, and where they need to take a back seat and become a supplier of products or services to a third party. The fight is real because the incumbent operators fear that the distribution of products through partners will erode their customer relationships. While this is a legitimate fear, traditional institutions may not have a choice as their competitors implement BaaS.
Don’t try to be a bank
BaaS not only gives aspiring banks an easier way to provide banking services, but enables non-banks to attract customers – especially young people, temporary workers, people from lower socio-economic strata and those from higher socio-economic backgrounds. immigrants – who have a cultural aversion to banks. Far from hiding the fact that they are not really banks, they celebrate it.
Chime’s website landing page clarifies this fact, stating that “Chime is a fintech company, not a bank. Banking services provided by The Bancorp Bank or Stride Bank, NA ”
Some, like Goldman Sachs and BBVA, are working diligently to digitize their existing operations and have launched their own BaaS platforms. Goldman Sachs created their new Transaction Banking (TxB) cloud platform to meet their own cash flow needs, but soon realized that they could share this system with their corporate treasury clients to integrate banking services into. their own products.
BBVA’s Open Platform (now known as the PNC Open Platform) offers a variety of consumer and business-centric APIs for transferring money, opening accounts, and issuing cards. A client of the BBVA platform is To catch, a personal benefits platform that helps freelancers and hourly workers who don’t receive benefits calculate how much they should be saving on each paycheque to pay their taxes, take vacations, save for retirement, and pay their taxes. Health Insurance. Catch needed a bank to withdraw these funds from each client’s account, hold the funds, and meet KYC requirements.
Not all fintechs see the need to follow the BaaS playbook. Social Finance (SoFi), a digital personal finance company, acquires Golden Pacific Bank in order to obtain a national banking charter. Payments giant Square secured an industrial banking charter, while Varo Bank went through a grueling, multi-year process to secure a full OCC charter, one of the few neobanks to attempt it.
What to do next
Oliver Wyman suggests that banks approach BaaS by answering four key questions:
1. What is our overall strategy? Decide if you are going to become a distributor or a producer of financial products. If you become a producer, are you ready to allow a non-bank organization to put their mark on your product? It requires strategic soul-searching. Are you ready to let go of your customer relationships?
If you decide not to enter BaaS, how will you protect your existing business model and revenue from threats from competing BaaS offerings?
2. How much income will we earn? BaaS is changing banking business models, but the big questions are: can you make money with this? Early entrants had above average ROA and ROE results, but that may not be for everyone. Are you considering adding subscription services such as Identity Theft Monitoring to increase revenue? Can you take advantage of the more granular customer data you’ll get?
11fs reports that a change in mindset could transform the way financial institutions make money. Instead of competing on digitization and customer experience, they could monetize by playing the role of enabler of new market entrants.
3. Who should we target? Determine which markets offer the greatest opportunity. Is there one type of industry or brand that it makes sense to target? Think about how you configure your operating model to serve these target distributors?
4. What technology should we use? You can choose to use your existing technology stack or create a new “greenfield” BaaS platform. With existing infrastructure, acquiring a customer can cost anywhere from $ 100 to $ 200, says Oliver Wyman. This cost drops to between $ 5 and $ 35 per customer with a new BaaS technology stack.