Banking as a Service / BaaS is used by fintech and non-fintech companies for online banking without focusing on the licensing requirements. Companies shift the entire focus to enhancing their customized services.
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Define Banking as a Service (BaaS)
We already know what BaaS is, and non-banking companies use Baas to provide core financial services to their clients by integrating with banks via APIs (Application Programming Interfaces). Fintech and non-fintech businesses create products using customer data from conventional banking services.
Online ticketing platforms like Book My Show, MakeMyTrip, etc., are good examples of BaaS. To improve sales and increase customer loyalty, these companies offered the following:
- Customized cards for customers
- Redeemable loyalty points on each purchase
- One-click loans for tickets
These offers directly improved sales and boosted customer satisfaction. Moreover, analyzing customer buying habits and providing customized offers to increase customer loyalty has become easier, especially for businesses that do not have banking functions or work with banks.
Banking as a Service (BaaS) lets non-banking outlets integrate with banks. Through this, they can offer their customers more accessible digital banking services.
All this happens without the hassle of getting a bank license, which is challenging to acquire.
Banking as a Service (BaaS) Players
BaaS usually involves three major players:
- Traditional and New Age Banks
- Banking as a Service Provider
- Fintech or non-fintech companies that want to integrate fintech services into their product.
1. Traditional and New Age Banks
The banks provide the physical infrastructure and the necessary service like the server and communication hardware. Banks require licenses to do core banking services and offer their core banking system to BaaS providers.
IaaS (Infrastructure as a Service) is available on-demand and non-fintech in nature. Like, one can rent servers from Amazon Web Services (AWS) to start an app. Likewise, one can rent IaaS from traditional banks on demand.
2. Banking as a Service Provider
The Banking as a Service platform delivers software that guarantees safe data communication between the traditional bank and a business/ fintech company. This is known as the ‘middleware’ or ‘banking as a Service’ level. The fintech companies and businesses dig into the BaaS medium like a block. Most BaaS platform providers operate as a bank; however, they might need the underlying support of a traditional bank. The BaaS platform is API-based and has a back-end hosting of various Fintech startups and non-bank companies. The BaaS layer needs continuous monitoring to allow secure function across the domain, and secure authentication is equally critical.
For example, different BaaS providers may offer diverse banking functions. Like services that include issuing of cards, personal financing, easy lending, payouts, etc.
Cashfree businesses lead to effortless payouts via various payment modes like bank transfers, UPI, wallets, etc. Automated bulk transfers allow easy reconciliation that has higher success rates.
3. Fintech and Non-Fintech Businesses
Companies that interact with the end-user are the customers of the BaaS platform. These businesses can be both fintech and non-fintech companies. The customer is anybody showing interest in integrating these financial services into their product.
The fintech/non-fintech businesses use the BaaS platform to offer financial services to their customers. They must comply with all Baas regulations because they are using the Baas platform.
Ticketing is an example of a non-fintech business offering financial services through the BaaS model. A fintech company may use the BaaS for disbursing salary, loan disbursal, and collection.
Examples of BaaS: Some Cases
With its growing use in the consumer world, industries are using BaaS more and more for hassle-free transactions.
1. Online Banking
The advantage fintech/non-fintech companies using BaaS have is that they can offer online banking services to their customers without having bank licenses and integrations.
The services of BaaS are consumer friendly and technologically advanced and are an alternative to traditional banking for their customers.
The apps allow consumers to track daily transactions, account balances, and savings without physically visiting a bank. One gets faster access to funds and no hidden fees for a better customer experience. Checking the account balance and accepting and making payments through easy-to-use APIs have become extremely easy.
2. Offer Debit and Credit Cards
Banking as a Service, or BaaS, allows non-banks to offer credit and debit cards to their customers. For instance, Apple Credit Cards, Paytm Credit cards, etc. Customers get instant alerts of all their transactions through an app. Offers of cashback on credit and debit cards are some added features that attract consumers.
3. Loan Offers
BaaS allows businesses to lend funds to customers.
Businesses also offer customers Buy Now, Pay Later options, as we see on Amazon. The customer can schedule their payment in advance. Keeping track of monthly EMI payments through apps is a real-time hassle-free service.
4. Investment Services
BaaS helps non-bank and fintech players automate finances and investing assets, and customers get personalized investments with low-cost index funds. They can remain updated and compare their investment with offers of other companies.
5. Verify Customer Identification
Payment transfer failures cause huge reputational risks to an organization, which might lead to a company’s merchant account getting branded as a “high-risk merchant.” Once branded, the chances of losing many users become high.
Bank account confirmations help in reducing payment transfer failures. BaaS platforms help fintech/non-fintech businesses ascertain their beneficiary’s bank account before the transaction.
Benefits of Banking as a Service
The BaaS model has become revolutionary for the financial sector, leading to massive growth for banks and the non-bank industry. It is expected to change the whole concept of banking in the near future.
Advantages of Banking as a Service for Banks
1. Increased Sources of Revenue
BaaS allows banks to use APIs to share data with third-party financial institutions. As open banking becomes the norm, BaaS offers new revenue streams for banks. 43\% of banks charge a fee per API transaction.
Fintech and Tech companies lead innovation and technology, and banks have customer trust and massive funding capability at their disposal. Jointly, both parties can find new ways of generating revenue. For example, JP Morgan Chase teamed up with a fintech firm, OnDeck Capital, for speedier processing of small business loans.
2. Cost-Saving Initiative
BaaS can help with cost-saving apart from helping in generating revenue. On top of it, the banks can invest resources in something other than technological development.
As a result, they benefit from partnerships with third parties since they have ready-made solutions. This whole process can help banks make further investments and predictions of profitability.
77\% of banks aim to invest in open banking enterprises for their commercial customers.
3. Increased Customer Insights
If a bank teams with a third-party player, they gain new customers and understand customer preferences—for instance, their buying habits and financial requirements.
Now, banks can use this consumer data to customize offers for consumers. After all, 80\% of customers are more likely to respond to personalized plans. Moreover, they can follow a more targeted multi-channel marketing method, which can help them reduce expenditure.
Advantages of BaaS for Non-Banks and Fintech Players
Third-party providers and non-banks have limited access to customer information and banking. As we noted earlier, acquiring a banking license entails massive capital provisions. Moreover, the resources required to maintain legacy systems and comply with government regulations are only available to some.
Banking is a tough and challenging sector to start doing business with.
Most businesses need help to afford a banking license as it will distract attention from its core business proposition. Here, the BaaS becomes convenient. It helps the fintech players and businesses to avoid the banking licensing regulations by directly merging with a bank. Financial startups establish relatively faster without having to know a bank’s IT legacy.
Increased Customer Trust
Banks don’t only have the power of enormous resources, and they also have the customer’s trust. 43\% of customers leave it banks to look after their financial well-being in the long term.
Businesses can leverage that trust by integrating with banks to increase their customer base.
Businesses get customer insights when they merge with banks; otherwise, it takes a long to have customer insights. Hence, it can help banks make innovative and customized services for solving typical issues. For instance, automatic reconciliation for small and medium business transactions.
Advantages of Banking as a Service for End-Customer
BaaS promotes competition among financial service providers by allowing non-banks to offer core banking services. Innovative trends get a push, and more and more customers get access to customer-friendly products. It leads to greater financial clarity.
Third-party players can concentrate on specific customer pain points. For example, a fintech company may only focus on payouts for business. A neobank, also known as an online bank, internet-only bank, virtual bank, or digital bank, is a direct bank working solely online without formal physical branch networks. Its focus is on facilitating the process of lending money to customers. Neobanking focuses on the task rather than worrying about getting a banking license and other requisites.
The result is an easy and personalized financial service. The product is easy to use, attractive, and relevant to the current customer base that is becoming increasingly tech-savvy.
Superior Consumer Experience
Consumers take loans and make payments to run their businesses. Almost all customers are digital natives with a fair knowledge of IoTs. Customers of companies like Apple, Facebook, and Amazon expect instant gratification.
Customers also desire the same effortless and quick service from their financial institutions. The pressure is mounting with more technology companies entering the banking space.
Customer demographic is also another concern. The new customer base is tech-savvy and hopes for real-time access to financial information and offerings. Countries with a young population, like India, have the highest adoption rate of fintech services, and the speed goes as high as 50\% in India and China.
The customer becomes the focus anytime, and customer satisfaction is an accomplishment. After all, combining a bank and building financial products demands strong data protection and compliance measures.
Four Reasons for the Rise of Banking as a Service
The edges of BaaS are effective over other direct banking services. Let us find out the market trends leading to the growth of the BaaS model.
Here are the four most important reasons for the exponential boost in BaaS in recent years and why it will stay.
1. Customer Demand
The first and most evident reason is customer demand for integrated financial services. With more and more customers becoming tech-savvy, holistic, user-friendly financial products are a need of the times. Customers are looking for integrated experiences. These integrated experiences are called “ecosystems.” An ecosystem is an end-to-end product; the customer does not use any other service to complete the buyer’s journey. Ecosystem companies have 2x revenue in comparison to other companies.
To give customers the ability to shop with pre-paid debit cards various supermarkets offer cards. You should include installment financing and money-transferring services like Walmart, Simpl, etc., which led to a better customer experience and increased commitment. It developed an ecosystem where customers can pursue something other than the product to fulfill their financial needs.
Incidentally, many fintech players aim for small businesses as their potential customers. They provide user-friendly online banking services and affordable loans, as 70\% of small and medium businesses (SMEs) do not fulfill their financial requirements while interacting with traditional banks.
As a result, banks have to team with private financial establishments to offer convenient services to this demographic segment.
2. Growth of the Fintech Industry
The fintech industry is multiplying across the world- especially in India. India has a fintech adoption rate of 87\%, compared to a global adoption rate of 64\%. BaaS evolves as the only way for fintech players to debut in the market.
3. Regulatory Requirements
Organizations like PSD2 and Open Banking Working Group encourage open banking and use API across the banking infrastructure. Banks must make their APIs public to comply with the new rules in many landscapes to ensure healthy competition in the banking industry. API poses a threatening competition for traditional banks.
Therefore, banks have to adopt the BaaS model to guarantee customer satisfaction. Banks, too, benefit from integrating with fintech players and non-banks to access innovative tech to fulfill consumer needs.
4. Banking Revenue
We know that integrations with banks are crucial for fintech players. Recent reports infer that banking revenue and profitability may decline soon. For traditional banks, continued profitability is critical to stay in business.
Integrating with non-banks can help them open new revenue and product growth, give consumer services, and cater to their tech-savvy needs. For traditional banking, the most gainful partnership would be with businesses with a highly scalable business model.
The current market trends explained the meteoric rise of the BaaS model. Let us also look at the future of BaaS and its challenges.
Let’s find out.
Challenges of Banking as a Service: Road to Future
The challenges of using a BaaS strategy are too many, and the coexisting solutions lead the way for user-friendly financial products and solutions.
1. Modernizing Traditional Banks
The core systems of most traditional banks all over the world seem ancient and incompatible with modern technologies. It can be a big problem in executing the BaaS model as it would impose constraints for third-party integrations. Core banking has limitations in adopting tech-savvy solutions and proposing less time-consuming options for the end users. Consumers have less time in this fast-changing world and look for immediate results or simplistic processes, and time is a significant factor in their life.
The future of Banking as a Service must include modernized architecture for traditional banks, which would offer services, products, and processes like APIs.
Changing Roles of Players in the Finance Industry
A recent study shows that traditional banks slowly lose their “customer trust” advantage over fintech players. As a result, many tech firms like Apple Cards are venturing into the financial space to cash in their high customer trust levels.
The change-resistant, static banking industry has to transform to suit the times. Fintech companies function using the existing consumer database that traditional banks have. The Covid-19 pandemic also forced the banks to extend their digital services.
Tech advancement will bring about more changes in approaches and rules across the financial sector.
BaaS works by linking third-party players with many overlaps in their operational capacities. Likewise, many companies use white labeling while presenting product offerings, which may confuse end consumers.
The future of BaaS displays an enormous transformation in player responsibilities. Banks may shift from the role of “providers” to “compilers”, while they don’t have to focus only on their core banking services but also can include value-added services offered by their partners.
API Strategy
Starting a bank, fintech business, or non-banks through APIs is not a joke. The working processes and business abilities need to be explored. Yet, most organizations need help with creating an API strategy.
The primary goal while creating an API strategy should focus on easy integration, and it should be able to provide the highest business value while keeping unmanageable aspects of integration to a minimum. Global standardization of API strategy may be the next.
The difference between Open Banking and Banking as a Service
Banking as a service is an idea under Open Banking. Open Banking is restricted to sharing customer data. On the other hand, BaaS permits non-banks to embed financial services in their product offering and gives the customer access to core banking services.
Open banking is a broad term that allows third parties to access customer financial data through banks.
White Label Banking
White labeling is a strategy where businesses put their label on third-party manufactured products and re-brand it.
A Software as a Service (SaaS) provider puts its label on a BaaS provider and operates from the front end to the customer. For example, a grocery store can embed financial services in its ecosystem by white-labeling a BaaS platform’s services.
The BaaS sector shows signs of fast growth. It will be interesting to see how technical progress takes the BaaS model in the next decade.
