What Banks Need to Know About BaaS to Grow Revenue

As the banking landscape continues to transform rapidly, one thing is clear: Innovation isn’t just desirable, it’s critical. Banks are facing an array of challenges from revenue growth to keeping pace with customer demands to ensuring regulatory compliance across multiple fintech partnerships.

Many banks have turned to BaaS as a solution for addressing these pressures of modern banking while also unlocking untapped revenue streams.

However, like all new innovations, there is some confusion in the market about what BaaS is and how to take advantage of it—securely.  

In this blog post, we’ll take a deep dive into defining BaaS, how it’s transforming the banking industry, and most importantly, how your bank can leverage this strategy to stay relevant, competitive, and ahead of the curve. 

What Is BaaS?

BaaS, or banking as a service, has emerged as a game-changing innovation in the financial industry. It is accelerating a shift from traditional banking to a more agile, customer-centric model. But sometimes it’s hard to tell where software ends and banking begins. 

At its core, BaaS is a kind of behind-the-scenes infrastructure. It’s a model where licensed, regulated banks or credit unions integrate their digital banking services directly into the products of non-bank businesses via APIs. This approach is often referred to as “embedded finance” or “embedded banking” from the businesses’ point of view, and allows non-bank businesses to offer seamless financial services to their customers, all under their own brand.

One way to think about BaaS is as a wholesale model. Banks are “wholesaling” their products to a business that needs to be able to offer services like deposit accounts, card services, or loans to their customers. Those businesses can’t do that without partnering with a regulated bank. 

What does this look like in practical terms? 

• Example 1 – Buy Now, Pay Later: Imagine a popular fitness company that sells indoor cycling equipment for your home. Through BaaS, this company can offer its customers a loan for the products at the time of purchase. The fitness company is not a licensed bank, so it works behind the scenes with one to enable loan payments directly through its app platform. 

• Example 2 – Agile Cash Flow: Let's now consider a ride-hailing app. Through a BaaS partnership, it can offer its drivers the ability to get paid instantly after each ride. This feature is highly attractive to drivers who often need immediate access to their earnings, and it’s made possible because the ride-hailing company uses BaaS to embed banking services within its platform.

In both of these examples, the key to BaaS is that the customer sees a seamless, integrated experience. They’re not necessarily aware that they’re using a banking service. Instead, they view it as a beneficial feature of the retail or ride-hailing app. The result is a win-win situation: The retail or ride-hailing app enhances its customer experience and loyalty, and the BaaS provider (the bank) reaches new customers and revenue streams.

Embedded Banking vs. BaaS

The terms “embedded banking” and “Banking as a Service (BaaS)” are often used interchangeably, but they represent different parts of the same system. Embedded banking primarily focuses on the customer-facing solution that improves the experience of buying a good or service. On the other hand, BaaS is the behind-the-scenes process enabling non-banking entities to provide regulated financial services. The correct term generally depends on your perspective:

• If you’re the bank: You’re providing a BaaS partnership.

• If you’re the retailer or fintech: You’re providing embedded banking in your application or website via a BaaS relationship. 

The Benefits of BaaS for Banks

Up until recently, banks typically viewed fintech companies as competitive rivals within the industry. Today, BaaS is bringing together banks and fintech companies into mutually beneficial relationships, combining the innovative power of fintechs with the trust and regulatory compliance of traditional banks. 

Embracing the BaaS model enables banks to strengthen their market position, maintain relevance, and respond effectively to many of the significant challenges in today’s fast-paced financial landscape:

Customer Acquisition

Traditional marketing and outreach efforts may no longer be as effective in the digital age. Through BaaS, banks can indirectly reach the established customer bases of their non-bank partners, leading to more efficient customer acquisition. This is often achieved through two different bank-fintech partnership strategies: 

• Affinity play: Through affinity play, a bank gains access through a fintech to its targeted customer demographic or interest group (i.e., environmentally conscious consumers or recent college graduates).  

• Functionality play: This strategy allows banks to add new functionality to their existing products or services without having to build it themselves, while fintech companies gain access to a larger customer base.

New Revenue Growth

In addition to tapping into new customer opportunities without a significant change in marketing spend, banks can monetize their existing infrastructures and licenses to create new streams of revenue. 

Enhanced Customer Experiences

BaaS allows for the integration of banking services into day-to-day consumer and business applications, enhancing user experience through tailored solutions, convenience, and efficiency. This can help improve customer loyalty and increase the use of banking services. 

Innovation

BaaS fosters innovation, enabling banks to quickly adapt to market trends and customer needs.

There Are Challenges to BaaS

Without a doubt, any type of external partnership carries inherent risks. It’s crucial to proactively identify and strategize for potential challenges:

1. Finding the Right Fintech Partner: Not every fintech company will be a good fit for your bank. The potential partner must have a product or service that complements your existing offerings, aligns with your bank’s strategic goals, and is suitable for your customer base. Thorough due diligence is crucial to understand the fintech’s business model, its financial stability, and its regulatory compliance status.

2. Regulatory and Compliance Burden: The bank, as the licensed financial institution, is ultimately responsible for the compliance of the financial services provided. Even if the bank delegates some operational responsibilities to fintech, the bank still has the burden and risk of ensuring compliance with all relevant financial regulations. This includes everything from anti-money laundering (AML) rules to data privacy regulations.

3. Counterparty Risk: If a fintech partner goes out of business, the bank is left to deal with the fallout. For instance, if a retail partner were to suddenly cease operations, the bank would be responsible for recovering loans from the retailer’s customers.

4. Exposure to Deposit Insurance Limitations: BaaS often involves the bank holding deposits on behalf of various fintech partners. If a single depositor holds funds across multiple fintechs, and all those funds are underpinned by the same bank, it could inadvertently result in a depositor exceeding FDIC insurance limits at that bank. 

5. Deposit Spreading and Risk Management: To manage the risks associated with deposit insurance limits, banks need to thoroughly understand their deposit base. This includes knowing which customers are using their services through various fintech partners and monitoring the total deposits of each customer across all platforms. 

How to Securely Embrace the Advantages of BaaS for Your Bank

The potential for BaaS in the banking industry is enormous and growing. Per Bain & Company, embedded banking in e-commerce and other software platforms accounted for $2.6 trillion, or nearly 5%, of total U.S. financial transactions in 2021. By 2026, it’s projected to exceed $7 trillion.

The practical steps toward BaaS implementation involve a strategic blend of choosing the right fintech partnerships, focusing on customer needs, and ensuring regulatory compliance. With the right guidance and expertise, these steps can be navigated seamlessly.

If implementing BaaS seems daunting, we encourage you to reach out to us. Let’s discuss how Core10 can guide your bank on the journey to becoming a future-ready financial institution that leverages the power of BaaS.

Start securely growing your bank’s revenue with Core10’s BaaS solutions. Learn more by contacting us.