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Banking as a Service – With the Right Technical Foundation a Scalable Digital End-to-End Opportunity Exists

In recent years, FinTech has grown exponentially as the number of nonbank financial institutions (NBFI) or nonbank financial companies* (NBFC) providing add-on financial services, such as payment services, wallets, bank accounts, and loans have entered the market. These banking-like services are examples of embedded finance that nonbanks offer to provide more value to their customers in their efforts to retain, meet their needs and desire for more simplified banking processes.

Businesses of all types in different stages of maturity (FinTechs and other non-bank companies like retailers, insurance providers, car manufacturers, software and big tech companies, telcos, and logistic firms) are taking the leap to launch embedded financial services to serve both consumer and business segments. To keep up with the demand for embedded finance services, the number of banks offering banking-as-a-service (BaaS) continues to grow. BaaS brings great opportunities to those banks who want to take advantage of the demand for such services now being offered by FinTechs and other business sectors.

*These are financial institutions that provide bank-like and financial services but do not have a full banking license. Examples are investment banks, mortgage lenders, insurance companies and P2P lenders.

What is Banking as a Service?

In general, Banking-as-a-Service (BaaS) is a bundled offering of white-labeled or cobranded services that banks, or other financial institutions provide to nonbanks (e.g, FinTechs), who can then offer to their customers. BaaS differs from open banking in that open banking is the concept of generating composite services while BaaS provides the means of supplying the services.

Banking-as-a-Service can be better defined as an end-to-end process that ensures the comprehensive completion of a financial service. BaaS is provided on demand via the internet and managed within a specific time frame. This service includes:

  • The financial service used
  • An environment for management, deployment and delivery
  • A licensed bank providing legal compliance with banking regulations
  • Security mechanisms such as strong authentication throughout the entire process to be in compliance with regulations for data protection (e.g., PCI DSS, FIPS 140)

What Does BaaS Mean for Traditional Banking Models?

Banks will need new technologies and capabilities to make BaaS work. Banking as a Service is typically distributed to clients (FinTechs) through APIs. This means the embedded finance partner (e.g., bank) will need strong risk and compliance management. They will also need to adopt new business models, including B2B2C and B2B2B distribution capabilities, pay-for-use-monetization, and increased consideration of their branding.

According to McKinsey & Company, banks can expect to see the following six trends in the areas of Banking-as-a-Service and embedded-finance:

1. Customers demanding more integrated experiences that make it easier to access banking services all in one place.

2. New and future FinTechs will need banking partners that they can work with to access BaaS to deliver to their customers such offerings as bank accounts, payment processing, and lending.

3. Regulatory trends, such as open banking and PSD2 are promoting the development of banking APIs and universal access. It will require banks to modernize their IT systems, which adopting BaaS models can help fund and recoup expenses for such projects.

4. It is projected that banking revenue and profitability will continue to decline, hence the need for banks to explore alternative sources for revenue and product growth, with the most promising being those that have scalable business models.

5. As the move for digitization (e.g., automation and APIs) continues to accelerate, banks can scale BaaS faster and make embedded finance available to companies considering such services.

6. Incumbent banks no longer have the trust advantage they once had over FinTech companies as more brands have higher trust levels that they are now using as leverage for offering financial services. Banks can take advantage of this through cobranding or white-labeling financial services with such partners.

FinTechs Continue to Compete with Banks

FinTechs are new players to the financial services industry. They have grown in numbers since the 2010s and have evolved to provide banking online as-a-service. FinTech Weekly defines a FinTech as “a business that aims at providing financial services by making use of software and modern technology.” What this means is that FinTechs are the marriage of technology and finance that allows startups and service providers to offer streamlined services and financial products. In the past, these were only available through heavily-regulated, traditional financial institutions.

Today’s and tomorrow’s FinTechs seek to revolutionize the banking industry. This of course means that they will continue to compete with traditional banks for customers. Some of the more familiar names in the FinTech industry include PayPal, Lending Club, Square, and Prosper.

As FinTechs continue to grow and gain more market share, incumbent banks are doing themselves a disservice by failing to capitalize on the opportunities that embedded finance can provide them by offering Banking as a Service.

Banks Should Consider BaaS as an Imperative

When considering whether to enter the arena of offering Banking-as-a-Service, many banks do have concerns that doing so could threaten their existing client relationships. However, they should be considering BaaS as an imperative because of the expected increase in end users adopting embedded finance. BaaS can allow banks to enable partners to offer their banking products, resulting in low-margin, high-volume business for banks.

We can compare this opening up to the deregulation in the telecom-sector in the 1990s. The incumbent telecom service providers were initially reluctant to open up their infrastructures to third party service providers. However, the emergence of new business models as a result of deregulation created new demand and new opportunities for telecoms to generate profits.

Having the Right Technical Foundation is Crucial

For traditional banks to offer Banking-as-a-Service, they must undergo a digital transformation. The good news is that many have already begun or have completed this process.

In adopting BaaS, banks must embrace the technology and equipment needed to meet the need to securely process transactions while remaining highly scalable to allow for future growth. Banks and other financial institutions are required to comply with highly demanding IT compliance requirements and regulations. They are at high risk for security breaches, cyberattacks and frauds that continue to dramatically increase in frequency. Therefore, it is crucial that they build the right technical foundation that provides reliable and proven cryptographic cybersecurity solutions.

Utimaco’s security solutions make it possible to capitalize on what the future of BaaS holds for the banking and financial service industry with a comprehensive portfolio of on-premise and ‘as a service’ solutions. 

Blog post by Dawn Turner and Ulrich Scholten

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