Banking as a Service (BaaS) Unpacked
What is Banking as a Service (BaaS)? There is a fair amount of confusion on this topic, and I have yet to see a definitive guide that accurately addresses this. Here, I’d like to highlight the most critical factors that people should know about.
BaaS refers to platforms that connect seemingly disparate players: traditional banks, technology firms, and non-financial brands.
In this post, I will:
- Walk through the architecture of BaaS — what it is, and what it is not
- Outline the models, advantages, challenges, and implications for both consumers and regulatory bodies
BaaS: a Fusion of Banking and Technology
At its core, BaaS allows tech firms and non-financial brands to provide banking services to its end users. The tech firm in this equation is not a bank. They lack the charter and regulatory oversight that is integral to banking. BaaS serves as a bridge between the tech firm — which cannot store money — and the bank, which has the legal and institutional capacity to do so.
The Uniqueness of Banks: Charters and Regulations
A bank is not just another business; it carries a unique status conferred by a banking charter. This charter brings a myriad of regulations designed to protect not just individual customers but the broader economic framework. Such regulations include stringent compliance and governance protocols, ensuring a high level of integrity and security to the banking operations. Our economy works because we have trusted banks that work.
Current BaaS Models: A Spectrum of Arrangements
There are primarily three kinds of BaaS models:
- Bank-Direct Model: In this model, banks develop their own APIs or interfaces. They handle all aspects of the partnership, including sourcing customers and ensuring compliance and governance. Some large financial tech firms prefer this model as it enables them to navigate complex financial scenarios. However, the interfaces are less agile and comprehensive than other models and often take considerable time to integrate.
- Bank-Vendor Partnership Model: Multiple banks work in conjunction with vendors like embedded banking software provider Treasury Prime, and core providers FIS, and Fiserv to provide banking products to tech firms. The bank remains responsible for compliance and governance but may ask the API vendor, such as Treasury Prime, to help source clients. While the banking API connects the two parties, the bank and the tech company still have direct lines of communication with each other. This model is technically sophisticated and quick to integrate, combining the benefits of the Bank-Direct Model without its drawbacks.
- API Dealer Model: Here, companies act like banks but without a charter. Many of the BaaS companies that are getting into trouble use this model. These API dealers act as middlemen and intercept communications, compliance oversight, and governance for the tech firm while sometimes seeking approval from a partnering bank. Despite its technical capabilities, regulators disapprove of this model, making it risky to implement. If you want to act like a bank, be a bank and get a charter.
Model Efficacy and Regulatory Implications
Among these, the Bank-Vendor Partnership model — which Treasury Prime set the standard for — is generally considered the most effective, the safest, and the cheapest at scale. It is the go-to option for many large fintech companies. Working directly with multiple banks through the BaaS platform, tech firms are able to scale and launch new products with other banks at the pace they want.
The Bank-Direct model, while also effective, has drawbacks mentioned above such as less agility and longer integration time. But the biggest disadvantage is that companies that work with just one bank expose themselves to concentration risk in case something goes wrong with the relationship or the bank itself. Migrating to a new bank can be time-consuming and costly.
Though technically proficient and theoretically expedient, the API Dealer model has faced regulatory hurdles that have led to recent high-profile failures.
Finding a bank partner in the bank-vendor partnership model
In approaching a BaaS relationship, view the bank as an equal partner, not just a vendor. Both the fintech company and the bank should derive value from the collaboration to sustain over the long term. This direct Bank-Vendor Partnership model stands in stark contrast to the API Dealer dynamic and sets the stage for a relationship where both parties are invested in mutual success. A one-sided relationship will not only be short-lived but may also pose regulatory challenges for the bank.
Selecting the right bank partner is equally critical. Treasury Prime offers a marketplace of potential banking collaborators, allowing fintechs to partner with institutions that align with their vision and goals. Before jumping in and partnering with a bank:
- Conduct thorough research, present a demo of your offerings, and actively seek the bank's feedback and insights.
- Gauge the bank's experience and openness to innovation; a compatible partnership can yield long-term profitability for both parties.
- Once you have enough information, make an informed decision and commit to the relationship. It is an investment that will pay dividends in the long run.
Banking as a service is a beacon of the ongoing transformation in the financial sector, adapting traditional banking into more flexible and modular services. While the BaaS landscape has developed distinctive models, each with pros and cons, the regulatory environment continues to be a decisive factor in shaping its evolution. As we move forward, BaaS will likely continue redefining how we think about banking, financial services, and the very nature of economic transactions in the digital age.
Wondering how embedded banking could help your bank? Contact Treasury Prime — we have established fintech and embedded finance clients and extensive compliance experience. Read more about our $40 million Series C Funding and why Tearsheet named us the Best Banking as a Service company two years in a row. Talk to the best embedded finance team in the industry.
Related digital banking solutions content:
- Future of Banking: Grasshopper Bank
- How Banks Can Grow Low-Cost Deposits with Embedded Finance
Related BaaS fintech content:
- Leveraging Multi-Bank Partnerships for White-Label Banking Products
- How Embedded Finance Can Help Your Vertical SaaS Company During a Recession