Traditional financial institutions are being challenged to stay relevant in an increasingly digital world. One way they’re doing this is by allowing other types of businesses to build off their infrastructure – for a price – to invent new banking solutions tailored to the needs of modern financial customers. This practice is called providing banking as a service.
So what is banking as a service (and what isn’t it)? How does it work? Who does it benefit, and why? And what are some examples of banking as a service providers already on the market?
Read on to find out.
“BaaS,” or “banking as a service,” is a business model where licensed banks allow their data and digital services to be integrated, via APIs, into the products of other types of businesses. That allows those businesses to offer banking services without needing financial regulation and oversight.
Part of understanding the banking as a service business model is recognizing what it isn’t. There are a number of related terms and concepts to BaaS that aren’t quite the same thing. We’ll go over a few of the common ones below.
Embedded finance refers to the practice of a non-financial business offering methods of conducting financial transactions from directly within its products. The main difference between banking as a service vs. embedded finance is that BaaS is the behind-the-scenes infrastructure that makes consumer-facing embedded finance solutions possible.
Another way to think about the difference is in who uses each model, and why:
Banking as a Platform (BaaP) is a business model where a registered financial institution builds off the APIs of non-financial businesses – usually Fintech companies – to offer a wider range of services. This is also sometimes called platform banking.
The difference between banking as a service and banking as a platform is that the two business models are basically the inverse of each other:
Open banking is a set of rules and processes that govern how financial and non-financial institutions can share customer data through APIs. Like with embedded finance vs. banking as a service, the difference between banking as a service vs. open banking is that the former is made possible by the latter.
The other main difference between the two is in what is shared over an API:
So with open banking only, a person can organize and review their financial data on a non-financial platform. This is useful for simple budgeting tools, for example.
Add BaaS on top of that, though, and the person can actually make financial transactions on a non-financial platform – such as opening accounts or taking out loans – as if they were directly interacting with a licensed bank.
Essentially, BaaS is a licensed bank lending out connections to its data and functionalities to non-financial businesses for a fee.
The non-financial businesses then use these borrowed capabilities to build bank-powered transaction capabilities into their products. Or they may create product-specific financial applications that fill banking as a service use cases beyond what a bank’s typical functions cater to.
The basic process looks like this:
This sequence is sometimes extended by a Fintech company using a bank’s API to develop a new financial product, and then licensing the product’s functionality via API to another company for building its own applications. In this way, a Fintech platform can become a BaaS platform as well.
Banking as a service benefits banks, as well as Fintechs and other non-financial companies, in several ways. It can also be advantageous to customers of both of these types of businesses.
There are already several examples of banking as a service being used by well-known businesses. Here are some prominent instances of banking as a service companies partnering with big players in other industries to create innovative new financial products.
Uber is making it easier and more attractive for people to make money as ride-sharing drivers, thanks to BaaS. By partnering with Barclays Bank and Fintech company Green Dot, Uber has turned its app into a financial management hub for its drivers. That includes services like taking out loans for car purchases or rentals, as well as cashing out trip earnings or cash-back rewards at automotive-oriented businesses.
Tech giant Apple has partnered with noted financial institution Goldman Sachs to offer its own credit card: the Apple Card. Besides its capability to be used like a regular payment card at a point of purchase, the Apple Card unlocks additional features for applications on Apple’s iPhone and Apple Watch devices. These include budgeting and bill payment tools, retailer locating functions, and biometric payment approval.
Chime is one of the most well-known neobanks – a Fintech company that uses BaaS to offer financial services and target demographics that traditional banks often don’t. Through partnerships with The Bancorp Bank and Stride Bank, Chime has expanded its product lineup from prepaid debit cards to functions like early paycheck availability and checking accounts structured for easy credit-building.
Treasury Prime is an example of a banking as a service Fintech company. That is, it develops new financial solutions by leasing the infrastructures of licensed banks, and then loans these products out to other companies that need them. One of these clients is First Internet Bank, one of the first ever neobanks that provides personal finance management, loans, and mortgages.
Treasury Prime augments First Internet Bank’s offerings by providing BaaS functions like account openings, money transfers, payment cards, and compliance/risk management.
Banking as a service, or BaaS, offers some exciting new opportunities for both registered financial institutions and Fintech startups. But one of the fundamental challenges for the banking as a service industry going forward will be maintaining the security, privacy, and trust of customers. This will be especially critical given that many more types of businesses will be able to access not only financial data, but also actual financial functions.
BaaS providers will need to have powerful transaction and suspicious activity monitoring programs to detect fraud and money laundering attempts – not only for their own systems, but also for any BaaS products that leverage those systems. Contact Unit21 today to see how we can help.