The convergence of open banking regulations, API integrations and fintech business models is enabling Banking as a Service (BaaS) as a new financial opportunity. BaaS is a business model where banking services are outsourced to third parties. Banks can act as platforms, providing their services to new digital banks or other organizations. It can also work the other way, with fintech companies offering their services to banks.
Stemming from open banking regulations, BaaS uses secure API connections to share customer data and applications in a seamless experience. The ability to effectively connect and use resources from multiple vendors is delivering innovative financial services, optimizing costs and creating vast opportunities.
Banking and financial services companies that deploy effective technology and build cohesive business partnerships and develop services markets will have substantial advantages over their competitors. For example, an Oliver Wyman report found that the BaaS customer acquisition cost of only $5-35 was significantly less than the typical $100-200 cost of traditional methods. As lead report author Dan Jones states:
BaaS is a great opportunity for existing banks, insurers and wealth managers to reach a greater number of customers at a lower cost by teaming up with non-financial businesses. But if they do not react in a rapid, strategic manner, BaaS could also pose a threat, as it opens up the financial services market to new challengers.
Not your parent’s bank
The capabilities of BaaS are changing who banks should consider as competition. As Bill Gates famously said in 1994, “Banking is necessary, banks are not.” Users flocking to non-bank apps for services that a bank traditionally provides is a competitive threat.
While banks have trusted brand names and precious bank licenses, the question is: Are these advantages defendable from the onslaught of newer brands and alternative providers? What if internet giants or other massive brands decide to use their status and expertise to provide bank-like services? Google and Apple have already launched their pay services and Facebook puts significant efforts into Diem, so perhaps banking may be another service ripe for disintermediation?
The wide-spread adoption of mobile banking — 80% of U.S. banking customers use it as their primary banking interface — does indicate that banks can participate in the digital economy. However, many of these apps replicate traditional services in an app.
To thrive in an open banking ecosystem, banks need to adapt their strategies and technologies:
- Service offerings
What services will they add to their interface? Which services will they keep in-house and which services will they outsource? How will they label their offerings; will they be diluting their brand or adding to it?
- Technology stack
Will banks continue to use legacy infrastructure and add-in APIs as appropriate? Or will they create new divisions from the ground up with brand new systems? What elements will they own versus trusting third parties to deploy and operate?
Many of the choices will depend on the institution’s culture and where they operate. Many institutions will only open up access to data and customers if required by regulators. Financial institutions are already seeing substantial growth in other markets due to open banking as consumers decide to adopt new ways to transact, invest and take more control over their financial lives.
The ever-expanding fintech universe
With over 25,000 fintech companies globally, the options to integrate innovative applications and new services are unprecedented. Just as important, the BaaS model is becoming increasingly standardized and accepted by banks, regulators and consumers.
The primary purpose of open banking is to level the playing field for fintech companies and establish a standard, secure methodology to access and share information. Protocols help ensure vital security and privacy considerations are met. Beyond that, it’s the mindset that sharing information and using third-party technology in operations is acceptable and, in fact, desirable. As Nanda Kumar, Founder and CEO, SunTec puts it:
Banks of today must embrace a cultural and mindset shift and transform to adopt a more platform-centric approach that allows them to solve broader lifecycle needs and deliver experiences that customers truly value. This choice will enable banks to evolve toward collaborating with a host of partners and create broader ecosystems.
For consumers, the most important aspect is trust. In general, they’ve built long-term relationships with their primary bank and rely on that trust to gauge other financial products and services. They are willing to use fintech services if the experience is seamless and appears connected to their bank. They might try them out for outside services, but are often reluctant to trust them with their paycheck.
While some major brands might have the reputation needed to take market share on some financial services, the banks have a long history of trust that is still core to BaaS. Fintech companies compete with banks in some areas, but it’s often about cooperating and providing the best services and experiences that will determine ongoing success.
As the range of fintech services is so broad, deciding what services to offer and how will be critical. Some possible services include:
- Pre-paid cards
- Credit cards and associated account services
- Direct debit set-ups
- Payout set-ups
- Clearing and settlement
- Card processing
- Credit checks/scorecards
- ACH alternative remittance
- Transaction screening
Determining how the services are packaged and offered to consumers requires careful attention. Bundling a large selection of BaaS functions together is not enough. Organizations that can create seamless experiences — thoughtful, personalized, dynamic presentations of opportunities and value — will build their relationships, while others confuse and frustrate the consumer.
The same can be said for the relationship between the fintech industry and banks: creating effective working relationships is the key to fully developing the potential of BaaS. However, a survey by ClearBank found that fintech companies “are misunderstood, underserved and that their current bank [provider] is increasingly inhibiting their business as well as the potential of the wider fintech market.”
Banking identity verification and authentication
While numerous factors are essential to the success of BaaS, one lynchpin is the need for effective identity verification and authentication.
Financial information is among the most sensitive and valuable types of data. Without effective security and privacy measures to protect the integrity of financial accounts, there is no market for BaaS. In the EU, strong customer authentication (SCA) requirements are strictly described and how customer identity is gathered, shared and confirmed is fundamental to trust in the whole open banking system.
As BaaS opportunities start to emerge worldwide, careful attention to identity proofing and access procedures is necessary. Acceptance by consumers and providers might falter if fraudsters and criminal actors penetrate accounts, cause cyber havoc and sow mistrust.
On the other hand, following identity best practices regarding compliance, fraud prevention, and trust and safety will enable BaaS to flourish and new economic opportunities will quickly emerge.
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