What is Banking as a Service?
Banking as a service or BaaS allows non-banks to offer core financial services to their customers by integrating with banks via APIs. Non-banks (like fintech and even non-fintech businesses) build products on top of the traditional banking infrastructure.
Here is an example.
Let us say you own an online ticketing platform (for instance, Book My Show).
Naturally, you want to increase sales and boost customer loyalty. So, here’s what you decide to do:
- Offer customized cards to your customers.
- Loyalty points for each purchase
- One-click loans for upcoming shows.
Now, these initiatives will directly increase sales and increase customer satisfaction. Moreover, you can analyse customer buying habits and provide customized offers to them to increase customer loyalty.
Sounds simple enough right?
Not quite.
Offering banking services to customers comes with a lot of strings attached. In fact, you need to have a banking license or other related licenses for offering banking services like depositing and lending assets. For instance, you need:
- PPI (pre-paid instrument license) for issuing pre-paid cards.
- NBFC license for offering loans for upcoming shows.
Needless to say, licences are extremely hard to obtain. Especially for businesses that do not pursue banking operations or work with banks.
Banking as a Service Definition
Banking as a Service (BaaS) allows non-banks (like the ticketing platform in our example above) to integrate with banks. Through this, they can offer digital banking services to their customers.
All this- without going through the hassle of getting a bank licence.
On that note, let’s try to understand how Banking as a Service works. In the next section, we will be covering BaaS players, what they do and how they do it.
Banking as a Service (BaaS) Players
BaaS usually involves three major players:
- The Bank: Traditional or New-Age
- Banking as a Service Platform
- Fintech company or non-fintech business that wants to embed fintech services into their product.
Now, let us dive deeper into each player to understand what they do and how they do it.
Traditional and New Age Banks
What Do They Do:
The banks provide the physical infrastructure aka the “Infrastructure as a Service” (IaaS) layer. These are the basic infrastructure services like the server and communication hardware.
How Do They Do It:
Banks have the licences required to do core-banking services. They expose their core banking system to BaaS providers.
Now, these IaaS services may be available on-demand and non-fintech in their nature. For instance, servers can be rented from Amazon Web Services (AWS) after starting an app. Similarly, IaaS services can be rented from traditional banks on demand.
Example:
An example of a traditional bank would be Goldman Sachs or ICICI bank. Solaris Bank is an example of a new-age bank.
Banking as a Service Platform
What Do They Do:
The Banking as a Service (BaaS) platform provides the software that ensures safe communication of data between the traditional bank and a business/ fintech company. This layer is also known as the ‘middleware’ or ‘banking as a service’ layer.
How Do They Do It:
The fintech companies and businesses plug into the BaaS platform like a lego. Interestingly, some BaaS platform providers have licences to operate as a bank. However, they might not have the underlying basement of a traditional bank. Famous financial thinker and expert Chris Skinner defines these BaaS platforms as “decomposed banking services”.
The BaaS platform is API-based. So, think of it as a back-end that host various Fintech startups and non-bank businesses. The BaaS layer requires constant monitoring to enable secure operation across the domain. Moreover, secure authentication is equally important.
Example:
Different BaaS providers may offer different banking functions. For instance, services like card issuing, personal financing, easy lending, payouts etc.
Cashfree helps businesses do easy payouts via diverse payment modes like bank transfers, UPI, wallets, etc. Automated bulk transfers have higher success rates and allow easy reconciliation.
Related Read: Smarter Alternative to Enet HDFC
Fintech and Non-Fintech Businesses
What Do They Do:
Finally, we have the companies that actually interacts with the end-user. These businesses are the customers of the BaaS platform.
Now, it is important to understand that these businesses can be fintech or non-fintech company. The consumer is anyone interested in integrating these financial services into their product.
How Do They Do It:
Usually, the fintech/non-fintech businesses plug into the BaaS platform to provide financial services to their own customers. Since the fintech services are provided through a BaaS platform, they need to be compliant with its regulations.
Example:
Remember the example of the online ticketing platform in the first section of this blog?
Well, that’s an example of a non-fintech business offering financial services to customers through the BaaS model.
On the other hand, a fintech company may use the BaaS model to offer lending services. For instance, Early Salary. They use Cashfree (BaaS provider) for user onboarding, loan disbursal, and payment collection.
Pro Tip: Complete Payments Toolkit for NBFCs
While these are just two examples, there are several use cases for the BaaS model. Let’s try to uncover some of them.
Banking as a Service Examples: Detailed Use Cases
We took the example of a ticketing platform in the previous section. However, banking as a service model is being implemented across industries.
Online Banking
BaaS can help fintech/non-fintech companies provide online banking services to their customers. Instead of focusing on bank licences and integrations, they can focus on improving their services.
These user-friendly and technologically advanced products can be a better alternative than traditional banking for their customers.
Moreover, they can create apps for their customers to track daily transactions, account balances and savings. Apart from that, they can ensure quicker access to funds and no hidden fees for a better customer experience.
For instance, Cashfree Payments offers Account creation services for neobanks and NBFCs. This enables their end-customers to create and link accounts. Moreover, they can use it to check balance, accept and make payments. Interestingly all of this possible through easy-to-use APIs.
Offer Debit and Credit Cards
Banking as a service or BaaS model can allow non-banks to offer credit and debit cards to their customers. For instance, Apple Credit Card.
Customers can get real-time updates of all their transactions through an app. The customer’s account details and payments are displayed in a user-friendly manner.
Moreover, businesses can attract customers by offering lower interest rates.
Interestingly, a lot of companies offer cashback offers on their credit and debit cards. For customer satisfaction, this cashback can be assets that have no expiry date and can be used to buy any products/service in stores, websites or apps.
Offer Loans
BaaS can also allow businesses to lend funds to customers. For instance, an airline can offer one-click loans to customers to ensure undisrupted travel plans and a better customer experience.
Moreover, businesses can offer customers a Buy Now, Pay Later options. The customer can choose their payment schedule upfront. An app can help them keep track of these monthly EMI payments.
Investment Services
Another way non-bank and fintech players use the BaaS model is by helping customers automate finances and investing assets. They can help customers get a personalized investment with low-cost index funds. Moreover, they can automatically rebalance the portfolio that is consistent with the customer’s investment plan. Furthermore, they can match the investment needs of the customers.
Verify Customer Identification
Payment transfer failures can cause huge reputational risk to an organisation. Moreover, it might lead to a company’s merchant account being branded as a “high-risk merchant.”
Bank account verification can help in reducing payment transfer failures. BaaS platforms can help fintech/non fintech businesses verify their beneficiary’s bank account before starting the payment process. This can be done in the case of bulk payment transfers across different payment modes like net banking, UPI etc.
This section explained how BaaS can help take financial services to the next level.
But what are the benefits of implementing the BaaS model?
Let’s find out.
Advantages of Banking as a Service
The banking as a Service model has been revolutionary for the financial sector. In fact, it leads to tremendous growth for banks and non-banks alike.
The customer, of course, comes out as a winner in both cases.
Let’s understand how.
Advantages of Banking as a Service for Banks
Increased Sources of Revenue
BaaS allows banks to use APIs to share data with third-party financial institutions. As open banking becomes the norm, BaaS offer new streams of revenue for banks.
In fact, 43% of banks prefer to work in a model which allows them to charge a fee per API transaction.
Fintech and Tech companies have the lead on innovation and speed. On the other hand, banks have customer trust and enormous funding capability at their disposal. Together, both parties can discover new ways of generating revenue
For instance, JP Morgan Chase teamed up with a fintech firm named On deck for faster processing of small business loans.
Cost-Saving Initiative
BaaS can not only help banks generate revenue but also help them with cost-saving. Banks do not need to invest resources in technological development.
As a result, they can benefit from partnerships with third parties as they already have access to ready-made solutions. In fact, this can help banks do further investment and forecasts of profitability.
No wonder 77% of banks aim to invest in open banking initiatives for their commercial customers.
Increased Customer Insights
If a bank collaborates with third party player, they gain new customers. But not only that, but they also gain insights into customer preferences. For instance, their buying habits and financial requirements.
Now, banks can use this newfound knowledge to create customized offers for their customers. After all, 80% of customers are more likely to respond to personalized offers. Moreover, they can pursue a more targeted approach to multi-channel marketing. This can help them reduce above the line spending dependency.
Advantages of BaaS for Non-Banks and Fintech Players
Bypass Banking Regulation = Faster Startup Launch
Third-party providers and non-banks have restricted access to customer information and banking capabilities. Like we mentioned earlier, acquiring a banking license entails enormous capital requirements. Moreover, the resources required to maintain legacy systems and comply with government regulations are not available to all.
In simple words, being a bank is not a piece of cake.
Moreover, most businesses can not afford to get a banking licence as it will divert attention from its core business proposition. Here, the speed to market and product innovation will take a massive hit.
This is why the BaaS model comes in handy. It helps the fintech players and businesses to bypass the banking licencing regulations by directly integrating with a bank. Financial startups can launch significantly faster without struggling with a bank’s IT legacy.
Increased Customer Trust
Banks don’t only have the leverage of enormous resources. They also have the customer’s trust. In fact, 43% of customers trust banks to look after their financial well being in the long term.
By integrating with banks, businesses can leverage that trust to increase their customer base.
Moreover, businesses get their hands on a lot of customer insights when they integrate with banks. This insight is drawn out of long periods of consumption. Hence, it can help customers build innovative and customized services for solving specific issues. For instance, automatic reconciliation for small and medium business transactions.
Now, these points are enough proof that banks and non-banks have a lot to gain by implementing the BaaS model.
But how is the customer the real winner? Well, let’s find out.
Advantages of Banking as a Service for End-Customer
Higher Competition = Innovative Products
Banking has always been a heavily regulated yet exclusive industry.
BaaS enables competition in financial services by enabling non-banks to offer core banking services. As a result, innovation gets a push and customers get access to customer-friendly products. Moreover, it results in greater financial transparency.
Third-party players focus on specific customer pain points. For instance, a fintech company may only focus on payouts for business. On the other hand, a neobank may focus on simplifying the process of lending money to customers.
This allows them to focus on the task on hand instead of worrying about obtaining a banking licence and everything that comes with it.
The result is a frictionless and customized financial product. This product would be easy to use, attractive and relevant to the present customer base that is becoming increasingly tech-savvy.
Superior Customer Experience
Customers have always been taking loans and making payments.
So, what is so different about these financial products arising out of the BaaS model?
Well, it is as much about the product as it is about the customer. Today, customers are digital natives. Regular customers of companies like Apple, Facebook and Amazon have been conditioned to expect instant gratification.
Needless to say, customers expect the same level of service from their financial institutions as well. As more and more technology companies enter the banking space, this pressure has only started to increase.
Another aspect of this phenomenon is the customer demographic. The new customer base is tech-savvy and expects to have real-time access to financial information and offerings. Interestingly, countries having a young population have the highest adoption rate of fintech services. In fact, the rate goes to as high as 50% in India and China.
At the end of the day, the customer does come out as the winner.
However, reaching that point of customer satisfaction is a feat in itself. After all, integrating with a bank and building financial products on top of that requires strong data protection and compliance measures.
So yes, the advantages of BaaS are plenty. But what are the market trends that led to the growth of BaaS model?
Let’s find out.
4 Reasons For Rise of Banking as a Service
Here are reason four reasons why BaaS has seen exponential growth in the reason years.
And why it shows no signs of stopping.
Customer Demand
The first and the most obvious reason is customer demand for integrated financial services. After all, more and more customers are becoming tech-savvy. The demand for holistic, user-friendly financial products is bound to grow.
Moreover, customers are looking for integrated experiences. In business-speak, these integrated experiences are called “ecosystems.” In simple terms, an ecosystem is an end-to-end product so the customer does not have to use any other service to complete their buyer’s journey. In fact, ecosystem companies have 2x revenue in comparison to other companies.
Naturally, a financial offering will be an important part of this ecosystem.
Let’s take an example here. Let’s say you own an online supermarket. You want to give your customers the ability to shop with pre-paid debit cards. You might even want to include instalment financing and money transferring services. (Walmart did something similar recently)
This will lead to a better customer experience and increase loyalty. Most importantly, it will create an ecosystem where your customer will not have to seek another product to fulfil their financial needs.
Furthermore, a lot of fintech players are targeting small businesses as their potential customers. They provide user-friendly online banking services and affordable loans to them. On the other hand, 70% of small and medium businesses (SMEs) do not meet their financial needs while interacting with traditional banks.
Naturally, they give traditional banks a run for their money in this segment previously classified as the ‘unbanked.’
Resultantly, banks have to collaborate with private financial institutions to offer relevant services to this demographic.
Growth of Fintech Industry
The fintech industry is growing across the world- especially in India. In fact, India has a fintech adoption rate of 87%, compared to a 64% global adoption rate.
Fintech companies require integration with banks for their product offering. As we mentioned before, getting a bank licence is not feasible for most companies. The capital requirements and compliance needs of a banking licence ensure that.
The result? The BaaS model becomes the only way for fintech players to debut in the market.
Regulatory Requirements
Organisations like PSD2 and Open Banking Working Group are promoting open banking and the use of API across the banking infrastructure. In fact, banks have to make their APIs public to be compliant with the new rules in a lot of geographies.
This move is to ensure healthy competition in the banking industry. However, with open API comes competition for existing traditional banks.
As a result, banks have to embrace the BaaS model to ensure customer satisfaction. Moreover, integrating with fintech players and non-banks helps them access innovative tech to fulfil customer needs.
Banking Revenue
We know that integrations with banks are indispensable for fintech players.
However, recent reports speculate that banking revenue and profitability may decline in the near future. For traditional banks, continued profitability is important to stay in the business.
Integrating with non-banks can help them open new streams of revenue and product growth. They will be able to serve more customers and cater to their tech-savvy needs. The most lucrative collaboration would be with businesses that have a highly scalable business model.
These market trends explained the meteoric rise of the BaaS model in the recent past. But, what about the future? What are the future of BaaS and its challenges?
Let’s find out.
Challenges of Banking as a Service: Road to Future
The challenges of implementing a BaaS strategy are plenty. Thankfully, the accompanying solutions pave the way for user-friendly financial products and solutions.
Let’s dig deeper.
Modernizing Traditional Banks
The core systems of most traditional banks are outdated. They are not compatible with modern technologies. This can be a big issue in implementing the BaaS model as it would cause hindrance for third-party integrations.
The future of Banking as a Service would include modernized architecture for traditional banks. This would aid in exposing services, products and processes like APIs.
Changing Roles of Players in Finance Industry
Recent research shows that traditional banks are slowly losing the “customer trust” advantage they had over fintech players. On the other hand, many tech companies are venturing into the financial space as they have high customer trust levels ( Eg. Apple Card)
Moreover, BaaS entails collaborating with third-party players. Naturally, there are a lot of overlaps in functional capabilities. Furthermore, a lot of companies use white-labelling while offering product offerings. This can confuse end customers.
Keeping these points in mind, the future of BaaS shows an immense shift in player responsibilities. Banks may shift from the role of “manufacturer” to “assemblers.” This means they won’t just be focusing on their core banking services. Instead, banks will assemble the services offered by their partners as value-added services.
Well-Defined API Strategy
Opening up a bank or a business (middleware) through APIs is no small feat. The operational processes and business capabilities need to be exposed optimally. However, most organisation face issues while creating an API strategy.
The main goal while creating an API strategy should be ease of integration. It should be able to deliver maximum business value while limiting the cumbersome aspects of integration. The future of the finance industry may include global standardization of API strategy.
Taking all factors into consideration. The BaaS sector shows no signs of stopping. It would be interesting to see how technological advancement shapes the BaaS model in the next decade.
FAQs on Banking as a Service
What is the difference between Open Banking and Banking as a Service?
Banking as a service is a concept under Open Banking.
Open banking is just limited to sharing of customer data. On the other hand, BaaS allows non-banks to embed financial services in their own product offering. It focuses on giving the customer access to core banking services.
Open banking is a much broader term. It allows third parties to access customer financial data through banks.
What is White Label Banking?
White labelling is a system where companies put their own label on a third-party manufactured products and re-brand it as their own.
White label banking is when a Software as a Service (SaaS) provider puts their label on a BaaS provider and operates a front end to the customer. For example, a grocery store will be able to embed financial services in their ecosystem by white-labelling a BaaS platform’s services.
