For FinTech, the last year has been a turbulent one. From layoffs, acquisitions, and announcements of companies shutting down, all sectors in financial services have felt increased pressure.

The Banking-as-a-Service segment (in which banks work with other companies to offer white-labeled banking products) is no different. FIS made an announcement in June to acquire Bond. Other BaaS players are feeling a slowdown from startups unable to fundraise for new banking products. Without additional funding, these prospective platforms are having to pivot away from banking or shut down.

Despite the economic downturn, the market potential for BaaS is still expected to grow — about 15% annually, reaching over $65B by 2030. This market opportunity is expected to come from large, established enterprises gaining competitive advantages by adding banking products. Big-box retailers (Costco, Target, IKEA) could feature financial services that go beyond payments to deliver a better customer experience.

So, where does Banking-as-a-Service go from here? TL;DR —>

• Co-branding is a way to prototype a potential bank play, but shouldn’t be a long-term solution;

• A lookback at the fragmented model in BaaS and why it no longer fits in this market;

• To thrive, BaaS is moving upstream towards enterprises with an established customer base;

• Enterprises are in need of full-service providers delivering embedded finance, not fragmented vendors in BaaS;

CO-BRANDING as a ‘LITE’ Version of BAAS

There have been varied approaches in the past, but some form of co-branding (a company collaborating with a bank or card issuer) has existed — even before Banking-as-a-Service.

For retailers, having a branded card meant more business from customers, increased marketing exposure, and an additional revenue source. Companies in other verticals (such as business management services and software) may also participate in referral programs to banks — through a link on their website/app that takes clients to a another website.

This resembles a lightweight approach to BaaS, but ultimately it’s a hand-off to a 3rd party. Any new product opened is not part of the existing client’s user experience; if there’s an issue with a card or bank account, the customer can only interact with the issuing bank or card provider.

Despite co-branding having a minimal lift and cost, companies also gain only a small upside with a referral fee. There’s a higher risk of damaging existing relationships if the referred product comes with a poor experience.

Many large enterprises are looking to avoid legal and risk obligations in directly offering a bank product, so they pursue a co-branded program. Unfortunately, there’s too many missed opportunities in terms of shared revenue and customer loyalty — the result is that these initiatives tend to be short-lived.

If the point is to test out a hypothesis for 12 months or less, then there is some value to co-branding to run a prototype with minimal expense.

the Legacy Banking-as-a-Service Model

The 3 major components in BaaS that delivers white-labeled banking products: a bank, technology provider, and customer-facing platform (which can be a fintech or non-fintech) offering the product to their clients (the end-user).

This is the simplified breakdown that the industry is accustomed to. However there are multiple elements missing, specifically with:

• Compliance — performing required checkpoints on new users, ongoing monitoring of user activity, fraud management; for most programs, this is not covered by the bank; vendors are added to fulfill requirements;

• Program management — connecting & managing all the parties involved in building and maintaining a bank program (vendors, technology partner, bank); also, ensuring bank partners provide timely approval for new products;

• Processing — this is tied to the settlement, posting, and reconciliation of transactions; payment files are sent and received by bank partners, but ledgering isn’t included; tech providers may or may not have these capabilities built-in;

Unfortunately for many companies that went down this road, the ‘unknowns’ (listed above) proved to be too much from an expense and capacity standpoint. Even when funding from investors was at its peak (2020 - early 2022), many startups still struggled to launch a program through BaaS.

This legacy path also came with numerous vendor relationships to manage — Know Your Customer (KYC), tech stack, payments processor, transaction monitoring, card issuing & printing, fraud manager. Tying all of these players together was the responsibility of a project manager, part of the customer-facing platform. Unfortunately, these individuals tend to lack experience with program management and struggle to get all the pieces in sync.

For the companies that did make it through implementation, their program was permanently tied to one bank partner. If that bank decides to exit the BaaS space or no longer wants to partner, the customer-facing company would have to temporarily shut down, find a replacement bank, and start over (a process that could take 6+ months).

In light of the bank collapses earlier this year, the likelihood of a financial institution shutting down is higher than ever. Mid-size and regional banks, who represent the majority of partner banks in BaaS, are most prone to closures.

This inability to diversify banks makes this 1:1 fragmented, legacy model too high risk for enterprises looking to avoid business disruptions.

regulatory climate dampens baas operations

There’s also high risk for those on the opposite end of Banking-as-a-Service: Banks.

Regulators in the US worry that partner banks lack proper oversight over the companies that white-label them. Third party risk management is a top theme going back to September 2022 with Blue Ridge Bank, who was forced to cease partnerships by regulators. This caused other partner banks active in BaaS to become more cautious with the platforms they approve.

For banks choosing to stay active with BaaS, there needs to be more of a methodical approach to platforms that they approve and partner with. These mid-size, regional institutions have small teams that must divide their time between serving their own core customers and supervising BaaS platforms. We’ve seen this with the minimal amount of new programs launched this year, as compared to 2021 - 2022.

A key dynamic for banks in this space is: (i) how can they participate in partnerships with companies that take on more of the risk obligations, and (ii) how can they focus on smaller parts of a whole program (such as only payments, or card BIN sponsorship) instead of all components (aka Legacy BaaS).

the way FORWARD: EMBEDDED FINANCE

Fragmented models that have only one partner bank will be replaced by full-service offerings that connect to multiple banks.

Large enterprises (especially those outside of banking or fintech verticals) are not planning to hire or develop expertise in-house. They would rather partner with reputable providers that have done this before and at the scale that will match their existing customer base (1M+ end-users). As an industry, Embedded Finance will be the best way forward in capturing the $50B market opportunity.

Embedded finance is a full-service version of Banking-as-a-Service in which an enterprise company works with one provider who delivers: (a) licensing needed for a banking program, (b) a modern tech infrastructure that connects to partner banks, payment networks, and end-users, and (c) all the required operating + compliance functions.

For established, non-fintech enterprises adding banking products in the next 1-3 years, embedded finance will be the way forward. Industry verticals that have a clear opportunity to benefit are: payroll, HR & benefits, travel, telecom, business management vendors, retail & eCommerce, healthcare, trucking, and logistics.

Does embedded finance fit with smaller-size companies (such as startups)?

Yes, but there needs to be a clear understanding that this approach isn’t for companies building a prototype. There needs to be solid funding or budget (18 - 24 months) to cover the cost of implementation, launch, and maintenance of the program. Companies need a sound product vision (based on their target market and existing regulation) and a team that can execute.

If any of these pieces are missing, the Legacy BaaS model would be the only way to try and get a product launched, gain traction with users & volume — at this point, line up funding from VCs, THEN switch to a full-service provider.

STILL to come in the next 12-18 months

We expect a few key themes to play out going into 2024:

• Regulators in the US will continue to apply pressure on banks, which will trickle down to Banking-as-a-Service vendors, partners, and platform clients;

• This pressure will lead to a demand for more program oversight, which will then increase the ‘sticker price’ of programs across the industry;

• The newest BaaS providers (less than 3 years in operation) will be unable to hold onto to low price points since overhead costs have gone up;

• The approval process for new platforms will continue to be slow (with or without BaaS) — speed is no longer a reliable value prop;

Through this transition process towards embedded finance, only the providers, bank partners, and enterprises able to stay the course (through adversity) will make it through.

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