Banking-as-a-Service — or BaaS — would probably win the award for the hottest fintech trend of the last few years. Lately, though, it seems at risk of losing its crown.
For those still unfamiliar, BaaS is a novel model by which a chartered institution provides the regulatory umbrella necessary for a non-chartered company to offer financial services. And it took the industry by storm as a slew of fintech companies emerged in need of bank partners to offer financial services, and banks took an interest at the promise of new revenue in a highly competitive environment. Sponsor or partner banks are behind some of the most well-known names in fintech today, including unicorns like Chime and Current. But now, we’re starting to see some shifts, driven by a number of critical and accelerating pressures, including tightening private capital, increased regulatory scrutiny and market saturation. Together, these pressures threaten to undermine the BaaS model and its potential opportunity.
The heat and excitement of BaaS were largely driven by an influx of private capital into the market, especially in 2021, when fintech funding reached $141.2 billion, dwarfing the prior two years by a factor of nearly three, according to CB Insights. That made it easier for companies to secure funding and resulted in many new fintechs that needed bank partners to underpin their services. However, with funding now pulling back against an uncertain economic backdrop, fewer companies can get capital, and existing companies have less room to run before they need to either make money or close up shop. In the context of a BaaS bank, that means there are fewer options out there to begin with, as well as the risk that their current clients could fail entirely.
In the meantime, regulators are putting a spotlight on the space. The Office of the Comptroller of the Currency (OCC), Consumer Financial Protection Bureau (CFPB), and Treasury Department all recently issued comments suggesting increased concern around BaaS and expressing a need for greater oversight. In particular, Michael Hsu, Acting Comptroller of the Currency, said in September, “My strong sense is that this process if left to its own devices, is likely to accelerate and expand until there is a severe problem or even a crisis.” This increased scrutiny is translating into actions against some of these activities — for example, the OCC recently ordered Blue Ridge Bank to reform its compliance practices regarding BaaS, and the bank also has to receive no objection for new relationships.
Ultimately, the two above elements are creating an environment where it’s increasingly important to place good bets (and stay on the good side of regulators), while, at the same time, there are fewer and fewer good bets left on the table. And now that more banks have gotten in on the action, or have at least expressed interest, it’s getting harder to achieve the right positioning to win those bets.
So, what is a bank to do?
The answer really lies in two things: minimizing risk and increasing value. Banks will need to invest heavily in risk and compliance outfits to support these relationships. Until now, it was not uncommon for a bank to rely on a BaaS provider, or technology-first facilitator that acts as a connector, to help with initial due diligence and oversight of their BaaS relationships. Those days are likely over. Meanwhile, as part of this shift, there will probably be greater emphasis on non-bank clients with large, established revenue streams. These are companies that already have profitable businesses and are looking to include financial services as an additional benefit to their existing customer or employee base — Walmart’s foray into banking with Coastal Community Bank is one example of this. However, such clients will be in high demand, which means that finding ways to make value propositions more attractive is key. Wrapping other services around a basic BaaS offering is one way banks may want to consider adding value — for instance, by offering technology solutions, back-office support or compliance support.
In the end, the goal should be to understand that BaaS is evolving as a concept and develop a strategy for how to respond. It’s no longer an “everybody jump in,” situation, and that’s perfectly okay. It doesn’t mean that BaaS is over; it’s simply experiencing growing pains. The most successful BaaS banks will likely be those that realize this and use it to their advantage. It will be those who figure out how to identify the right clients and offer them solutions that resonate. That will require a thoughtful approach and a clear but agile roadmap, to be sure. Even more, though, it will demand an ability to think proactively and see beyond the chaos.
