Is BaaS Really The Way To Go?

Banks have been on a multi-decade-long digitalization journey during which they have been called on to respond proactively to client needs for more accessible, efficient, and cost-effective banking by completely transforming their business models.

From the first internet banks launched in the mid-1990s to the first smartphone banking app brought to market in 2011 and now Banking as a Service (BaaS), banks have had to confront the reality that if they don’t keep pace with the rapid pace of innovation in the industry, they will fall behind.

Open banking changed the game, but Banking as a Service (BaaS) ups the ante even further by introducing a new way of distributing banking products to clients. It enables banks to provide non-financial services companies with their existing banking products and solutions, which they, in turn, add to their ecosystem and offer to their end clients. Also described as embedded finance, McKinsey describes BaaS as bundled financial services offering, often white-labelled or co-branded services, that non-banks can use to serve their customers. According to McKinsey, industries increasingly looking to add financial services to their offerings are retailers, telecommunication companies, the Big Tech companies and software companies, car manufacturers, insurance providers, and logistics firms.

However, API solutions and cloud-based BaaS don’t solve all the problems banks and non-banks encounter when setting up an embedded bank offering.

Developing the APIs and back-end software internally can be extremely costly for the bank. JP Morgan, for instance, has employed 50 000 software engineers and plans to invest $12billion in technology in 2022 — news that sent the bank’s share price tumbling.

Some of the other issues that make BaaS offerings unattractive for building new products are:

• Lack of flexibility. Most BaaS platforms are being distributed “as is,” and customers should not expect any customizations to be made. While many BaaS solutions on the market cover many types of businesses and use cases, many businesses still require more attention than BaaS vendors can give.
• Lack of geographic coverage. Getting to the global market is the most common goal for many FinTechs, but few BaaS vendors can provide this kind of geographic coverage. So, one day, when customers need more flexibility from their vendors, will they get it?
• Data protection. BaaS platforms are typically built using multi-tenant architecture, meaning that all clients share the same back-end resources, which may have critical implications for the data storage. Certain types of customers and regulators are not comfortable with this approach due to security concerns, and BaaS companies are not always transparent about the architecture of their software solutions.
• Ownership of Intellectual Property. Building a product on top of the existing back-end API means your business becomes locked into a single vendor, the owner of the intellectual property. Some companies offer highly attractive pricing for startups looking to get the product to the market without making a substantial initial investment, but then customers end up paying more if the product is successful because they don’t have access to the IP. Thus, starting with an enterprise solution does not always make sense for new product initiatives, as you can lose more than you could gain as the proposition grows.
• Migration and support. Many BaaS platform solutions are focused on serving newly established companies and products. But many existing businesses would love to buy modern cloud banking software. However, they often struggle because the data migration and system integration services offered by those suppliers are lacking.

BaaS offers immense potential for both banks and their non-bank partners. But the long-term success of the offering depends on the sustainability, scalability, and flexibility of the digital banking platform. What looks less expensive now could prove far more costly in years to come. So, you must choose wisely to ensure that your system provides the superior financial services and customer experience you are seeking.