What is Banking as a Service (BaaS)?
An emerging business model in the financial and technology sectors is changing the way that businesses connect customers to banking products and services: banking as a service (BaaS).
But how exactly does BaaS work? What are its shortcomings? And how does Kotapay envision a “next-gen” solution to make banking as a service a safer, more secure option for businesses? In this article, we’ll answer each of these questions and leave you with a better understanding of BaaS.
What is Banking as a Service?
Suppose a business outside the financial sector wants to offer customers various banking products – such as deposit accounts or credit cards. Because that business is not a financial institution, it does not meet the regulatory requirements established by oversight-providers like the FDIC.
That’s where banking as a service comes in. Financial institutions have begun offering these businesses the ability to embed financial services to their app platforms, thereby giving them the ability to offer financial products and services via partnerships with banks.
Perhaps the easiest way to visualize banking as a service is to imagine a stack of Lego® bricks. Each financial product or service can be represented as a brick. Banking as a service allows a business to create their own “stack” of services to build into its product offerings.
BaaS emerged in the last half-decade as fintechs and other large companies began looking for ways to integrate banking services within their own platforms. Those companies had no interest in becoming banks themselves but wanted to embed specific financial services in their core products and customer experiences.
Shortfalls and Legal Scrutiny
The early BaaS model provided short-term benefits – especially speed-to-market, which fintechs heavily favored when searching for options. But early BaaS providers were not necessarily built for scale and scrutiny.
Some early BaaS providers lacked the size, financial resources, systems, or teams of experience risk management and technology professionals required to adequately provide safe, secure banking services.
These shortcomings have not gone unnoticed by regulators.
For good reason, banking is a highly-regulated industry. Oversight providers like the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) have been watching the emergence of BaaS closely to ensure that consumers are adequately protected.
This has led to a surge in regulatory enforcement actions in the BaaS world. According to S&P Global, “BaaS banks accounted for 13.5% of severe enforcement actions issued to US banks in 2023.” Regulators have flagged banks for insufficient third-party oversight of their partners, as well as weakness in BSA/AML (Bank Secrecy Act/Anti-Money Laundering) policies.
The Next Generation of BaaS at Kotapay
The message that responsible financial service providers have taken from recent regulatory actions against BaaS providers is this: banking as a service must be centered around a responsible bank charter – and banks must retain control of the technological solutions they provide to their partner companies.
Kotapay’s Chief Payments Officer Trent Sorbe has become a leading voice in the payments industry on the topic of banking as a service and its future. “In a next-generation BaaS model, the bank becomes the gateway to the technology ecosystem from which fintechs and other business partners benefit,” explained Sorbe. “Regulators need to know that banks are in control of the services they provide to third parties. When the bank maintains that control and demonstrates a clear understanding of risk management, banking as a service becomes a much more viable option for fintechs and banks alike.”
