Synopsis: In today’s article, we will discuss how the new-age FinTech companies are revolutionizing the financial sector through Banking as a Service (BaaS) and its implications for the incumbent traditional retail banks.

Innovation in technology and the development of new business models have been upending the financial services sector. A growing number of FinTechs and non-banking companies are now joining the legacy banks in providing various financial services through Banking as a Service (BaaS). The BaaS platform market is touted to grow at a 26% CAGR between 2021 and 2031.

But what is BaaS, and how is it auguring a profound transformation of the financial sector? Let’s understand.

Banking-as-a-Service Overview

In India, the concept of BaaS was pioneered in 2013 when Yes Bank and RBL Bank opened some Application Programming Interfaces (APIs) with developers. This allowed banks to unbundle their services and create APIs for various specialized functions, such as providing loans, accepting payments, offering insurance, etc. 

These APIs are then utilized by companies running digital platforms to build innovative financial solutions. Thus, basic banking products became fully commoditized, and the market structure of the financial services industry turned modular.

BaaS is a model that allows FinTech companies and non-banks to offer core financial products and services to their customers by integrating with traditional banks through APIs and webhooks. This means that instead of developing their own banking business, these non-banks license access and infrastructure of incumbent banks. Then, they build their financial products on top of this traditional banking infrastructure.

To illustrate, consider a cab company exploring ways to expand its customer base and loyalty. Issuing debit cards that allow its customers to make payments and earn loyalty points is one way to go about it. 

Eventually, armed with the customer’s data on spending patterns, this company may also offer single-click, small-sized customized loans. But as per regulations, you will need a license to sanction such loans. That’s where BaaS comes into the picture. This cab company can offer loans if it has tied up with a bank through the BaaS platform.

With BaaS, non-bank businesses can embed financial services in their business model without going through the hassle of applying for a banking license. These companies can thus, offer bundled offerings that are either white-labeled or co-branded. On the flip side, banks can increase their revenues by servicing the consumers of these FinTechs through BaaS – a win-win situation for all the stakeholders involved.

The BaaS Imperative

Customers today have become tech-savvy and are increasingly demanding integrated experiences. They are flocking to these multi-product ecosystems that offer end-to-end processing of services. Such ecosystems are supported by sophisticated tech stacks, which enable companies to offer financial products tailored to a customer’s needs at a relatively lower cost.

BaaS is also benefiting FinTechs as it has lowered entry barriers to the lending business and has given a fillip to embedding financial services within the business model. Through BaaS, non-banks can offer customized core financial products at a mass scale. 

FinTechs majorly focus on front-end app development to improve the user’s interface while relying on banks for the requisite back-end functions.

But this brings up an interesting conundrum for banks. On the one hand, BaaS models offer banks better prospects for business expansion at lower costs. While, on the other hand, they also squeeze bank margins due to the increased competition from FinTechs that offer loans at cheaper rates. 

So, how are banks dealing with this dilemma?

BaaS-as-a-Threat to Banks

Traditional banks have been facing stiff competition from two sources. First is the entry of tech giants such as Google, Apple, and Meta into the digital payments space. And the second is the meteoric rise of new-age digital banks and FinTech that focus on providing specialized financial services to their customers.

This competition is adversely affecting the customer base that banks can tap into. It is also forcing banks to improve their processes for loan disbursal and to lower the interest rates charged on sanctioned loans to stay relevant in the market.

Even if banks choose to enter into co-lending partnerships, they are concerned about worsening their existing client relationships by distributing financial services via third-party providers.

BaaS-as-an-Opportunity for Banks

But if BaaS makes banks uncompetitive, then why would any legacy bank lend its licenses and infrastructure to the new-age startups in the first place? This is because BaaS is also creating new opportunities for banks to reimagine and restructure themselves to adapt to this digital age.

Integrating with non-banks enables banks to tap into new streams of revenue in the form of fees from third parties. This fee is charged for the use of a bank’s infrastructure. The more scalable the business, the higher the fee earned.

Through BaaS, banks can broaden their customer base, as they service their co-partners’ clients. Collaborating with partners belonging to different industries, including health, education, travel, etc., enables banks to increase their clientele without a commensurate increase in costs. This also increases their access to data, thus further helping in the personalization of services.

To summarize, BaaS has the potential to benefit banks, even after accounting for all the cons. So, banks will need to find ways to capitalize on the BaaS trend to stay competitive. 

How Can Banks Survive the BaaS Revolution?

The new propositions from BaaS models have been disaggregating many profitable elements of the traditional banking value chain. But they have also accorded banks a low-margin, and high-volume business opportunity for product distribution. This is especially useful as banks are currently struggling with their cost structures, due to legacy technology infrastructure.

To survive, banks need to think beyond categorizing customers into classic, gold, or platinum segments. They must undergo IT modernization, and take advantage of tech builds. Banks need to transform their infrastructure akin to Lego blocks, with each block denoting a particular functionality consumed through API.

Banks should also adopt a product-centric approach, instead of classifying teams as per front-end and back-end data functions. This will enable them to unbundle each banking function and partner up with different FinTechs/non-banking businesses as per their client base.

Additionally, banks must strategize when to use partner ecosystems and when to offer in-house services. Another requirement is to frame a criterion for determining the suitability of the FinTech partner.

Finally, it is the leadership that is responsible for framing policies that encourage the deep embedding of tech in their banking systems. This will determine whether a bank will perish or will it leapfrog ahead of the competition.

Wrapping Up

While BaaS will not result in the death of banks, it will revolutionize ‘who’ does the banking along with the role played by legacy systems. The technological advantage of FinTechs enables them to amass users at a growing scale, and banks will need to adapt to their new roles of being facilitators of financial services.

But at the heart of it, it is the customer who will benefit the most. The continuous development of innovative applications will provide consumers with an integrated, holistic platform, which is tailored to their needs. Even MSMEs will benefit as access to real-time data will result in easier, faster, and fairer funding application processes.

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