Compete or disappear: Why SMBs need to embrace banking-as-a-service
SEP. 30, 2024
In an era where traditional banks grapple with outdated systems, banking-as-a-service (BaaS) emerges as a game-changing solution for small and medium-sized business banks, enabling them to compete effectively in the digital landscape.
Traditional banks, weighed down by legacy systems and outdated practices, are struggling to keep up with the demands of the digital age. Small and medium-sized businesses (SMBs) are particularly exposed, as they lack the resources of their larger counterparts to invest in digital capabilities.
But amid this upheaval, a new opportunity is emerging: banking as a service (BaaS). This innovative model is empowering SMB banks to offer financial services through fintech partners and other businesses, leveling the playing field and opening up new avenues for growth.
The current state of BaaS
BaaS, in essence, is about breaking down the walls of the traditional banking system. It allows businesses to offer financial services directly to their customers without needing a traditional banking license.
But, as Lumenalta’s Art Crosby explains, the BaaS idea “isn’t brand new. It’s been around with different levels of hype and using different terms.”
The roots of BaaS can be traced back to the early 2000s when a handful of fintech pioneers began experimenting with the concept. Back then, it was focused on offering basic banking services like account inquiries and balance checks through APIs—the digital glue that connects different software systems. While innovative for its time, these early iterations of BaaS were limited in their scope and adoption.
However, the recent rise of open banking and the increasing demand for embedded finance have breathed new life into the BaaS model. Today, it’s experiencing a renaissance.
European neobanks like Revolut and N26 have been at the forefront of this trend, offering a wide range of financial services. These services include everything from checking and savings accounts to international money transfers and even cryptocurrency trading. And they’re offered through their own platforms and by partnering with other businesses to embed banking into their offerings.
This trend is now making its way across the Atlantic as U.S. banks and fintechs recognize the potential of BaaS to revolutionize the way financial services are delivered.
Impact of the macro environment
From regulatory changes to technological advancements, several factors within the macro environment are creating fertile ground for BaaS to flourish:
- Regulatory and compliance pressures: New regulations, such as open banking initiatives, are forcing traditional banks to open up their data and infrastructure, creating opportunities for new players to enter the market.
- Business pressures on banks: The cost of acquiring and maintaining customers is rising, while competition from neobanks and fintech companies is intensifying. This is pushing traditional banks to explore new business models like BaaS to remain competitive.
- The role of AI: Artificial intelligence is transforming the financial industry, enabling new capabilities in areas like fraud detection, risk assessment, and personalized customer service. BaaS platforms are increasingly leveraging AI to deliver more sophisticated and tailored solutions to their customers.
The strategic importance of BaaS for SMBs
BaaS is more than a fleeting trend—it’s a fundamental change in the delivery of financial services. It couldn’t come at a better time for small to medium-sized banks.
As Crosby puts it, “SMBs are at a crossroads. They either stay exactly where they are or recognize the potential of modernizing into BaaS.”
BaaS is your ticket to unlocking new revenue streams and expanding your reach beyond your traditional customer base. It empowers you to offer a comprehensive suite of banking products and services to businesses in various industries without those businesses needing to obtain a banking license or navigate regulatory complexities.
But the benefits don’t stop there. BaaS lets you:
Expand your reach
Imagine partnering with innovative fintech companies in various industries, seamlessly integrating your banking services into their existing offerings. This allows you to expand your market reach and position your bank as a forward-thinking partner. It’s about transcending the limitations of traditional banking and forging strategic alliances that drive growth for both you and your partners.
Level the playing field
The big banks used to have a monopoly on financial services, but BaaS is changing the game. Now, SMB banks can compete head-to-head with the giants, offering a similar range of services at a fraction of the cost. BaaS democratizes access to financial tools and empowers SMB banks to become powerhouses in their own right.
Adapt to change at warp speed
The financial landscape is constantly evolving, with new technologies and customer expectations emerging every day. BaaS platforms are built for agility, allowing SMBs to quickly adapt to changing market demands and offer the latest financial innovations to their customers. It’s about staying ahead of the curve, not just keeping up.
Build customer loyalty
While BaaS providers typically don't directly own the end customers, they play a crucial role in enabling their fintech partners to build strong customer relationships. By offering a more convenient, personalized, and seamless banking experience through your BaaS platform, you empower your partners to create a loyal following that’s satisfied and enthusiastic about their brand.
This translates to higher revenue for both you and your partners, stronger customer relationships for the fintech, and a competitive advantage that’s hard to beat.
Core components of banking-as-a-service
Successful BaaS implementations require more than flashy features and a slick interface. You need to strike the right balance between robust banking products that meet customer needs and a solid operational foundation that ensures security, compliance, and long-term sustainability.
Banking products and services
At the forefront of any BaaS platform is its suite of banking products and services. These are the tools that customers interact with daily, so they need to be intuitive, reliable, and tailored to their specific needs.
This could include a range of offerings, such as:
- Lending: Flexible loan options, lines of credit, and other financing solutions that empower businesses to grow
- Checking and savings accounts: Basic banking services that provide a secure and convenient way for customers to manage their finances
- Card products: Debit cards, credit cards, and even loyalty or rewards programs that enhance the customer experience and drive engagement
Operational underpinnings
The true strength of a BaaS platform depends on its operational underpinnings. These are the critical components that ensure the platform runs smoothly, securely, and in compliance with all relevant regulations.
- Compliance: Navigating the complex web of financial regulations is no easy feat, but a robust BaaS platform has it covered, ensuring adherence to all applicable laws and protecting both the business and its customers.
- Data privacy and security: Nothing is more important than protecting sensitive customer and financial data. A secure BaaS platform employs cutting-edge security measures to safeguard this data and maintain customer trust.
- Regulatory response: New financial regulations are sprouting up all the time. A well-designed BaaS platform is agile and adaptable, responding quickly to regulatory changes to ensure ongoing compliance.
Benefits of BaaS for the ecosystem
BaaS is a game-changer for SMBs, but it also creates a ripple effect of value across the entire financial ecosystem, benefiting banks, fintech partners, and end consumers alike.
For banks, BaaS opens up new revenue streams and allows them to reach a wider audience without the need for expensive branch networks or extensive marketing campaigns. Partnering with fintech companies and other non-bank entities enables banks to leverage their existing infrastructure and regulatory expertise to offer financial services to a broader range of customers. It’s a way for traditional financial institutions to stay relevant and competitive in the digital age.
Fintech partners, on the other hand, benefit from the ability to offer banking services without the burden of obtaining a banking license or building their own infrastructure. They can focus on their core competencies—developing innovative products and services—while relying on the bank’s expertise for the regulatory and compliance aspects of banking. This allows them to get to market faster, with lower costs, and focus on delivering a superior customer experience.
The end consumers—the individuals and businesses who interact with the products and services offered by your partners—are perhaps the biggest beneficiaries of BaaS. It enables a seamless, personalized, and convenient banking experience woven directly into the platforms and services they already use and trust.
Imagine a traveler effortlessly purchasing travel insurance through their favorite airline’s app or a shopper earning loyalty points with their go-to retailer through a co-branded debit card. BaaS makes banking invisible and seamlessly integrated into everyday life, creating a win-win scenario for everyone involved.
Challenges in implementing banking-as-a-service for SMBs
While the potential of BaaS is undeniable, it’s important to acknowledge the challenges that SMBs may face when adopting this model.
Cost considerations
One of the biggest hurdles for SMB banks is the cost of implementing a BaaS solution. They typically require a significant investment in technology, infrastructure, and expertise on top of the ongoing cost of maintaining legacy systems.
As Crosby puts it, “There’s a lot of legacy technology in banks that costs a lot to maintain. If you’re going to take on an initiative like this, you have those costs plus the investment in the transformation program.”
Bank culture and organizational structure
Another challenge lies in the traditional culture and organizational structure of many banks. These institutions are often slow to adapt to change, with siloed departments and rigid processes that can hinder their ability to offer new technologies like BaaS.
To successfully do so, banks need to foster a culture of innovation and agility, embracing new ways of working and collaborating across departments. This may require a shift in mindset and a willingness to challenge the status quo.
Data governance and management
You can’t overstate the importance of trust in the financial sector. Clients entrust you with sensitive financial data, and it’s your responsibility to ensure it’s handled with the utmost care.
Robust data governance policies, from collection and storage to access controls and security protocols, are not just about compliance—they’re about building a foundation of trust with your partners and their customers. Demonstrating this commitment positions you as a reliable BaaS provider.
AI implementation and data maturity
While AI is a powerful tool for enhancing BaaS, its implementation can be complex and challenging. SMBs need to have a certain level of data maturity and technical expertise to effectively leverage AI.
This may involve investing in training and development for their staff or partnering with an experienced provider who can guide them through the process.
Key performance indicators for BaaS success
A BaaS implementation is an investment in the future of your financial institution. Like any investment, keeping track of the right key performance indicators (KPIs) can ensure you stay on track.
Cost ratio
Traditional banking models are often burdened with high operating costs, from maintaining physical branches to managing legacy systems. These costs can eat into profits and limit a bank’s ability to innovate and grow.
BaaS offers a leaner and more agile approach. It can help banks slash their cost ratios by streamlining operations, automating processes, and leveraging cloud-based infrastructure.
This efficiency advantage translates to more resources available for innovation, growth, and, ultimately, a stronger bottom line.
As Crosby notes, “You can drive cost ratios down to 30-40%. If you’re doing that as a bank, you’re probably one of the best-run banks in the world.”
Partner growth and success
BaaS can help expand your reach by enabling you to work with more fintech partners. Track metrics like the number of new partnerships, the growth rate of existing partners, and the overall transaction volume across your BaaS platform. This will give you insights into how well your BaaS strategy is performing in terms of market expansion.
Business performance and innovation
BaaS isn’t just about playing catch-up—it’s about propelling your business into the future. Embracing this model opens up a world of new opportunities for innovation and collaboration.
Track metrics like the number of new products and services launched, your time-to-market for new offerings, and the overall agility of your organization.
Making the banking as a service decision
Embracing BaaS is a pivotal decision for any SMB. Before diving in, it’s crucial to assess your organization’s readiness.
This involves evaluating your current technology infrastructure, data capabilities, and risk tolerance. Do you have the systems and expertise to support a BaaS platform? Are you prepared for the cultural shift that often accompanies such a transformation?
Selecting the right partner is equally important. Look for a proven expert with a deep understanding of both banking and technology who can tailor a solution to your unique needs and goals. With the right partner by your side, you can confidently navigate the challenges of BaaS implementation and unlock the full potential of this transformative model.
