BAAS - WHAT IS IT?

Banking as a Service (BaaS) has emerged as one of the most important strategic agenda items for CEOs in a variety of businesses other than banking, ranging from manufacturing to healthcare. With relevant financial services interwoven in the consumer experience, BaaS enables any organization to offer new and innovative propositions. By 2030, the value of the BaaS market is estimated to reach $7 trillion. (Finastra source) 

Traditional banks that are tech-savvy can stave off the threat of fintech by going into the BaaS industry and sharing their data and infrastructure. Access to this kind of data will become standard for digitally native consumers in a few years, so banks who start now will be ahead of the curve and likely rewarded with strong demand.

The supply of banking goods and services via third-party distributors is known as BaaS. BaaS products enable innovative, customized offers and bring them to market faster by combining non-banking enterprises with a regulated financial infrastructure. BaaS options are fast gaining momentum as consumer discontent with old offerings grows. Here are a few important figures on the condition of the market (Deloitte source):

• 30% of customers are considering switching banks

• 42% of customers have used a Buy Now, Pay Later service

• 2x ROAA for banks focused on BaaS offerings

THREE KEY PLAYERS OF THE BAAS MARKET AND THEIR MONETIZATION APPROACHES

In contrast to brick-and-mortar banks, which owned the full value chain, BaaS providers are mostly focused on one of its phases (or stages). Today's effective BaaS players (or agents) fall into one of three categories:

1. Distributors - they integrate fintech services (in our case it’s banking) directly into existing customer experience through proprietary customer channels. These players often center on retail sphere offerings and consist of e-commerce businesses and retailers themselves. So, generally speaking, BaaS for distributors vastly simplifies access to innovative payment solutions for financial institutions of all kinds. It allows even the tiniest organizations to provide the highest quality products to their clients. Furthermore, small companies see their banks as trusted advisors with the ability and technological solutions to help them develop and scale successfully.

For the retail segment, more than 50% of distributors choose BaaS over traditional banking services to:

1. improve their product/service capabilities and offerings;

2. gather more customer data in order to select and analyze new prospects

3. boost consumer retention/loyalty and gain new ones;

4. increase their transaction volume, by firms shifting sales to a platform with a much larger customer base

How can distributors achieve more and join the overall market trend of monetizing BaaS? Distributors charge various types of fees, the most popular being:

• Recurring monthly fee for a flexible time period (61% of SME)

• Consumption-based fee or pay as you use (59% of SME)

• Recurring monthly fee for a fixed time period (57% of SME). Larger enterprises, on the contrary, prefer charging upfront fees for a fixed time period, while small and medium businesses see this type of fee as the most unpopular one (48% of SME vs 52% of large enterprises)

2. Enablers - they are often involved in the integration of financial services into third-party platforms and apps. By bringing creative additions to the embedding of banking products (for example, more data for underwriting lending products), increasing user experience (e.g., quicker / digital access to banking products), and establishing brand value in the market, enablers provide both influence and value. In some cases, they are called Aggregators, which put a special emphasis on bringing together various elements of BaaS into a usable, ready-to-distribute solution. Enablers should concentrate on high-growth areas in BaaS, such as retail and small and medium-sized businesses.

They also have their own monetization perspectives and approaches, which include:

• Using case-based differentiation of opportunities: Enabler monetization opportunities vary depending on the use case. BNPL and payments, in particular, have quite a significant commercialization potential, whereas bank deposits have a low monetization prospect.

• Сreating specialized solutions: e-money/electronic wallets, payments cards, lending engines as a proposition, and payments as a service seem to be the most prominent customized solution ideas in the industry. There is a widespread belief that the marketplace offer necessitates sophisticated back-end and complicated system integration, both of which are difficult to acquire but are also crucial for success.

Some analytics (like Finastra) also include the following in the list of capabilities of enablers as the main intermediaries in the BaaS implementation cycle:

• Marketplace offering choice of providers. That means building an array of providers to potentially attract more customers among distributor companies as an intermediary.

• Marketplace of distributors. That means developing a diverse and wide distribution network to potentially attract more partnerships with providers.

• Expertise in specific sectors - to digitize end-to-end client experiences and provide auxiliary specialist solutions that suit the specific demands of businesses. For SME and corporate banking, this might include billing, KYC, identification of potential risks, and fraud protection.

3. Providers - they are financial institutions that hold a banking license and have the right and the ability to produce regulatory correct and compliant financial products. Providers showed an interest in developing the retail BaaS market in order for it to include a wider variety of goods and valuing low-cost deposits (as an example, through customer accounts) above collecting a significantly small part of the overall transaction value. 

But how, and by which kinds of strategies and solutions providers, can BaaS be monetized and value gained from it?

In general, there are several core capabilities and prospects:

• Modular composition and sector-specific products and services. To succeed in the SME and corporate BaaS spaces, providers will need to offer customisable products; these organizations have hitherto been underserved due to constrained offers. Customization of products for each distributor offers a more compelling value proposition for end users.

• Market-Facing APIs. Pre-existing APIs made by providers that are accessible externally can be used by distributors that want to manage some or all of the front-end experience can use pre-existing APIs that are accessible externally.

• Cost. The Durbin Amendment's interchange fee cap applies to many of today's main bank providers, generating additional money for the bank while lowering direct costs to the distributor and end consumer.

• Analytics platforms can help to improve risk decisioning. This might need the provider to obtain SME data from an enabler, combine it with internal data, process and analyse the data, and make judgments quickly. This approach may necessitate immediate scalability, which isn't always possible in on-premises data centers.

SO WHAT NEXT? NEW PROSPECTS AND POTENTIAL GROWTH

So far, the BaaS market has remained relatively modest, with digital banks and fintech on the provider side and digital non-financial giants like Amazon and Uber on the distributor side.

Nevertheless, as orthodox banks' core sectors and profits are progressively threatened by innovative fintech companies, many think that BaaS will be their savior. Little and medium banks working on a subscale level have already begun to embrace BaaS.

In the next three years, there is  much potential for growth in BaaS.

Here are some key points:

• SME lending - grow by ~30%
  SME lending presently generates more market income than point-of-sale finance, payments, or corporate loans, and is predicted to expand by 30% by 2024. A BaaS SME financing product powered by an API-enabled marketplace has a lot of promise. Traditional banking has historically failed to meet the demands of SMEs, giving limited flexibility and disadvantageous terms. As a result, SMEs will increasingly resort to embedded finance and other technological developments.

• Payments and bank accounts - grow by ~30%
  By 2024, bank accounts and payments (including payment cards) are expected to expand by 30%. As the market will get increasingly competitive after 2024, the development will most certainly slow.

• Corporate lending - grow by ~14%
  In the banking business, corporate lending has a large market share and is predicted to expand by 14% by 2024. Because of their emphasis on current banking connections, cybersecurity, and big per-transaction volumes, several companies may shun embedded finance in the near future. Over the next few years, the bulk of BaaS growth will be driven by banks, tech firms, and fintech companies.

Banks are struggling to boost their loan volume in this market cycle and must consider alternate growth techniques. What are the approaches in question? Mergers and new product creation are two key methods. Both of these are effective bank expansion tactics, but they might take a long time to pay back. BaaS provides a quicker route to expansion for mid-sized banks than traditional techniques. However, the market is heating up, and early adopters are receiving vital insight into how the new environment operates.

According to the Cornerstone Advisors 2022 study, a generic modeled sponsor bank, where the  number of consumer accounts grows at 2%/month starting from 1 mln, will generate a total of 17.2 million annual non-interest income from different BaaS services provision:

While speaking about commercial bank accounts, experts got a picture, that is rather similar in structure, but a very dissimilar in value distribution:

For years ahead, experts expect BaaS will tie together digital technology platforms and financing to reshape the face of economies. Banking institutions have a clear capability to attract additional revenue flow at a low cost by using BaaS. Furthermore, a BaaS firm is also adaptable and nimble, making it ideal for breaking into new markets and subsequently growing each year. Distributors may use financial data to gain a far better insight of customer behavior and develop additional income streams at favorable margins.