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58. BaaS (Part 1)

Do you know that the price of a Big Mac burger can be used to determine the Purchasing Power Parity (PPP) and thus, determine whether a currency is undervalued or overvalued when compared to the USD. Interesting concept… not accurate but interesting concept… Big Mac Index (Read Here)

Talking of burgers, I am craving for a McSpicy Chicken Burger… and I have three options… (1) Go to the nearest McD outlet (2) Order on the McD App (3) order on a food delivery App.

Each of the model has its own pros and cons (Refer below)

Illustration 1

But the model that we are more interested in is… the third one… Burger is of McD (So quality, quantity etc. is with McD) but the distribution and customer acquisition belongs to the food delivery App. (remember this point)

From a customer point of view, the customer wants a McD burger and gets one. And from McD’s point of view, they have burgers that need to be fed to hungry customers.

Illustration 2

And folks… that is what BaaS is all about — Burger as a Service.

End of the blog !!!

Cool… you crossed the burger hurdle.

Let’s start with the BaaS that we are interested in talking about — ‘Banking as a Service’.

Here are a bunch of words you might be hearing these days, depending how close you are working in the FinTech domain.

FYI: I am into word clouds these days. I have made one of my favourite vegetables & fruits, one of my favourite movie characters. So although not needed, I made one on FinTech (enjoy!)

Anyway, coming back to BaaS.

The fundamentals of BaaS is the same as the burger model — there are products that need to reach customers via distribution channels. We will eventually get to BaaS but before that, let’s touch upon a few basics.

Banking Products and Services:

Below are some of the standard banking products and services that we are familiar with.

Illustration 4

Bank’s Distribution Channel:

  • Branches:

For long, branches have been the main touch point for the banks. Branches are the place for sales, customer engagement, cross-sell and everything related to customers. Branches drive linear growth — so to increase growth, a bank has to add more branches. That means additional costs related to real estate, operations and resources. (same as the McDonald’s outlet model)

  • Digital Channels (Website/App)

With penetration of the internet, even banks adopted an App strategy wherein Banks’ websites/App allowed consumers to engage with the banks. (Same as McDonald’s App)

The above two models are very straightforward but is it possible to replicate a third model, where third parties can sell banking products?

Yes, that is what BaaS is about, where banking products are sold to customers via third parties who can manage customer acquisition and distribution but the bank will control the product and its attributes including governance, compliance.

Who are these Third Parties:

Any entity that is interested in extending a bank’s products or services to its customers (SMBs, corporate or retail customers), partners (delivery personnels) or vendors (e.g. seller or restaurants).

Some of the usual suspects are;

  • Payment Aggregators
  • Neo banks
  • Merchants/Corporates
  • API platforms/Technology Service Providers (TSPs)

I will talk about each of these entities in detail in the next chapter… For now, let’s move on to the next point

How do they achieve this?

APIs… Yes, “APIs”, one of the over used and over pitched words of FinTech/Payments world only after the most popular line “Reduce the commercials”. Every sales deck of any payments company will have pitches such as ‘Powerful APIs’, ‘Simple APIs’, ‘deep integration APIs’.

What is an API? Application Programming Interface… (Yuppy, one point for getting the definition right).

Basically, APIs allow one system to communicate with another system. APIs are simple to understand, implement and manage. Please read the basics of APIs (Here and Here)

So BaaS will work in two steps:

Step 1: Banks will develop APIs for its product or services and externalise them so a partner (third parties) can use those APIs. Through APIs, banks will pretty much govern the product. (E.g. Bank’s UPI APIs to a payment aggregator won’t have the check account balance API but banks offer it only to a PSP App).

Do not expect all banks to have ready-made APIs… few banks have done substantial investments in developing APIs for third parties but few have not. Plus, few banks are flexible and few are rigid for any customisations.

Step 2: Third parties can consume the APIs and launch products. As usual, there are multiple ways one can go about it. A merchant can integrate with the bank API directly but efforts will increase if the merchant wants to add multiple banks. Alternatively, a merchant can use a Payment Aggregator or TSP’s API who in turn would have integrated with multiple banks. (As I always say… think of Russian Nesting Dolls whenever you think of FinTech or Payments)

A bunch of APIs and Processes have to work together to launch a single product… Take the example of a savings account

Illustration 5

The idea is to give you an understanding that banking products are not simple… for years, we have been using our bank accounts and do not think about how things work in the background. Hence, replicating it is not easy. When you start thinking of lending products, the process becomes more complex as more financial aspects (cost of capital, underwriting) and collection aspects kick in apart from customer qualification (credit check)

Governance and Compliance:

As we are talking about banking products which follow high governance and guidelines by the regulator, and on top of it, every bank will have its own risk & compliance frameworks. So banks make sure the APIs are exposed as per the compliance framework and third parties follow the processes.

Hope you are with me so far…

<To be Continued>

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