What’s Next for European Banking-as-a-Service

Banking-as-a-service (BaaS) companies help customers reduce the time-to-market to launch a fintech product. They provide modular product offerings like accounts, cards, payments, compliance etc. In some cases, they allow their customers to piggyback on the BaaS’s existing licences, avoiding the need for the customer to get their own.

I have always had a soft spot for BaaS, having been on the team at Pleo responsible for issuing our first cards under our own EMI licence in 2019. I have seen firsthand the huge challenge of launching a fintech product yourself, without the help of a BaaS provider.

(Jan 2019) Deep in the weeds scoping out what Pleo needed to build. Working with a BaaS partner would have simplified the project dramatically. Note: Images are not necessarily representative of what was built.

In the years since I left Pleo, more than a dozen European BaaS players have emerged, and their platforms have become the building blocks for several times that number of customers. Three, Starling Bank, Railsr, and SolarisBank, have already raised at unicorn valuations, and together the European BaaS players have raised a combined $2.5B in funding.

Some of the European BaaS players we are tracking. Funding information from PB, unconfirmed by Balderton.

Looking ahead, I believe that the next period of banking-as-a-service will be defined by some key headwinds. At the same time, however, several large and exciting opportunities remain for the sector.

Headwinds:

• We are out of the fintech frenzy of recent years, when a heavy stream of new fintechs looking for a platform offering a fast time-to-market lifted the entire BaaS sector. That period of easy money is clearly over, and many of those fintech customers will not survive the downturn due to poor unit economics.
• The European BaaS market is getting crowded now, and new entrants will need differentiation to compete. Last year, if you wanted, for example, a Spanish IBAN for your customers to send funds to, it was actually pretty difficult to find a BaaS provider that could give you this. Today, however, within the core Baas components of accounts, cards, and payments, the existing BaaS players have pretty good coverage of the large European markets between them.
• Existing BaaS will need to defend themselves against the ‘graduation problem’. This is when your most successful customers (and your most important) look to cut you out to improve their own economics. BaaS platforms will need to defend themselves from this by either (a) providing deep value-add that the customer can’t/won’t DIY, or (b) create pricing structures where your most ‘advanced’ customers can bring some functionality in-house, and only pay for the BaaS services they need.
• Microservices make it simpler for other fintechs to spin out a new competitive BaaS offering. Today, most tech companies have traded monolithic architectures for microservices, mini-applications which communicate together over REST API to form your main application. This works remarkably well if you want to repackage part of your technology as your own BaaS product. Starling Bank, one of the original BaaS players, had exactly this origin story. Looking ahead, I believe we’re likely to see more fintechs launching BaaS offerings in search of new revenue opportunities.

Opportunities

• Credit remains a massive opportunity. Within the core components of BaaS, credit stands out as the least developed. There is a huge opportunity for BaaS to offer better credit underwriting software to replace what is functionally a wasteland of legacy tech that has accumulated over years of poorly done tech-enabled lending. There is a dire need to solve this problem, which is particularly acute for more vulnerable customer groups like the underbanked. Embedded financing as an industry, which includes BNPL and revenue-based-financing (RBF), has enjoyed huge growth in recent years, but it is the lenders who own the user experience, and take a large part of the financing profits. Even mega-platforms like Shopify choose to work with partners like Klarna for BNPL and YouLend for RBF. In time, I would expect that the balance of power will shift away from these lenders, and towards the platforms themselves — creating opportunities for BaaS platforms to provide them with credit decisioning software, and even debt-funding-as-a-service.
• Digital card penetration is still not there in Europe. Pleo, most-recently valued at $4.7B, counts 20,000 companies as customers — a drop in the bucket compared to the 28M+ SMBs in Europe, the large majority still on traditional issuers. BaaS players will be key to driving future step changes in digital card penetration. We are particularly excited about underpenetrated verticals, like trucking. Another super interesting development will be if the card schemas make ‘level 3 data’, which means item-level data, more readily available to BaaS platforms and card issuers in Europe. This will be a game-changer when it comes to the software applications that you can build on top of cards.
• Expansion opportunities outside Europe. Just as European BaaS companies serve as sponsor banks for non-regulated companies to launch fintech products in Europe, the BaaS companies themselves can partner with licence holders in other parts of the world to give them regulatory cover to enter those markets.
• Every company is definitely NOT a fintech yet! A driving reason for the growth in BaaS companies is the oft-repeated idea that eventually “every company will be a fintech company”, ie, that every company will have the opportunity to derive a considerable percentage of its revenue from fintech services. We have only seen the earliest stages of this play out.
• Focusing on new customer types is one way for BaaS’s to differentiate. For instance, Fiat Republic focuses on serving crypto companies, who have their own complexities when it comes to onboarding and transaction monitoring.

Another trend that we’re monitoring is the ‘unbundling’ of BaaS, into specialist solutions that focus on just one of the core modules of classic BaaS platforms. Our portfolio company Numeral, for instance, focuses just on payments. Interestingly, these specialist companies benefit from the aforementioned ‘graduation problem’, because they are the natural next step for a company looking to bring some BaaS functionality in-house.

Taking all of this into consideration, I believe that BaaS’s moment in the sun is definitely not over! We will see how European players navigate the challenges and opportunities ahead.

If you are a founder building in the BaaS area, please feel free to reach out to me at greta@balderton.com. We are actively investing from Seed to Series C and would be keen to speak with you.