Banking as a Service(BaaS): Fad or Future?
Banking as a Service(BaaS) — I’m sure most of us have heard about it in the recent few years.It is yet an another fintech innovation that is enabling collaboration between banks and fintech. But does it have the potential to turn any business into a fintech effectively? What is it exactly? What isn’t? How different is it from Banking as a Platform? Where does Open Banking or API Banking fit into the scheme of things?
The Banking sector has gone through somewhat of a metamorphosis in the past few years. Every new fintech player evolving has made this transformation unstoppable. Financial services have undergone a rapid transformation in which Banking as a Service(BaaS) plays a vital role, at the core of everything.
So, what is Banking as a Service?
The provision of banking processes as a service using an existing licensed bank’s infrastructure with modern API-driven platforms.BaaS allows any brand to embed financial services by selecting modular capabilities — offered by providers and license holders — into its user experience.
Well, sounds confusing right? Internet is full of these jargons. let’s break this jargon into simpler terms.
But before it, let’s first break down the functions of a bank — holding money, remittance, payment processing, and many more activities. To support these functionalities, banks need to put in a ton of investment and build the necessary infrastructure. Now banks are banks, they are not pioneers in technology (at least their core functionality is not building technology). The processes, along with the complex infrastructure are like gridlocks to the traditional banks. These factors gave an opportunity to fintech companies or non-bank to venture into BaaS.
Let’s illustrate it more with an example –
Consider a ticketing-based platform like BookMyShow (BMS). Now, they want to increase their sales and boost customer loyalty as the market in which they are operating is very competitive. So, they came up with an initiative of offering customized cards for their customers. Customers can also avail themselves of credit for upcoming shows. But BMS doesn’t have a banking license to offer these products. In India, licenses are extremely hard to obtain. Especially for businesses like BMS which do not operate in the banking space.
Now, Banking as a Service(BaaS) allows non-banks(like BMS in our example) to integrate with banks. This will be possible through Banking as a Service Platform(Cashfree in this example) between the bank(ICICI Bank) and the non-bank(BookmyShow).
In detail, let’s try to comprehend how each player in this model helps the other –
Traditional Banks like ICICI in our example provide infrastructure or “Infrastructure as a Service (IaaS)”. Banks have the required licenses to perform the core banking services, they expose these services to BaaS providers.
These BaaS providers provide software to ensure safe communication of data between traditional banks and non-banks/fintech companies. Now, how do these BaaS providers do it? The non-banks/fintech plug into the BaaS platform like a lego. Some of these BaaS platforms have licenses to operate as banks but they might not have the underlying basement of a traditional bank. Banks don’t have the technology but have the license and these fintechs have the technology but no license and core banking systems. In combination, it’s a win-win for everyone. As I mentioned earlier, Banking as a Service can transform any business into a fintech with this model.
Now are Banking as a Platform (BaaP), Open Banking, and Banking as a Service the same? No.
Banking as a Platform is the opposite of Banking as a Service. BaaP enables fintech and non-fintech companies to provide services to banking institutions. These BaaP service providers would develop a service and “rent” it to the bank. Now, BaaS and Open Banking are different in the way how the APIs(Application Programming Interface) is used — BaaS uses APIs to access banking functionality, whereas Open Banking uses APIs to access consumer data. If they look the same, it’s because they are made of the same elements.
So is BaaS the future or just a fad like many recent developments?
Post-pandemic, BaaS has been transforming financial services in India. Traditional banks are losing GenZ, and Millineals to digital financial service providers. This is happening because digital financial services are more cost-effective, provide users with a better overall experience, and give them tools they cannot get from traditional banks. We have also seen several success stories where traditional and emerging financial technologies have combined to create new products: Uber and the State bank of India partnered to provide vehicle finance to drivers. Razorpay and RBL Bank have collaborated to simplify digital merchant onboarding and payment solutions. Open, an Indian based Neo-bank uses ICICI Bank APIs to manage payments, billings and accounting for startups. These are just few examples that i can think off, all the major private banks in India are using BaaS. BaaS is becoming increasingly critical for the future of financial institutions as banks that are able to succesfully adopt this model will be well positioned to changing needs of their customers and stay competitive in market place. It also increases competition in financial industry by providing more options and convinience to the customers and helps smaller companies and fintechs enter the financial market without investing expensive infrastructure and compliance. On a whole, we can agree that BaaS is a disruptive force that is taking over the fintech industry and evolving in multiple ways. While technically any company can turn into fintech with the help of BaaS, how the regulatory challenges of this predicament will be tackled will surely be interesting.
References:
(1) https://finbox.in/blog/what-is-banking-as-a-service-and-why-you-should-care-about-it-/
(2) https://timesofindia.indiatimes.com/blogs/voices/banking-as-a-service-the-future-of-finance/
(3) https://www.finextra.com/blogposting/20099/what-the-hell-is-banking-as-a-service-and-what-is-it-not
