The state of the BaaS market
A glimpse into Banking as a Service (BaaS), a data-driven revolution reshaping finance. Beyond a mere tech upgrade, BaaS disrupts traditional models, offering unparalleled user experiences and empowering businesses with streamlined financial services. Join us as we explore the numbers behind BaaS, redefining the essence of modern finance.
The evolution of BaaS has transformed the financial services industry. Initially faced with challenges such as legacy systems and slow innovation, traditional banks started collaborating with fintech startups. This partnership has fuelled a surge in fintech startups utilizing BaaS solutions.
The BaaS market is expected to grow by 15% year on year, to reach $66 billion by 2030.
The number of startups in the fintech sector has seen remarkable growth in recent years, with thousands of new entrants worldwide. Funding in the fintech industry has also been substantial, reaching billions of dollars annually. These investments have enabled fintech companies to leverage BaaS platforms, driving innovation and expanding their reach to customers across the globe.
Use cases
The BaaS (Banking-as-a-service) market has been extremely dynamic in the past 10 years. Use cases have kept emerging, as multiple trends like embedded finance or open banking have been driving the market upward.
BaaS is the provision of banking products and services through third-party distributors. Through integrating non-banking businesses with regulated financial infrastructure, BaaS offerings are enabling new, specialized propositions and bringing them to market faster.
A banking-as-a-service software is built around three pillars — a licence, a back office, and an API — BaaS companies can therefore provide banking services under a white label instead of through traditional banks and their legacy infrastructure.
BaaS has reshaped how financial products and services are accessed and distributed. BaaS fintechs offer white-labelled plug-and-play licensed financial products that enable fintechs (e.g., neobanks, lending, wallets, PSPs, etc.) and corporates (e.g., fuel, insurance, retailers, etc.) to embed these products into their own customer journeys.
The BaaS model has proven highly successful for some, but there are also costs to consider. The business might require significant up-front tech investment and, as real-life examples have shown, it can take several years to build a substantial business. Moreover, banks often need to increase their spending on compliance to ensure their fintech partners are adhering to banking regulations.
Banking as a Service (BaaS) empowers non-financial companies to integrate banking and financial services into their offerings through APIs and technology from financial institutions (FIs). This approach offers numerous advantages for FIs:
- Revenue Diversification: BaaS opens up additional revenue streams for traditional banking institutions.
- Market Reach: Collaboration with non-financial firms broadens customer reach.
- Innovation Acceleration: BaaS partnerships with tech-driven companies foster rapid development of new financial products.
- Cost Efficiency: Sharing infrastructure and technology reduces operational expenses.
- Regulatory Expertise: FIs guide partners through complex regulations, ensuring compliance.
- Customer-Centricity: Tailored financial services meet evolving consumer needs.
- Data Insights: Collaboration generates valuable consumer behaviour data.
- Brand Expansion: FIs extend their presence beyond banking services.
- Competitive Edge: FIs stay competitive amidst industry transformation.
- Market positioning: BaaS positions FIs at the forefront of a dynamic and customer-centric financial ecosystem.
How do these companies differentiate?
In the past few years, key players in the space like Treezor, Marqeta, SolarisBank, and even banks themselves have all taken very different paths.
For instance, Treezor got acquired by Société Générale in 2018 and now offers Treezor tech to startups and scale-ups, as opposed to building something in-house.
Other banks like JP Morgan or Santander opted to develop the tech in-house addressing similar use-cases.
We can segment the users into 2 categories for this kind of solution:
Apart from their ICP, BaaS providers differentiate on product, and the way the customers interact with it.
Easy implementation: Some of these solutions have easier implementation processes than others, mainly due to varying compliance requirements. Regulators have played a key role in BaaS development in the recent years, especially when it comes to customer onboarding.
Differentiation: The key differentiators here are their ability to integrate, willingness and flexibility. Customization is another one. These key differentiators can mainly be developed by companies that own their full tech stack and do not rely on any external providers (own their ledger, core banking system, care issuing processor…). Many players are not that developed yet. The number of integrations could also be a way of differentiating, SolarisBank has for instance more than 10,000 integrations with banks. It is tough to grow and acquire volume, and once you actually get significant volume, the regulator never stops coming to you to see how you’re doing. And that’s when they discover atrocities and then Wirecard happens. That’s why the BaFin, the German regulator, blocked Solarisbank from adding more customers, and they have to ask for permission. Another important point for the actors targeting the mid-market and SMEs is that some (most) of them get their revenues from a single customer (Marqeta with Square for instance).
Verticalization: Verticalization is also a key way of differentiating BaaS companies. Although some are horizontal solutions, others like Marqeta, Tallied or Weavr developed a solution to address very specific use cases (card-as-a-service, payment…).
Higher ACV and reduce churn: A bunch of players are trying to seize this opportunity to reach high ACVs and reduce the churn many BaaS players are facing when they target SMEs. Sales cycles are longer, compliance and regulatory requirements are stricter but we believe that it represents a very interesting business opportunity. Companies like Tallied.io or ByQwest that launched recently are willing to address this market segment and offer a comprehensive tech stack to their customers. Synapse, created in 2014, adopted a similar positioning with 7 banks as customers, along with 100 fintechs.
These new companies are cloud-based technologies, it would offer more flexibility than on-premise legacy solutions.
Regulatory aspect
Regulation is also playing a major role in the adoption of BaaS solutions.
Multiple bank regulators have stressed throughout 2022 that they are increasing the attention on banks’ third-party risks, with more banks stepping into BaaS and seeking deposit and fee growth from fintech partnerships.
In particular, banks are expected to have independent oversight on transactions taking place via its fintech partnerships in order to meet anti-money laundering and know-your-customer requirements.
Banks are also expected to take more accountability in marketing and communications with the end consumers, to make sure the disclosures correctly describe the nature of the banking products.
The Open-banking regulation, PSD2, passed in Europe in 2019 has opened many doors to BaaS players on the market. It allowed them to scale drastically among merchants and B2C companies, and we believe that it is still going to be one of the key market driver in the coming years as an increasing number of SMEs are bundling banking products in their offer.
Finastra found that 85% of businesses have or intend to use Banking as a Service (BaaS) in the next 12–18 months after interviewing more than 1,600 senior industry executives.
Conclusion
BaaS are tech providers, and in the future banks will offer BaaS products to their own customers and either leverage one of these tech providers or build it in-house like JPM or Santander have. However, the product might not be as flexible and comprehensive.
There are many local players (Solaris in Germany, Swan and Treezor in France, Weavr, Griffin and Modulr in the UK, Marqeta, Synctera or Synapse in the US), but no clear winner yet. Regulation makes it very hard for local players to challenge incumbents in other markets. It could be done through an acquisition though.
We believe that designing a product to address banks and large enterprises offer a very interesting market opportunity, high ACVs and strong distribution channels through banks, which could distribute licenses to use the tech owned by BaaS companies. This would require from the BaaS to own its tech stack in order to be the tech provider (core banking system, card processor…).
In 2023, we have seen a lot of signs that this segment might start consolidating, with companies struggling to raise subsequent rounds, and maintain their business. As of July 2023, only $194M has been invested in BaaS companies, against $3.3B in 2021. Many of them also went through massive layoffs, like Synpase, more recently.
About Illuminate Financial
Illuminate Financial is a thesis-driven venture capital firm dedicated to fintech and enterprise software companies building technology solutions for financial services.
Illuminate’s LPs and strategic partners include some of the largest and most well-respected banks and financial institutions who supply diverse market and industry knowledge.
If you’re building the next category-defining company in B2B fintech (digital asset infrastructure, enterprise tech, financial market infrastructure or sustainable finance), give me a shout at hh@illuminatefinancial.com
