Banking as a service (BaaS) has been hailed as the great accelerator of the European fintech scene, and the force behind European fintech’s global dominance. The new era of decoupling technology stacks from banking services has helped deliver on regulatory aims around consumer choice in financial services, but recently, large BaaS providers have (rightly) begun to receive the same financial crime compliance scrutiny from regulators as traditional banks. While the early stages of fintechs were full of ‘move fast and break things’ strategies, to fulfil its potential, BaaS needs to scale-up its anti-money laundering (AML) approach along with its user base. Compliance should always be an early consideration.
The short of the long history of banking
Before the creation of fiat currencies ancient temples emerged as the first banks for the wealthy around 2000 BC. They were deemed safe spaces for their coins and gold to be held, thanks to the presence of priests and guards. Society progressed, institutions were established for holding money, lending and borrowing, and then came modern banking, with card issuers and cheques. The late 20th century brought us the era of digital banking, with the first ATM in the 1960s and online banking system in the 1980s. The Banking as a Service era first emerged in 2009, and became a reality around 2016. There are some key challenges for BaaS to overcome if it is to become as influential as ATMs in the history of banking.
What is Banking as a Service?
Banking as a Service, or BaaS is a new model of embedded finance in which licensed banks integrate their digital banking infrastructure and services directly into the product of another business via an API.
Also referred to as embedded banking, these integrations are enabling not only new digital banking products and services to market faster, but also non-financial businesses to integrate financial services into their existing products. But AML controls are often an afterthought for these players.
More traditional firms such as Goldman Sachs Developer and BBVA have been offering BaaS for a number of years, but in recent years fintechs and neobanks have been dominating the market. BaaS is not only an opportunity for the financial sectors – financial institutions are right to want a stake in the game. The new banking era is set to become a $25 billion opportunity for banks by 2026.
The bright future of BaaS for consumers and banks
Retailers are already offering financial services through credit cards and Buy Now Pay Later schemes to boost loyalty. But opening new credit lines and using underregulated loans are still not groundbreaking offers for many consumers. BaaS could take this one step further and integrate financial services that encourage more positive financial habits, such as savings, investments, and support, into pre-existing products, with the non-financial brand on the front end.
Imagine purchasing a holiday with a travel agent, getting onboarded as a customer within minutes, and offered support with a high-interest savings account, embedded into the customer experience. Backed by BaaS, you can safely take this route in the comfort of your money being protected by a scheme like the UK’s Financial Services Compensation Scheme (FSCS). Once enough money has been saved, your loyalty earns a reward of points to put towards the holiday. A win-win situation for you, and the travel agent, who converts a new loyal customer, and creates new revenue lines.
BaaS is certainly an exciting prospect, but, Oscar Wilde’s saying, ‘everything in moderation’ rings true. All of this is only possible with the right controls in place to prevent misuse of these services. As with any new innovation in the financial services world, BaaS comes with its own set of inherent risks to be considered from the outset.
Fulfilling the BaaS potential by managing its risks
Banks with fintech partnerships took a disproportionately large share of US enforcement action in 2023, accounting for 13.5% of fines. BaaS providers should maintain a risk-based approach when it comes to ensuring financial crime compliance. BaaS providers and retailers using their services need to strike the right balance between providing smooth, instant customer experiences and achieving compliance.
Every BaaS customer will come with their own risk profile, customer base, transaction volumes and varied products and services. For example, a jewelry dealer using BaaS to offer financial services might have a little more risk than a global flat pack furniture brand, or a budget fashion retailer. A generic, blanket approach to financial crime compliance will not effectively manage risk, and will encourage further regulatory scrutiny. And with more fintech choice, the complete customer relationship and financial services history is more often spread across multiple providers, with varying degrees of AML sophistication embedded within their processes. Piecing together the full picture of a customer profile is more challenging.
For BaaS to fulfil its potential and survive regulatory pressure, risk and compliance should always be top of mind. For BaaS providers, there are different regulations to adhere to for those with e-money vs banking licenses. For BaaS users, is important to implement transaction monitoring, client screening and KYC embedded, which are basic requirements of most jurisdictions. This should be customizable for different jurisdictions and as regulations and financial crime trends evolve.
BaaS has the potential to revolutionize the way we interact with products and services, those that take a step ahead will be banks, fintechs and retailers who keep up with their regulatory requirements as a priority, not an afterthought.
Learn how Satchel secured Banking as a Service for a new generation of users with Napier AI's compliance solutions
Photo by Shubham Dhage on Unsplash
