Deposit growth remains a high priority for bankers, according to BAI Banking Outlook: 2024 Trends. When expanding their deposit gathering channels, banks typically use traditional methods — attracting new customers through existing channels, expanding their footprint via acquisition and branches or finding ways to offer existing products through new distribution partners.
The industry often refers to the expanding distribution partners as last mile partners, which includes brands or fintechs within the banking as a service (BaaS) or embedded banking models. There are a number of examples where banks that outsourced their compliance functions to their third-party BaaS provider received consent orders. Learning from that experience the second-mover advantage now available to banks is to remain in the driver’s seat to launch and scale responsibly led programs, backed by the banks’ existing compliance and regulatory controls.
Technology
New banking platforms are reshaping the landscape to allow banks to launch embedded banking and BaaS programs above the core. These new direct BaaS platforms resolve the constraints that neither the core nor BaaS middleware providers could.
Alex Johnson, of Fintech Takes, categorized the existing technology gap in the market, saying, “Core [p]roviders built a platform just for banks where the bank acts as their client and the end user. BaaS providers built a platform just for fintech where the fintech acts as their client and the end user. What the market needs is a platform built for banks (the client) but with fintech as the end user.”
Today, newer platforms built specifically for bank clients to power fintech users in a multitenant fashion and provide the resiliency the bank needs for a thorough view into their fintech customers and know your customer results, account status and ownership, transactions, anti-money laundering (AML) monitors and more. This resiliency is created through a virtual account system that provides settlement to a set of core operating accounts. The key is eliminating core dependencies, costly fees and timelines from legacy core providers.
Economics
By removing the BaaS provider middleman, banks can also gain an economic advantage that allows them to scale their program and compliance staff. What banks need to realize is that BaaS providers get paid by both fintechs and banks; switching to a direct BaaS model means the bank receives the fintech fees. Fintech fees allow the bank to cover the cost of scaling its compliance and operations teams. Additionally, new platforms do not get in the middle of interchange, allowing the bank to retain the uplift from more interchange and fees. Lastly, the bank can maintain their existing fraud, AML or card providers and plug them into the open platforms, avoiding replicated costs that exist with BaaS providers.
Compliance
By employing a direct BaaS model, the banks have the choice to maintain their existing ecosystem and their rules, limits and fraud controls that align with their existing digital channels.
For many banks, BaaS is not novel. It represents another digital channel to offer their existing compliant products. By ensuring they have diligent third party risk management on the fintech client, the bank can leverage a modern platform above its core to provide real time customer vetting, transactions and transaction monitoring and settlement automation — all based on bank-defined configuration and settings. This approach fosters strengthened dialogue with the Federal Deposit Insurance Corp., Federal Financial Institutions Examination Council (FFIEC), Office of the Comptroller of the Currency and Consumer Financial Protection Bureau.
The void left by BaaS middleware providers means fintechs and brands need to go directly to responsible banks that provide a technology differentiation through their platform offering, which includes modern application programming interfaces, better economics through a direct relationship and built-in, bank-managed compliance. This is where banks will have the second-mover advantage to reliably expand their deposit growing distribution channels.
In building their strategy, banks should:
1. Be deliberate in their choice of a direct BaaS model and the bank’s expected benefits from it.
2. Clearly assess financials between providers, including revenue upside and costs in a direct BaaS model.
3.Review the regulators’ third-party risk management guidelines to build a distribution partner acceptance criteria.
4. Take inventory of compliance controls and policies to confirm reuse versus renew in a BaaS ecosystem.
5. Talk to other banks that have been in the first mover and now second-mover environment.
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