Banking-as-a-Service: How API technology is creating partnerships between former competitors
Historically, incumbent financial institutions and modern fintechs have been viewed in contrast. The former, the dominant players with a stronghold over the industry but with a lack of will, or ability, to modernise. The latter, the disruptive challengers aiming to build more customer-centric financial products and services, yet without the clout or trust that their rivals gained over decades.
This is now changing. It is becoming an increasingly established view that the future of our
industry is not in the battle between these two factions but in the collaboration between them. This collaboration has, in a large part, been down to APIs.
APIs are what allow different software systems to communicate and share information. They
exist both seen and unseen everywhere in our day-to-day lives. The weather app on your
phone, your satnav, paying with ApplePay/Paypal - all of which use APIs to get information from one system and display it via another.
Now, finance is beginning to see the benefits that can come from this, and API collaboration
between financial institutions and fintechs is growing rapidly. One of the most prominent
examples of these partnerships can be described as ‘Banking-as-a-Service’ (BaaS).
Examples of BaaS
BaaS describes an ecosystem in which licensed financial institutions provide access to their
services to non-banking businesses. There are countless examples of what this can look like.
One would be employee expense cards - an emerging market, which relies upon BaaS.
Managing employee expenses has often been a cumbersome task for accounting teams,
frequently needing to make payouts to employee bank accounts and making their tax reporting more complicated. Now, fintechs are emerging which not only allow businesses to issue employee expense cards but link those cards to a reporting software which makes expenses a far easier task to manage and control.
This uses BaaS as the payment services are ‘leased’ to the fintech from a regulated financial
institution such as a bank, all through a single API call. The fintech then builds their own tools, interface and UX for the product to be used in the most customer-centric way.
Without BaaS, the fintech would have struggled to provide this type of service without
embarking on a very long journey to market. They would either need to enter into agreements with banking providers, which is typically a long and arduous process or attempt to become regulated themselves which would almost certainly take even more time and investment.
BaaS has rapidly improved how fintechs, and end users, can access financial products and
services. This is bringing benefits not just to consumers but to the financial industry as a whole.
Why BaaS is so beneficial
Playing to your own strengths: Whilst fintech has been one of the fastest growing industries
of the past decade, with certain unicorns emerging which have truly changed finance, it can’t be viewed as an unmitigated success. Despite the innovation that has arisen, traditional financial institutions still dominate the market and the success rate of fintech startups is fairly low.
Whilst incumbent institutions struggle with modernising due to giant customer bases, numerous internal processes to get through and legacy technology, fintechs struggle to get the regulatory approval they need and then still find it difficult to get consumers to switch over to a new provider. When it comes to their money, even if an alternative service is stronger, people are often somewhat hesitant to change.
By collaborating so that the banking services are provided by the financial institution and the
user experience is designed by the fintech, both parties are able to play to their strengths.
Better customer experience: The previous point leads nicely on to the third group that stands to benefit from BaaS collaboration - the consumer. BaaS simply enables more to be done with financial services. Easier access to these services will enable different fintechs to offer a wide range of options when it comes to finance.
Over time, this leads to the bar being raised. Consumers will expect more from financial
services, whether that be in terms of what they are offered, how enjoyable they are to use or
how they link with other products and services. In other words, BaaS is creating a far better form of competition - instead of fintechs vs banks, it’s individual product vs individual product.
Emerging markets establishing themselves quicker: Banks do not only inhibit innovation
due to legacy technology and legacy thinking - they are naturally risk averse. This is not a
criticism of banks, it makes sense that due to the sheer volumes of money they are custodians of, and the financial crises of the past, they need to exercise a certain level of prudence.
However, this has made it difficult for industries such as cryptocurrency to establish themselves in the mainstream, as they are seen as an unappealing risk. With BaaS however, it is easier to offer particular services to different groups to remain protected whilst encouraging new services to thrive. It is more agile, and therefore far more can be done with it.
Looking to the future - embedded finance
What’s arguably most exciting about this API-driven collaboration is that it doesn’t stop with
BaaS. We are now entering a new era of embedded finance.
Embedded finance is similar to BaaS but goes a step further. It does not just grant access to
particular banking services from a regulated financial institution, but fully embeds them within a business’s own ecosystem so that they can offer those services to their customers.
This will lead to not only further collaboration between fintechs and banks but will change how we come to define fintech. Within a matter of a few years, it is perfectly possible that a large percentage of businesses will be what we now describe as fintechs. Clothing websites could offer payday loans. Supermarkets could round up your weekly shop and invest it for you. The possibilities are endless and our own research suggests that 95% of businesses are looking to implement embedded payments over the next 5 years.
The immediate future of finance is incredibly exciting. We are about to experience a change in how we interact with financial services as they become far more commonplace in our day-to-day lives.
It is a collaboration between the relevant industry players that has gotten us here and it will be a collaboration that guides us through this next stage. As a provider of BaaS and embedded finance, OpenPayd is thrilled to be upfront as we march into this new era of finance.