Why Every Bank Can Be, and Should Be, a Banking-as-a-Service Company

“At the heart of every bank is a service company.”

Jim McCarthy, president of i2c, remarked to Karen Webster that there’s ample opportunity (and a few challenges) in front of traditional financial institutions (FIs) as the move to digital channels raises the bar on financial experiences and expectations for consumers and businesses.

Many individuals, he said, are growing up and moving through life barely ever having set foot in a brick-and-mortar branch. The app and the mobile device have been the conduits enabling everyday financial life.

But far from being obsolete in 2022, he said, banks have a real role to play in the evolution of finance, as trusted provider — and as providers of wide-ranging technology stacks that can help third parties craft their own bank-like offerings embedded in platforms.

There are signs that FIs are taking notice of the potential: Consider the fact that, per PYMNTS research, 11% of FIs are pursuing a banking-as-a-service (BaaS) strategy, while 46% are open to considering one. Another report predicted a global value for the BaaS platform industry of $12.2 billion by 2031, from a $2.5 billion threshold in 2020.

See also: How Integrating BaaS Can Enable Nonfinancial Companies to Offer Next-Gen Payment Experiences

BaaS’s moment has arrived.  It’s only been a decade, he said, but “we’re a long way away from the days of ‘rent a BIN [bank identification numbers].’”

The BINs, of course, are the digits on payment cards that help identify issuers and FIs. Then, sponsor banks would “rent” the right and the ability to nonfinancial entities to offer cards and other products and services.

And though the white-labeling of account numbers and cards has been around for a while, now, 22 years into the new millennium, open banking and APIs are combining compliance, payments and all manner of back-end functions in ways that open up banks to new possibilities beyond the confines of BIN numbers, pipes and rails. JPMorgan stands out, McCarthy said, having committed billions of dollars of capital annually to various tech upgrades and initiatives.

Banks need to move nimbly beyond their traditional “swim lanes,” he said, if they want to be the provider in the background that helps other firms cement long-lasting relationships with end users — especially software companies. In McCarthy’s view, every software firm has the chance to become a FinTech, helping facilitate payroll, for instance, or Treasury services to corporates. And every bank, the chance to become a service provider that enables the delivery of compliant banking services to them.

From Competitors to Partners

Of course, the battle has been fully joined as banks and FinTechs jockey for position with enterprise and platform clients.

“The jury may still be out as to who wins this race, but you need compliant and regulated entities,” McCarthy said, “and banks have a formidable foundation that most FinTechs don’t have.”

The economics of BaaS are making it extremely attractive for U.S. banks, especially those with under $10 billion in assets, the so-called Durbin-exempt players. These banks are exempt from interchange caps and are well-positioned to make money from customer swipes (and these banks have traditionally been the “BIN” sponsors noted above).

“But now a lot of banks have started to wake up to the fact that they can play a deeper role,” he said. “Compliance is an asset.”

Read more: Consumer Demand Driving Banking-as-a-Service Innovation

Banks are becoming emboldened enough to offer the technology stack that client firms and platforms need. That, in turn, helps forward thinking clients move well beyond the confines of just offering prepaid cards with fancy mobile interfaces, and look more toward offering small business and consumer credit, and even BNPL. Prepaid or debit are just pieces of the larger puzzle.

Traditional FIs’ expertise is especially valuable for FinTechs as these firms navigate tough macro headwinds and margins shrink amid inflation. Capital is harder to come by, he said, and FinTechs are examining how to get to where they want to go, strategically. For the FinTechs, the measure of success is shifting from chasing growth to chasing profitability.

As McCarthy said, “If you can ‘land’ FinTechs on top of your ecosystem in a way that is easy for folks to take advantage of — with modern capabilities and a strong, regulated foundation, then you’re in a good position.”

Looking Ahead

Looking ahead, he said that Europe remains ahead of the curve when it comes to open banking adoption, and the rest of the world lags a bit. Banks will initially grapple with the fact that there is no money to be made off of interchange.

“But there’s still a lot of opportunity globally,” he said.

To get there, FIs will need to view their individual and enterprise clients through a broader lens of retail banking profit and loss. The banks, he said, have historically had trouble discerning small businesses’ needs from individual consumers, which is something the FinTechs navigate with aplomb. Advanced tech and machine learning can help banks help their users examine their own liquidity and cash positions. The traditional FIs, he said, have the broad range of mortgage, auto, consumer lending and other financial products to mine the data that gives rise to a holistic view.

In the meantime, over the next five years, there will be a market shakeout, more banks come into the space and help embed finance fully into various ecosystems. Banks should think about compliance not as something that holds them back — but as something they are good at, and has real value to client firms.

“Banks bring the trust,” he said, “and they still own the trust.”