Don’t throw the baby out with the BaaS water

Imagine if any business could offer banking services without the headache of building their own payment, lending and settlement infrastructure – this is the power of BaaS (Banking as a Service). By granting third parties access to bank systems, BaaS allows companies to integrate banking functions directly into their products effortlessly. This transformation, often termed “Embedded Finance,” is reshaping how financial services are consumed and delivered.

💸 Embedded Finance at Scale

Embedded finance unlocks a massive market opportunity. By 2026, embedded finance revenues in the U.S. are projected to more than double, reaching $51 billion, and worldwide revenues are expected to quadruple to over $160 billion (Bain). More impressively, by 2026, over $7 trillion in transactions will be processed through embedded financial services. This growth underscores the vested interest both banks and users have in making these services ubiquitous and continuously modernized.

⛔️ The Middleware Misstep

However, not all implementations of BaaS have been successful. The middleware approach to BaaS has faced significant challenges. It's not BaaS itself but the middleware architecture that has faltered, as illustrated by the recent struggles of Synapse. As QED Investors' Amias Gerety recently highlighted it, the BaaS model may be stronger without the middleware layer that Synapse represented (see article). The industry's evolution from these challenges has made it more resilient and robust.

🏦 Banks are Back

The pendulum is swinging back to incumbent banks, which are regaining their lead role in the ecosystem. While fintech players initially propelled embedded financial services, incumbent banks, with their robust compliance and risk management practices, are indispensable. These banks are now augmenting their existing transactional and risk infrastructures (AML, KYC) to enable new fintech offerings swiftly and in line with regulatory standards. This shift provides immediate alternatives to struggling middleware players and lays the groundwork for a new enablement layer atop core banking systems.

☁️ The Platform Approach

Financial institutions would benefit from pivoting from the BaaS middleware provider model towards developing their own platforms. Why? This internal approach mitigates the risks and compliance gaps inherent in middleware. By collaborating with software vendors, banks can build resilient and scalable platforms addressing key areas:

• Compliance: Ensuring bank-controlled, bank-rules, and bank-decisioning processes without replication.

• Risk management: Eliminating the risk of BaaS middlemen with ledgers outside bank control.

• Documentation: Maintaining documented and visible operating account structures, as well as defined funds flow and payment processes.

• Resilience: Ensuring built-in deposit resiliency, allowing banks to maintain accounts on their platform and migrate to the bank’s digital brand.

• Transparency: Keeping full access to all customer data, accounts, and transactions with no data transfers needed.

• Real-time enablement: Enabling real-time end-user account access and automated real-time data settlement operations.

In short, the BaaS model is far from broken. It simply needs a refined approach, leveraging the strengths of incumbent banks to build a more resilient, compliant, and innovative financial ecosystem. Let's not throw the baby out with the BaaS water.