What is banking as a service? And what is it not?
With the growing number of new banking and fintech business models emerging on the scene, it can be difficult to separate them all. The term “Banking as a Service”, in particular, still has many scratching their heads. But don’t scratch anymore! We’re here to guide you through the jargon jungle of new banking business models in our comprehensive overview. We will cover:
- Bank as a service
- Open bank
- Banking platform
What exactly is banking as a service?
The best way to explain Banking as a Service is to use an example. Imagine for a moment that you are the manager of an airline. You are faced with stiff competition and you want to retain your customers. If you could offer your customers, for example, a debit card, you could give them loyalty points every time they pay with their card. Then, every time your customers use their card, they’re engaging with your brand. By analyzing the purchasing behavior of your customers, you will be able to better understand them and offer them more appropriate services.
Or if you could offer your customers an online loan for their plane tickets directly on your website? So your customers could finance their vacations without ever having to interrupt their customer journey. You could increase the number of airline tickets you sell and directly influence the amount your customers spend. A loan also represents a much closer customer relationship with many more points of contact than a simple sale.
There are dozens of ways that non-banks can improve their customer experience and increase their income by offering their own banking services. However, if you want to offer banking services, in reality all governments around the world require that you hold a banking license. And because of the systemic importance of banks to the functioning of the economy, such a license is difficult to obtain. Obtaining a license imposes not only significant capital requirements, but above all compliance with strict regulations on money laundering, banking secrecy and deposit protection, to name a few. This is where the Bank as a service comes in.
Banking as a Service (or BaaS for short) describes a model in which licensed banks integrate their digital banking services directly into the products of other non-bank businesses. In this way, a non-bank business, such as your airline, can offer their customers digital banking services such as mobile bank accounts, debit cards, loans, and payment services, without the need to acquire their own banking license.
The bank’s system communicates via APIs and webhooks with that of the airline, allowing your customer to access banking services directly through your airline’s website or app. Your airline never really touches the customer’s money, it just acts as a middleman, which means it isn’t burdened with any of the regulatory obligations a bank has to meet.
So, with BaaS, just about any business can become a banking provider with just a few lines of code. This is why BaaS is also often referred to as white label banking, as banking services are provided through the non-banking branded product. Besides Solarisbank, other providers in the growing European BaaS landscape include ClearBank, RailsBank and Starling Bank. Across the ocean, established banking giants are also launching BaaS projects alongside their existing offering, like BBVA in the United States.
So banking as a service is the same as open banking?
Not really. The two models are often confused, as open banking also involves banks connecting to non-banks through an API. However, the models serve entirely different purposes. In BaaS models, nonbanks integrate full banking services into their own products. In open banking models, on the other hand, nonbanks simply use the bank data for their products. In industry, these non-bank companies are referred to as Third Party Service Providers (TPPs).
Let’s look at an example. Financial management applications are leading TPPs that benefit from open banking. They bring together information from all your different bank accounts in one application, allowing you to better monitor your finances. It can help you reach your savings goals or improve your spending habits. In order to aggregate the information, the app needs to extract transactional data from all of your bank accounts. It does this through API integration with bank systems.
Often, this API integration will be provided by another party. They are generally categorized as API banking platforms and can be seen as intermediaries connecting banks to TPP like financial management application. They provide the actual API layer that sits on top of the bank’s system and enables the flow of data between the bank and the TPPs. Important examples in the German market include players such as finleap connect, Ndigit and Fintecsystems.
There are many other use cases for open banking. The second European directive on payment services that came into force on September 15, 2019, better known as PSD2, requires banks to open their data to third-party service providers, with the aim of increasing these use cases. We’ve summarized the main TPPs and use cases below. Attention – acronyms to come!
Pretty cool stuff. The bottom line though, is that unlike BaaS providers, TPPs are unable to provide banking services (such as loans or deposits) because they do not hold full banking licenses themselves. . They simply reuse account information from your existing bank accounts to provide information or trigger transactions.
OK, understood. And what about platform banking? Where does it fit?
Platform banking is a whole different story. These are banks that integrate services from other fintechs to enrich their existing offer. So, for example, a bank can integrate a robo-advisor in its application to allow its clients to access investment products from the same account from which they carry out their day-to-day banking transactions. Platform banking can thus be described as the reverse of banking as a service. In the banking platform model, the bank owns the customer and integrates the services of fintechs. In the BaaS model, the customer is fintech / non-bank and integrates the services of the bank.
Banks often use the platform’s banking approach as a defensive strategy to avoid losing customers to smarter fintechs. By integrating fintech services into their platform, they can at least keep their customers in their ecosystem, even if it means ceding the lion’s share of revenue to fintech.
And there we have it. We hope to be able to shed light on the medley of technical terminology and business models in the evolving banking and fintech world. Yet this is only a snapshot of a slice in time. The banking landscape is constantly changing with new innovators constantly entering the scene. So, watch this space to stay up to date on industry developments and to hear our opinions on them.
For your information, here is a brief summary of the models discussed in the above article:
Bank as service providers
- What it is: licensed banks that allow other businesses to integrate digital banking and payment services directly into their own products.
- How it works: The company’s frontend is connected to the BaaS provider through an API, which allows the company to offer digital lending, account management and payment services on its own in its own applications and websites.
Open banking service providers (aka third party service providers)
- What it is: non-banks that access their customer’s bank account data to provide account information or trigger payments from an app or website.
- How it works: open banking service providers connect to the bank’s system through an API to retrieve the data. Often the API layer between the bank and the open banking service provider is provided by an API banking platform.
- What it is: banks integrating services from other providers, mainly fintechs, in order to offer their customers a wider range of financial services from a single bank account.
- How it works: Depending on the type of setup, fintech services are usually fully integrated into the bank’s app / webpage user interface through API.