It’s been a roller-coaster ride for the banking-as-a-service sector over the last year, with a host of mergers and acquisitions and layoffs. On the other hand, large companies are eagerly adopting the concept to get competitive advantages and to drive value for customers.
BaaS can refer to three different parts of the industry: One is the classic of offering bank-like services to other players in the industry, a second is providing the charter and bank services but not doing the underwriting, and a third is banking components, which is more of a fintech, that isn’t a bank, providing bank-like services without a charter.
“I believe [banking-as-a-service] is a potentially phenomenal growth space for banks to go after,” Accenture’s global banking lead, Michael Abbott, told TechCrunch+. “There’s already tried-and-true models out there, like private label and co-branding. You’re providing that banking capability, consumer lending and credit card portfolios to consumers, small businesses and increasingly at the corporate level.”
And it is a big market. Banking-as-a-service is expected to grow 15% each year to be valued at nearly $66 billion by 2030. Companies continue to attract venture capital, too. This year, Treasury Prime secured $40 million in Series C funding and Synctera raised $15 million to launch embedded products in Canada. Meanwhile, Omnio raised $9.8 million, and U.K.-based bank Griffin raised $13.5 million in June.
But it hasn’t all been rosy. Synapse and Figure Technologies were among the first to hold layoffs; Synapse laid off 18% of its employees in June, and Figure Technologies, which includes Figure Pay, laid off 90 people — or about 20% of its workforce — in July.
BaaS involves a lot of facets and can be quite confusing, so to make sense of what’s going on, we sat down with people representing BaaS companies, fintech experts and investors to chat about the sector and where it goes from here.
The struggles
While BaaS companies were the recipient of aggressive venture capital infusions in 2020 and 2021, in the last six to 12 months, there was “a recognition or a rationalization of those investments,” Synctera CEO Peter Hazlehurst told TechCrunch+.
Around two dozen companies in this sector were funded during those two years, and perhaps a half dozen are still operating today. So how did that happen? According to Hazlehurst, the answer is pretty simple. “They used venture dollars to make irresistible deals to customers to get usage,” he said. “Twelve months ago, we were losing deals because we wouldn’t sign someone up for free. The challenge was the actual market price of that transaction was underwater.”
Those kinds of deals aren’t happening as much anymore, and Hazlehurst said Synctera has even gained back some of the customers who were enticed by the free deals.
But losing customers to well-capitalized competitors isn’t the only problem BaaS faces. Regulatory headwinds are ever present; this is nothing new to the financial sector. But when partnering with a bank, BaaS players put risk exposures on those banks that are not typical.
Treasury Prime partners with multiple banks and facilitates direct relationships between fintechs, enterprises and the banks so there is a transparent compliance program, said Chris Dean, the company’s co-founder and CEO. But not everyone in the sector is doing the same thing.
“Some BaaS companies act as an unregulated middleman to handle important compliance functions,” he said. “This is a risky model based on recent consent decrees by regulators, who have indicated that compliance cannot be offloaded and handled by anyone other than chartered institutions. When banks don’t have clarity into what their fintech partners are doing, that’s when they run into problems.”
Sankaet Pathak, co-founder and CEO of Synapse, also cited risk and compliance as challenges to the BaaS sector. This means understanding what the role of the bank is and the role of the fintech to know how a particular business model should be regulated.
For example, with Synapse’s demand deposit account product, similar to a bank account, the oversight on that, from a regulatory perspective, should be that Synapse is the vendor of the bank, Pathak said. Whereas with its cash management product, the banks are the vendors for the Automated Clearing House processing. “The industry is trying to figure all of that out,” Pathak said. “The second big piece is the viability of the business model, and people have to really crack that nut, too.”
Accenture’s Abbott said chief among the risks are companies that are not banks providing bank-like services. “You have to make sure that what you’re doing is compliant,” he said. “As we move forward, eventually, you’ll get better categorization and a simple line of demarcation so you can see if it’s being provided by a bank, or regulated entity, or if it’s a fintech company providing banking services without a bank charter. That’s where the industry gets confused by the definition.”
It’s now more “tech” than “fin”
While BaaS continues to struggle, some notable movements in the sector could show signs of promise.
“The Fifth Third acquisition was brilliant,” Montage Ventures’ Matt Murphy said of Fifth Third Bank’s acquisition of Rize Money. “When you are not issuing new banking charters, you have to acquire one, and a lot of the banks don’t have the tech stack to offer certain platforms. Fifth Third is strong on the value creation and integration sides.”
Eventually customers will outgrow their BaaS needs. For example, Mercury used to sit on Synapse’s technology, and following a large infusion of capital, it is now the bigger entity. But that’s not something to worry about — yet.
“No one is going to worry about Synapse until FIS buys it and there is potential for them to take all of the business,” said Montage Ventures’ Todd Kimmel. “There is also a big hole in small business banking with Silicon Valley Bank and First Republic going away.”
But what else happens when a customer outgrows you? “What we saw in 2014 was that ‘fintech’ was more ‘fin’ than ‘tech,’” Murphy said. “Now after 2018, it is more ‘tech’ than ‘fin.’ If you are sitting on top of a technology that is not built in-house, how defensive is that? It is added functionality in your fintech offering, but sitting on top of BaaS.”
Meanwhile, interesting BaaS use cases are continuing to emerge by corporations that previously wouldn’t have tried to do banking or payments, said Synctera’s Hazlehurst. For example, fintechs are going after the NCAA sports categories now that student athletes can earn salaries, and software companies are offering lending options to small businesses.
“They all need the same services, and none of them have the resources to build it,” he said. “That’s where we’re starting to see the deal flow coming in: businesses that have an existing operation in one way, shape or form, want to add functionality that is banking or payments related. And, you’re seeing that behavior begin to go across lots and lots of different verticals.”
Can we call BaaS an outlier in fintech?
Those who shared their views for this story think so.
Dan Kimerling, founder and managing partner at Deciens Capital, called BaaS and third-party distribution of banking services not only “a critical evolution in the way that financial services are distributed in the U.S.,” but also “the future of financial services.”
Along with the compliance, legal and regulatory risks, there’s also the opportunity to be “massively multi-bank,” and by combining financial services with software, a “company can deliver a 10x customer experience compared to delivering financial services separately from software.”
“This is ultimately the future of how financial services are created, distributed and sold,” Kimerling said. “We just went through a period of capital euphoria. That being said, I am reluctant to throw the baby out with the proverbial bathwater. For the companies of substance, they should be able to weather the storm and come out stronger on the other side. Navigating the choppy waters won’t be easy, but playing in the startup space shouldn’t be for the faint-hearted either.”
Treasury Prime’s Dean came to a similar conclusion, explaining that the pandemic changed the way consumers are choosing to interact and use financial services. He cited a 2022 Bain and Company report that predicted that revenue opportunities for software platforms and the providers of the infrastructure for embedded offers will more than double to $51 billion by 2026.
During that same period of time, the transaction value of embedded finance will grow to $7 trillion in 2026 and account for 10% of U.S. financial transactions.
“The digitization of banking is a fundamental change in the financial services industry and will only continue,” Dean said. “The potential of embedded finance lies in its power to generate short-term and long-term gains for both banks and fintechs. I predict that once the dust has settled, we’ll witness a surge in BaaS adoption from banks and fintechs in the next two years.”