The underlying model of working with a partner to provide banking services has moved from what was defined as agency banking and morphed into Banking as a Service (BaaS). BaaS has transformed the financial services landscape by also enabling non-banking entities to offer banking products through partnerships with licenced financial institutions.

As a result, the line between bank and non-bank provision of financial services has become increasingly blurred. This has been compounded by the ambiguity around BaaS and the complexity of the ecosystem.

In the UK and Europe, BaaS is a popular yet loosely defined term. Fintech firms, payment institutions, non-bank entities and embedded banking providers are all part of the transformative model that is decoupling the front-end customer experience from the underlying core applications.

Further complicating the definition of BaaS is that the approach differs between the United States and European markets, influenced by their distinct regulatory environments and market structures.

In this article I’ll explore the origins of BaaS and how it works and how the model has evolved. 

The first iteration of the Banking as a Service model was typified by co-branded and white labelling products that allowed fintechs to partner with banks and offer financial products like credit cards using their own brand. 

The introduction of APIs (Application Programming Interfaces) allowed third-party developers to access banks' infrastructure securely, laying the foundation for the next phase of BaaS development. Regulatory frameworks like Europe’s PSD2 (Payment Services Directive 2) further accelerated this by promoting open banking and enabling non-banks to integrate financial services into their platforms. 

The use of ‘banking’ is something of a misnomer because today BaaS isn’t necessarily provided by a licensed bank. For example, Electronic Money Institutions (EMIs) and authorised Payment Institutions (PIs) can offer bank-like services such as accounts, virtual and physical cards, access to payment rails, and more. 

When these services are provided by an EMI or PI, they must also work with a bank to ensure that customer funds are safeguarded. It’s also worth noting that in the US, the BaaS model has subtle differences where a chartered bank allows a third party to market the bank’s products under the third party’s brand. 

As a result, the BaaS model is now delivered by a broad array of providers, allowing firms to provide various financial services to their own customers without having to hold a full banking license themselves. 

The key components of a modem BaaS offering typically include: 

• Core banking infrastructure
• Regulatory compliance frameworks
• Payment processing capabilities
• Accounts and account management
• KYC/AML verification services
• Card issuance capabilities 

The BaaS model has proven attractive to consumer-facing brands, primarily in financial services, to build out their offering, from single products embedded in customer journeys to a full banking proposition.

The BaaS model delivers significant benefits to market participants – from the banks, EMIs and PIs, the brands using the model and the end consumers by: 

• Creating new revenue streams: BaaS enables businesses to generate new revenue streams by offering financial services to their customers. It has also created new revenue opportunities for the underlying banks powering these services.
• Accelerating time to market: Challenger banks, fintechs and even corporates can launch new services by partnering with BaaS providers. For earlier stage firms, it lowers the barrier to entry without compromising on service capabilities.
• Delivering cost efficiency: Firms can deliver bank-like services while avoiding the high costs, both in terms of capital outlay and time of obtaining banking licences or building infrastructure.
• Increasing competition: Lowering the barriers and encouraging diversity in the provision of financial services by supporting firms to focus on their core competencies, such as user experience or customer service rather than underlying infrastructure.
• Enhancing the customer experience and loyalty: Integrated financial services reduce friction and enhance the user journey, offering the convenience of accessing services at the point of need rather than leaving the platform or app they’re using. 

Today, there are a diverse set of firms involved that has led to the term being stretched to encompass banking services, open banking, card platforms and other API (application programming interface) services. And that, in turn, has created the potential for a misalignment of expectations, leaving the customer under-serviced or not receiving the level or type of service they need. 

We’re already seeing the regulators pay more attention to the BaaS model, particularly in the US. This isn’t a surprise given the range of Community Banks being used under ‘rent a charter’ model. The Office of the Comptroller of the Currency (OCC) in August 2021, published a Bulletin with the aim of setting the standards it expects of banks when it comes to onboarding, KYC/B and the relationships they have with fintechs. 

November 2021, saw acting Comptroller Michael Hsu give a speech on “Modernizing the financial regulatory perimeter”, including potential risks of non-bank fintech firms that have reassembled a full stack of banking services.  

US fintech’s leveraging BaaS has also been censured around the misrepresentation of services, for example, when Chime was deemed to violate Californian banking rules as it described itself as a bank. The ongoing fallout following the collapse of BaaS provider Synpase, involving Evolve Bank & Trust and multiple fintech providers highlights how complex and interconnected some of these relationships have become. 

Europe has also seen the BaaS model come under the spotlight, most notably with the   failure of Wirecard in 2020. The payments processor had evolved into a BaaS provider before a major accounting scandal saw the firm collapse, affecting fintech clients across the UK and Europe. EMIs and BaaS providers have since come under the regulatory spotlight. Multiple firms changed their name by removing the phrase ‘bank’ to avoid any confusion, while others have seen their licences revoked due to Know Your Customer (KYC) and Anti-Money Laundering (AML) failings. 

In the UK, the Financial Conduct Authority has raised its concerns via its “Dear CEO” letter on four separate occasions in the last four years, each highlighting safeguarding as an area needing improvement. Its most recent letter to EMIs and payment institutions suggests that banks are still best placed to do this, as they have the regulations, backing and protections to hold funds safely. 

With fintech firms increasingly reliant on their BaaS providers to deliver their services and meet compliance demands, the clarity of who is responsible in the service chain has been bought into focus. 

The effect of this was shown in research we commissioned in 2022, “Confusion, cost, and compliance: The bifurcation of BaaS and Embedded Banking” that revealed that 40% of fintech firms had experienced service disruption, 33% had lost customers, and 20% had faced intervention by the regulator due to BaaS issues. 

It seems inevitable that regulators will be paying more attention to BaaS and we're likely to see increased regulatory scrutiny around BaaS regarding in three areas: 

Enhanced Due Diligence 

• Increased focus on partner vetting processes
• More detailed operational oversight requirements
• Regular assessment of partner financial stability
• Strengthened compliance monitoring frameworks 

Customer Protection Measures 

• Enhanced deposit protection communications
• Improved complaint handling procedures
• Stronger safeguarding of customer funds 

Operational Controls 

• More robust third-party risk management frameworks
• Enhanced monitoring and reporting requirements
• Strengthened governance arrangements
• Regular independent audits of BaaS relationships 

By lowering the barriers to access banking infrastructure, BaaS is empowering businesses across sectors to innovate and meet evolving consumer needs. As a result, BaaS has experienced substantial growth over the past decade. According to market research, the global BaaS market was valued at $21.27 billion in 2023 and is projected to reach $85.73 billion by 2032, growing at a compound annual growth rate (CAGR) of 16.76%. 

The catalysts for this projected growth are: 

• Ongoing digital transformation: The shift toward digital-first financial services across the globe has created demand for seamless integration of these services at the point of need.
• Fintech innovation: Startups and tech companies are leveraging BaaS to offer tailored financial products without needing their own banking licences
• Evolving consumer expectations: As new services launch, and consumers become increasingly comfortable with financial experiences being embedded into everyday applications from fintechs through to ecommerce platforms. 

As the BaaS model continues to grow and evolve, it holds the promise of making finance more accessible, efficient, and integrated into our daily lives. Arguably the biggest driver of that growth will be outside of financial services, through embedded finance applications, moves into more verticals.