BaaS and embedded finance

By interfering with the last-mile delivery of financial products, the initial wave of banking-as-a-service (BaaS) disrupted the supply chain for financial services. Fintech and retail brands have started using BaaS to offer new products and services to a variety of client segments, taking over the distribution to gain customers and improving the effectiveness of the financial system where banks used to have total ownership and control.

This growth is referred to as last-mile delivery, where the bank is only supplying the material and does not control the final mile of the client experience. BaaS gave banks the chance to work with fintech partners that can more effectively sell, promote, onboard, and increase the range of financial products they can provide to clients. Regulators were concerned because the first wave went too far in abstracting important elements from banks’ regulatory procedures and calling for client due diligence, including Know Your client (KYC) and fraud monitoring.

The Global Embedded Finance Market (GEEM) is predicted to reach a value of about $384 billion by 2029 as embedded finance (EF) becomes more widely accessible; greater moderation will be necessary to safeguard banks, companies, and consumers. Let’s examine this new development in banking and potential future directions.

Early disruptions

In the past, networks like HBO, Showtime, or Disney produced unique material and offered it on their own channels. Nevertheless, last-mile disruption caused by agile partners’ faster and cheaper content delivery led to rapid development. As the last-mile distribution platforms, Roku, Netflix, and Amazon Prime combined content from many providers into a specialized offering that quickly attracted customers.

Fintech businesses, retail brand apps, and enterprise applications that provide the customer-facing experience are disrupting the banking sector at the last mile. These fintech apps incorporate financial tools and bank material, and they frequently provide creative content as well. With EF, banks will be able to work with fintechs for last-mile distribution while also owning some delivery mechanisms. Simply defined, EF will enable banks to regain control over last-mile delivery by becoming a standard distribution channel that they can support, similar to the internet, mobile, or physical channels they currently support.

The banking sector and customers will gain from banks offering their own goods that can now be offered over many channels, much like the popularity of entertainment streaming services.

The Initial

Private branding of a bank account with a debit or prepaid card was one of the common use cases that propelled the BaaS movement. Customers would be drawn to the non-bank program that controlled the last mile of distribution due to its distinctive features. For instance, a department shop may offer a debit card bearing its own logo that enables registered users to accrue additional loyalty points for using this particular card. Due to the interchange fee splitting, the goal was to draw in more clients, boost deposits, and profit from debit card usage on the account.

As financial institutions look for more ways to expand their deposit base beyond standard deposit accounts and debit cards, this setup is still often used today. However, like with any supply chain methods, a company’s economic share will increase in proportion to the number of functions it can do inside the supply chain.

In BaaS, interchange revenue is an example of this. In a multi-tenant environment, banks with their own BaaS platform can directly power their deposit growth partners, enforcing compliance rules and developing goods and services specifically for their consumers. With control over their digital ecosystems, banks have a greater impact on the BaaS supply chain’s economics. The bank also reduces risk as interchange may degrade moving forward by controlling the client relationship and making sure their programs do not end if the BaaS provider middleman vanishes.

Moving forward

New opportunities arise from evaluating restrictions. On June 6, 2023, the FRB, OCC, and FDIC released their Interagency Guidance. This is their final tip on third-party risk management for banks, emphasizing that they are responsible for their dealings with others. BaaS’s current state stresses the need for banks to oversee their delivery programs and avoid outsourcing them to BaaS providers, which increases compliance and data protection risk. The Fed’s request for more oversight over BaaS/EF protects the financial system.

In order to provide transparency in customer information, accounts, and transactions, the bank leverages technology to enable automatic and programmatic oversight. The trend makes use of the bank’s technological infrastructure, giving them more control over their initiatives, risks, and results.

Consent orders indicate regulators are asking banks to handle KYC and third-party risk management. Banks with their own systems can manage fraud, Customer Identification Programs (CIP), and money flow exception management digitally and give their EF partners the tools they need.

When it comes to items like digital currencies and the methods used to supply financial services, the FDIC is also changing. In light of the FDIC’s recent announcement that it is soliciting feedback on potential changes to its regulations, banks that are now dominating the BaaS/EF market have a significant opportunity to go forward.

The market is already expanding beyond standard deposit accounts and cards and will continue to do so. The banks that will be in the greatest position to provide across any last-mile provider are the banks that expand their distribution channels and become skilled at bundling EF products and services together. These are the banks that will have the most chances to develop and, eventually, provide clients with the most value.