Banking-as-a-service is transforming the future of financial services

Imagine you are planning a trip abroad. You have to pay for your plane ticket, accommodation and have enough money saved to enjoy your holiday. This can be expensive, especially for long-haul flights and expensive tourist destinations. Financial institutions would not generally provide a loan for such scenarios. But your airline could. With embedded finance, the brand could provide point of sale (PoS) financing or another loan, within the same user journey and often without interest. They could also offer a savings account to help with spending money, and provide future ticket discounts and other perks.

Now imagine you are the business able to provide such financial services. Thanks to embedded finance, or banking-as-a-service (BaaS), that prospect is attainable. In fact, products such as small business loans and retailer-led financial services are already available in the first wave of offerings in a BaaS market expected to reach a value of $7tn by 2030.

BaaS is a revolution that combines the power of banks with the reach and customer loyalty of well known brands. How does BaaS work, and where do different players fit in?

The anatomy of BaaS
BaaS ecosystems have four prominent groups: The regulated financial services providers, the enablers – the fintechs and bigtechs which orchestrate an ecosystem for financial institutions and brands to meet, the distributor brands – such as merchants, online retailers or ERP systems and the customers.

Let’s first take a look at financial institutions, including banks and other regulated financial services firms, which act as the BaaS ‘providers’.

The payments industry alone is seeing rapid changes. If you go back to 2010, 95 per cent of financial transactions were completed by banks. Fast forward to where we are today, and 75 per cent of financial transactions are completed by banks. The gap has widened, filled by fintechs and other payment providers.

Banks are not on their way out. They have banking licences which are expensive and difficult to secure, well-established processes, and grand ecosystems designed to provide trusted services while meeting regulatory demands. They also have a huge pool of liquidity available to offer large amounts of loans and financing options. But they often struggle to serve all the market and reach customers in contexts that are relevant to them.

BaaS allows banks to open up their services and infrastructure capabilities for others to use. If they don’t embrace it quickly, they risk missing the market opportunity. They in turn benefit from the ability to keep pace with consumer demands, improve how they serve existing customers and reach new ones through alternative channels.

Enablers help to connect the financial services ‘providers’ with the brand ‘distributors’. By using modern technologies – such as APIs and microservices – they can orchestrate a flexible and scalable marketplace where providers and brands meet. The customers benefit from access to a broader range of financial products, tailored to their individual needs.

Next, the distributor brands are companies that offer financial services by leveraging a bank’s products or systems. Building and offering banking services, acquiring relevant skills and licensing can be very expensive and time-consuming for businesses. With BaaS, they can leverage a bank’s systems tailored around specific products. For these businesses, it comes to a great benefit. They can provide a richer customer journey for their customers – right at their fingertips.

And finally, and most importantly, the customer. By receiving financing options right where and when customers need it most, embedded finance puts financial products into context. Small businesses or consumers – who may not be aware financing options are available to them through lack of knowledge or poor credit – will now be offered relevant financing options, fit for their specific needs.

For example, through BaaS, business management platforms like Microsoft Dynamics 365 can offer a variety of loans to its small business customers without them having to leave the platform. Shopify can also do the same for its merchants.

Choosing the right BaaS partner
Partnering with an enabler allows BaaS to be implemented at scale, much more quickly and at a lower cost compared to partnerships based on point-to-point connectivity. By acting as a marketplace, they give multiple distributors access to numerous providers and vice versa. But how do you choose the right partner?

One key area to look at is whether or not the partner provides the technology benefits you’d expect.

Your BaaS partner must achieve three things. First, they remove the technology complexity. They handle the integration for both the provider and the distributor. Second, they speed up the time to market, leveraging their existing network of fintech apps. And third, they must be able to scale the distribution, helping providers reach more customers using the platform’s existing infrastructure.

There is also another question of how do you know if adding financial services is a good fit for your company? You must start with the use cases that will deliver the most value to your customers. You should be solving a customer need or pain point, rather than implementing an offering because it’s the latest trend.

For example, a key use case for many B2B brands is lending for small and medium enterprises (SMEs). Finastra’s Banking as a Service: Outlook 2022 report reveals that SME lending will grow by 30 per cent and POS financing by an enormous 104 per cent over the next three years. This solves a real issue of improving access to finance for SMEs, while also giving them the option to unlock offers within their business management platform, such as Microsoft Dynamics 365.

BaaS adoption is expected to continue to grow exponentially and will transform the way financial services are consumed. It is changing the market and setting the stage for a new era of financial inclusion.

Nour Sabri is the lead client partner for Banking-as-a-service at Finastra

Read: An overview of the Middle East fintech landscape