Breaking Barriers: How Small Banks Can Thrive with Banking-as-a-Service

The demand for simplified banking services is rising, as customers expect fast, convenient access to financial products. Corporate and retail consumers alike are increasingly drawn to Banking-as-a-Service (BaaS) because it offers a more convenient, accessible, integrated, and inclusive approach to finance products that they seek. 

BaaS has captured the attention of businesses across industries as it enables them to seamlessly embed financial products and services within the customer experience (CX), whether it’s an e-commerce platform, a healthcare app, or a ride-sharing service. BaaS eliminates the need for customers to go through multiple channels or platforms to manage their finances, demonstrating the increasingly interconnected and digital-first nature of the global financial ecosystem. 

With BaaS, nonbanks get a fast track into the banking market without needing to procure a charter. Banks get a prime position as customer-centric, agile organizations that can readily evolve in a highly competitive environment. 

Gartner projects that BaaS will reach near-ubiquitous adoption within the next two years and is heavily influencing technology investments for both FIs and nonbanks. 

For smaller banks, like credit unions, community banks and regional banks, BaaS has become a great equalizer, enabling them to benefit from collaboration to better align their financial products with a dynamic market and emerge as BaaS leaders alongside larger peers. 

But small FIs must act fast to capitalize on the BaaS opportunity and gain a strong footing in this space with secure, innovative BaaS offerings.

Smaller Banks are Joining the BaaS Landscape

Some key trends are influencing the BaaS landscape: 

• Integrating financial services into platforms has become a strategic digital transformation imperative to meet consumer expectations for all-in-one solutions while focusing on core competencies.
• Open banking regulations that require banks to open up their data and infrastructure to authorized third parties to foster collaboration and innovation within the financial ecosystem has enabled businesses to leverage BaaS to deliver enhanced services.
• Fintech disruption of traditional banking models has helped pave the way for BaaS and opened up a pathway for collaboration with banks.
• Consumer desire for seamless integration of financial products into their preferred applications and platforms has driven the popularity of end-to-end financial experiences.
• The growing sophistication and availability of Application Programming Interfaces (APIs) which enable data exchange and system integration, have accelerated BaaS solution adoption and scalability.
• The demand for seamless, embedded financial experiences via integration of financial services into non-financial platforms and applications.
• The increasingly competitive financial services landscape requires banks to seek new ways to differentiate themselves and deliver new value propositions to customers. 

Many FIs, including smaller banks, are leveraging BaaS to enhance client loyalty, support corporate payment demands, and secure their role in the future of banking. Community banks, regional banks, and credit unions, for example, have advantages, like agility, localized expertise, personalized customer relationships, and trustworthy reputations, to empower their ability to capability on BaaS. 

BaaS is the stepping stone smaller FIs need to align their financial products with emerging customer segments and markets to generate more revenue and diversify their customer pool. Of 300 surveyed credit unions and community banks, 125 are already providing BaaS services, and around 60 are creating a BaaS strategy.

Strategic Approaches for Smaller Banks to Offer BaaS 

In a BaaS model, a chartered bank partners with a fintech or non-financial business so the partner can offer financial products to their customers. It’s a win-win for both parties: partners don’t have to get a banking license or implement a banking infrastructure, and banks can reach a wider customer base at a lower cost. 

Smaller FIs can embrace BaaS through two different approaches: 

Partnering with a BaaS Provider (Indirect)

• The small bank collaborates with a BaaS provider to use their technology, infrastructure and services.
• The bank integrates with the provider’s platform and uses its capabilities to offer banking services to fintechs or businesses.
• The bank acts as a facilitator, opening up access to the BaaS provider’s services and serving as a link between the provider and the partner business.
• The bank can then extend its offerings, drive additional revenue, and benefit from the BaaS provider’s expertise and advanced technologies. 

Transforming into a BaaS Provider (Direct)

• The small bank can become a BaaS provider itself, developing its own cohesive BaaS platform and the corresponding technology, infrastructure and services.
• The bank’s BaaS platform is made available to fintechs and businesses so they can deliver financial products and services within their own brand.
• The bank acts as the service provider, offering banking capabilities, compliance support and infrastructure to its partners.
• The bank can then leverage its current resources, fuel innovation, vary its revenue, and reinvent its institution as a strategic partner in the financial ecosystem. 

Making a decision between these two different BaaS approaches depends on the small FI’s business objectives, technology capabilities, resources, regulatory environment, and how much control it wants over BaaS operations. 

But smaller banks that launch their own BaaS platforms are benefiting from new revenue streams through two key monetization strategies: charging clients for every individual service, or charging clients for access to the BaaS platform on a monthly basis.

Protecting BaaS from Complex Threats

Whichever approach small FIs choose to capitalize on the BaaS model, they must make risk management and compliance their top priority. We strongly advise preparing for every possible business and legal implication before they enter a BaaS arrangement. 

Though not an exhaustive list, below are some best practices to incorporate into a BaaS framework: 

• Evaluate potential BaaS partners, including their reputation, operational capabilities, and security measures.
• Frequently evaluate the BaaS partner for AML risk and transaction monitoring.
• Ensure the BaaS partner is aligned with regulatory requirements because banks retain ultimate responsibility for compliance.
• Develop data requirements and infrastructure with the BaaS partner that addresses data integration with the bank’s AML systems, and testing policies for new financial services or products.
• Establish a process to manage AML program features, like enhanced due diligence (EDD) and control distribution.
• Ensure the BaaS partner has appropriate data handling policies in place, including disaster recovery.
• Invest in robust fraud detection systems that are purpose-built for the needs of smaller banks to enable comprehensive, intelligent fraud prevention and risk management.
• Deploy multi-factor authentication, strong access controls and anomaly detection to mitigate risks, like account takeover (ATO) fraud.
• Implement smart identity verification techniques, like biometric authentication and real-time behavior-based analytics to prevent threats like synthetic identity fraud (SIF).
• Improve payment fraud detection and prevention with behavioral analysis and transaction monitoring capabilities, in addition to real-time fraud detection algorithms.
• Ensure compliance is maintained with all AML and KYC regulations via machine learning-driven risk scoring, integrated customer risk ratings, and intelligently aggregated data. 

Small FIs must view BaaS as another facet of their holistic digital transformation agendas rather than a segregated initiative. Remember, the potential of BaaS isn’t exclusive to larger FIs, but an opportunity for every organization within the financial ecosystem if approached with meaningful consideration for all business implications and possible risks. 

Also, we encourage you to explore the BaaS imperative for smaller banks in greater depth in our companion Insights Article here.