The last ten years have seen the emergence of fintech companies in most parts of the world, including the US, Europe, and Asia.
Although they are yet to dominate their respective markets, fintech companies have launched new products, built household brands, and acquired significant numbers of users and customers at a very strong pace.
They set out to reinvent how financial services such as payments, lending, or investment are packaged, delivered, and used. Consumers and companies benefit from an easier access to financial services that are embedded into the tools and platforms that they use on a daily basis and from an overall better user experience.
One of the reasons fintech companies were able to grow so fast is their successful partnerships with BaaS providers.
In this article, we break down the different dimensions of a BaaS provider and show how instrumental BaaS providers have been (and still are) in the launch and growth of a number of fintech products and companies in Europe. We then explain why some fintech companies eventually decide to leave their BaaS providers and what it takes.
Inspired by SaaS and Software-as-a-Service, BaaS stands for Banking-as-a-Service. It refers to the ability to embed banking services into a software without actually being a bank or a regulated financial institution. Just like SaaS enables companies to use software without hosting it on premise and paying for expensive licenses, BaaS enables companies to deliver banking services with limited complexity and initial investment.
BaaS providers package five components together into a single platform accessible through APIs:
1. A regulatory license, most often in the form of a credit institution, payment institution, or electronic money instruction
2. A direct or indirect membership or access to the payment networks and schemes (e.g., Visa / MasterCard for cards and SWIFT / SEPA for bank payments)
3. One or multiple banking partners in charge of safeguarding customer funds, giving the fintech companies and its customers access to the payment networks and schemes, funding the loans, etc.
4. A core banking system which enables fintech companies to onboard customers, hold customer accounts, generate cards, send and receive bank payments, manage deposits and loans, etc. through a set of APIs
5. Operations and compliance to onboard customers, verify payments, and comply with all KYC / AML / CFT regulations
Some of the biggest BaaS providers in Europe are Modulr, Bankable, Railsr, Solaris Bank, Treezor, Xpollens, and Swan.
Most BaaS providers are not end customer and end user-facing. Fintech companies build web or mobile front-end applications on top of the APIs of their BaaS providers. On a day-to-day basis, customers and users will thus be interacting with the apps of their neo-bank, neo-broker, etc.
In the background though, customers and users have signed a contract with the BaaS provider of the fintech company whose products they are using. They went through the onboarding procedures of the BaaS provider. Their accounts are held, their payments are processed, and their loans are serviced by the BaaS provider.
Now that we have defined what a BaaS provider is and does, let’s look at how a fintech company can benefit from partnering with a BaaS provider.
Building a fintech company and launching a fintech product is hard. Financial services are a heavily regulated industry. The number of partners and vendors necessary to design and operate financial services can easily reach 10-20. The core finance, legal, compliance, and operations team can be 3-5 people strong initially and grow to dozens of people. As a result, the upfront investment can be as high as €1-2M. That is before you have even launched your product and acquired your first customers and users, which can easily take 12-18 months.
By essentially renting their license, memberships / accesses, banking partners, technology, and compliance and operations teams to their fintech customers, BaaS providers remove most of this complexity. They also turn high upfront investments into variable costs and revenue-share agreements.
By partnering with BaaS providers, fintech companies can focus on designing and developing products with superior user experience, building distinctive brands, and acquiring large numbers of customers and users through differentiated marketing and communication campaigns. They can launch, learn, and iterate faster. The difference between a fintech company partnering with a BaaS provider and another fintech company going full stack can be 12-18 months of learnings and customer and user acquisition. That is a lead that can be very difficult to catch up on.
Some of the most successful fintech companies in Europe such as finance mega app Revolut, B2B neo-bank Qonto, peer-to-peer payment app Lydia, corporate spend solution Spendesk, and employee benefit solution Swile initially partnered with BaaS providers.
Although BaaS providers have a number of strengths that enable fintech companies to quickly bring new products to market, these strengths can turn into constraints and limitations as fintech companies grow.
BaaS providers only offer their fintech customers a limited control over the experience of their own customers and users. Fintech customers cannot completely choose the customers they are working with. Their BaaS providers might for instance refuse to onboard and deliver services to customers from entire industries. They might also refuse to onboard specific customers or execute certain payments for compliance reasons that might not be known to the fintech company.
BaaS providers might lack specific financial products, services, and features. This can be the case of new payment methods such as SEPA instant payment or advanced features such as card pre-authorisation. When this happens, fintech companies need to work and integrate with multiple BaaS providers.
Working with a single provider for onboarding, accounts, payments, cards, and other financial products and services means having a single point of failure. This is a major risk for the continuity of operations that is very difficult to hedge.
Last but not least, fintech companies working with BaaS providers only benefit from limited economies of scale. Although BaaS providers aggregate volumes from multiple customers and can negotiate prices down with their own banking partners and pass some of these savings to their customers, BaaS providers also add their own margin.
BaaS providers have been instrumental in the launch and growth of many fintech companies. The fintech ecosystem might not be as flourishing as it is today without the BaaS providers. But BaaS providers have some constraints. These constraints are the most limiting for fintech companies (i) with accounts and payments at the core of their product and (ii) processing more than 500,000-1,000,000 payments per year. The fintech companies that fit into that category will eventually outgrow and leave their BasS providers.
Successful fintech companies build products, technology, customer bases, teams, and capabilities that eventually enable them to become full-fledged financial institutions, have direct bank relationships and direct or indirect access to the payment schemes and networks, and leave their BaaS providers entirely.
This trend is also interesting for the ecosystem. Regulators get a better knowledge, understanding, and control over fintech companies as they become directly regulated as opposed to being simple agents. Banks too get a direct relationship with fintech companies and are able to serve them across all their needs, from cash management to capital markets to M&A.
Leaving a BaaS provider and becoming a payment or electronic money institution is by no means an easy thing. It has many moving parts. One of them is integrating and processing payments with a partner bank.
Numeral enables companies to automate and scale sending, receiving, and reconciling SEPA payments with their partner banks. Our cloud-based, API-first payment operations software abstracts the complexity of file-based bank connectivity solutions. Would you like to know how we support successful fintech companies such as Spendesk and Swile in becoming SEPA indirect participants? Simply subscribe to our newsletter to stay in touch.