Can banks handle their own Banking as a Service?

Profitable as it is for banks to provide BaaS, outsourcing that service to third party vendors is putting banks at risk of losing control of the narrative.

The Indian market has been evolving their BaaS business models with many banks having started these initiatives in the past 12-18 months. (AP)

Indian Fintech is big and has helped many an industry achieve low-cost profits and customer experience, and banking is among the top. Indian FinTech is a formidable force to be reckoned with, with the finance ministry saying that the market will reach about US$160 billion by 2025. According to a 2022 report by BLinc Invest, the Indian FinTech market is already the world's third largest.

But being a FinTech and being a bank are different things. Yes, India is big on FinTech. But where does Indian banking stand when it comes to controlling its Banking as a Service (BaaS)? 

The Indian market has been evolving its BaaS business models with many banks having started these initiatives in the past 12-18 months. This has been fuelled by the Central Bank's push towards digitalization. 

Today, banks are leveraging technology by providing BaaS, either outsourced or directly.

For example, in 2016, the State Bank of India partnered with Uber to provide vehicle finance to drivers. OPEN, a FinTech, uses ICICI Bank APIs to manage payments, billing, and accounting for startups. In 2018, Snapdeal and Freecharge tied up with Yes Bank to provide instant refunds. Last year, the State Bank of India initially partnered with Cashfree for payouts and cash withdrawals.

The concept of BaaS is not a new one in India. In fact, YesBank and RBL Bank have been leading the industry through the many APIs they offer to developers as early as 2013.  

However, profitable as it is for banks to provide BaaS, outsourcing that service to third-party vendors is putting banks at risk of losing control of the narrative, says Riaz Syed, CEO of a FinTech 100 company, infinant. 

“In outsourced BaaS, a bank works with a BaaS provider, in essence outsourcing the technology to FinTech providers (for KYC, fraud, cards, etc.) brand relationship, customers, and partial compliance to a third party. The bank is at the bottom of the value stack in this model holding the funds in an FBO (for the benefit of) account,” he explains.

On the other hand, in direct BaaS, a bank licenses a SaaS platform that runs above its core and provides the ability for the bank to own the customers and accounts, partner selection, brand relationships and full oversight of compliance.

Challenges banks face in outsourced BaaS model 

When a bank is in an outsourced BaaS model, there is a lack of transparency and clear accountability in the fraud and risk management between the BaaS Provider and the bank.  This has led to finger-pointing between the bank and their BaaS provider when it comes to regulatory compliance. 

“The regulators have placed added scrutiny into the relationship between financial institutions and BaaS providers that are managing these programs. In some cases this has led to the shut-down of programs at the banks,” says Syed.

In addition, with recent bank closures that put the spotlight on banks having high-risk concentrations of deposit types (read SVB), banks are at higher risk when outsourcing their programs to a BaaS provider, since the bank does not have transparency into the customers being onboarded.

“Regulators are aware that numerous contractual arrangements can be made between the banks and FinTechs that determine which entity's customer facing onboarding channel is used, which ledger is used to track money movement, who is marketing to the customer, who provides customer service, and who is responsible for the many various regulatory requirements,” he says.

“Nonetheless, irrespective of branding, who is performing the “work,” or who is engaging with the customer, Regulators have largely determined that the bank is often the entity ultimately responsible for the customer using these financial services and products, regardless of how "ownership" of that customer may be perceived by the customer or the contracts between the various players. As such, if the bank is responsible but lacks transparency into the data, processes, and compliance of a BaaS provider, it becomes a complex model,” he adds.

For these reasons, we see the market shifting to direct BaaS, where banks have control of their SaaS tech stack, full ownership of their customers and account data with the ability to select their partners, and have total control over their governance, risk, and compliance requirements. This allows the bank the ability to partner with FinTech and brands but avoid the pitfalls of traditional, outsourced BaaS.

The other side

The other side of this argument is that banks have taken their time to innovate. But then came internet penetration, which brought with it wild ideas about enhancing customer experience above generic bank functions like interest payments, security of money and assets, etc. Only then did we start hearing terms like embedded banking, open banking, digital payments, and neo banks. Infused with technology, we now have FinTech, which has led to heightened customer expectations from traditional banks.

 “71% of consumers expect companies to deliver personalized experiences. Although banks have long sought this, they still struggle with the difficulties in data and technology,” Suresh Shankar, CEO & Founder of Crayon Data, says.

Payments is an area that has seen specific disruption, especially in India.

“With digital natives such as Gen-Z demanding a seamless CX as table stakes, and with the rapid escalation of competition from neo banks and FinTechs, the next few years will see a complete reshaping of the customer experience in the payments space. 86% of banking, FinTech, and payment companies agree that traditional payment providers will collaborate with FinTech and technology providers for innovation,” he adds.

Customer satisfaction is key

Will banks take back BaaS under their control? The answer to this question lies with how satisfied customers are with the service provided.

Banks are gradually evolving their BaaS business models, leveraging technology to provide either outsourced or directly. Outsourcing BaaS to third-party vendors puts banks at risk of losing control of the narrative, while direct BaaS allows banks to license a SaaS platform that provides them with full ownership of their customers and accounts, partner selection, brand relationships, and full oversight of compliance. 

With the rise of digital natives demanding a seamless customer experience, banks must innovate and adopt new technologies in a way that creates advantages for all and sundry. A technology alliance where the bank can license a cloud-native platform to run their brand and fintech programs, which means the banks can own and have full transparency and access to all customer, account and transactional data.

Navanwita Bora Sachdev is a freelance contributor and the Editor of The Tech Panda.