Banking as a Service as a concept has attracted much hype and for good reason. Indeed, there was a lot more to the proposition than just hype-the numbers were headline grabbing. The consultant community forecast that BaaS could be worth around €100bn by as soon as 2030. There was, after all, much evidence of increased consumer appetite, especially from millennials and Gen Z. Combine this with e-commerce firms tapping BaaS to improve the customer journey and the result was the claim that BaaS was set to change the relationship between consumers and the financial services sector. The position today, is not quite so straightforward as Alex Mifsud explains.
RBI: There’s certainly been a lot of talk about the future viability of Banking as a Service (BaaS) in the past year. How do you think the perception of the concept has changed in recent times?
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Alex Mifsud, CEO of Weavr:
Not long ago, BaaS seemed like a revolutionary model where fintechs and non-financial brands could offer financial products using a bank’s license. In this setup, banks avoided product development, marketing, and customer service, as these tasks were handled by the fintechs or brands, who in turn shared a portion of the revenue. This allowed established brands to boost monetisation and fintechs to innovate quickly without the slow, costly process of obtaining their own financial licenses.
However, reality has played out otherwise, and it’s increasingly accepted that the BaaS model, in its original form, is unlikely to survive. Over the past 18 months, the BaaS sector has been hit with several setbacks. In the US, many banks involved in BaaS have been hit with consent orders by regulators, which place them under strict scrutiny and limit their ability to expand. The collapse of Synapse, a middleware provider for Evolve Bank, highlighted serious risks when customer funds were mishandled, leading to lost funds for consumers.
Similar regulatory challenges have emerged in the UK and Europe. Companies like Railsr and Modulr faced scrutiny, with Railsr’s European license being revoked by the Lithuanian regulator, and Modulr was for a time restricted from taking on new business by the UK’s FCA.
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By GlobalDataRBI: If you could expand on that slightly and explain why exactly the BaaS sector is currently facing challenges?
Alex Mifsud:
Synapse’s collapse revealed a fundamental flaw in the BaaS model. Evolve Bank, which was supposed to be overseeing the fintech’s activities, had no clear records of which customer funds belonged to whom. Worse still, the bank’s records didn’t match the data stored in Synapse’s systems. This raised serious concerns that banks involved in BaaS lacked full control over the operations conducted on their license.
The core issue lies in the complexity of managing risk and compliance when a BaaS provider supports multiple fintechs and non-financial brands, each serving diverse customer bases. In theory, it makes sense for fintechs to take on a large part of the risk and compliance responsibilities, as they are closer to the customers and developing the products. However, fintechs often lack the resources or incentive to focus on compliance. They prefer to invest in customer acquisition rather than in risk management, leaving banks vulnerable.
Banks, as regulated entities, face severe consequences for compliance violations, making the BaaS model a risky proposition for them. Despite its potential for high returns, the structure often results in operational failures, as fintechs and non-financial brands are ill-equipped to manage the full scope of compliance, leaving banks exposed.
RBI: From your point-of-view, how does embedded finance differ from BaaS, and why is it considered a more effective solution?
Alex Mifsud:
Embedded finance, defined as the integration of financial services into non-financial applications, differs from BaaS in several key ways. While BaaS can be seen as one way to achieve embedded finance, it has serious limitations. As I’ve argued, the original BaaS model has inherent risks and shortcomings when it comes to compliance and risk management.
A better solution is the emerging trend of Embeddable Financial Solutions (EFS). EFS are pre-built, ready-to-use financial products that are designed to be integrated into non-financial applications. These solutions typically don’t include a user interface (UI) but are made available through APIs, which allow the non-financial application developer to integrate the financial functionality into their product.
The main advantage of EFS is that the risk and compliance responsibilities are handled by the financial institution providing the solution. This contrasts with BaaS, where the fintech often takes on some, and in some cases, much of this responsibility. With EFS, the financial institution ensures the product meets regulatory standards, so the non-financial application developer only needs to focus on integrating the solution into their app or platform. This reduces the complexity for non-financial developers, allowing them to focus on customer experience without the need for financial expertise.
As a result, EFS provide a safer, more efficient way to deliver embedded finance, addressing many of the challenges inherent in BaaS.
RBI: How does embedded finance compare to other current solutions when it comes to integrating financial functionality into digital services seamlessly?
Alex Mifsud:
While Embeddable Financial Solutions make it easier to create compliant financial products, integrating these solutions into non-financial applications still remains a challenge since interactions between the customer and the financial solution needs to be secure and tamper proof. Fortunately, new tools are emerging to help make this process smoother for developers, even those without specialised financial knowledge.
For example, components for identity verification, biometric authentication, and secure customer onboarding are now available as embeddable components. These tools ensure that sensitive customer data is protected and that the financial services meet the necessary regulatory standards. Similarly, integrating financial solutions into mobile apps is being simplified with software development kits (SDKs) that enable seamless integration with biometric authentication systems like TouchID, as well as with payment methods like Apple Pay and Google Pay.
These advancements allow non-financial app developers to easily integrate financial services while maintaining a high level of security and compliance. Developers can now focus on user experience and functionality, without having to become experts in financial regulations. This shift is making embedded finance more accessible and scalable for a wider range of developers, while still meeting the stringent requirements of financial institutions.
As these technologies continue to evolve, we are likely to see more seamless and secure integrations of financial functionality into everyday digital services. This will help democratise access to embedded finance and provide users with more integrated, frictionless financial experiences.
Alex Mifsud, CEO of Weavr
