The rules shaping the future of BaaS
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The rules shaping the future of BaaS
Banking-as-a-Service, it’s clear, is invariably dependent on a whole ecosystem of products and providers to exist and grow. The right conditions are now in place for BaaS to take off and shape banking experiences in its image. Regulators are catching up now, though, and may pivot BaaS in new directions:
Mitigating risk
Risk is a cornerstone concern driving how BaaS solutions are built. Notably, risk mitigation helped drive tech developers away from web scraping and move them into API development. That motivation has catalyzed an expansive who’s-who of backend-focused teams that are helping create innovative and secure financial solutions.
But risk may also begin to stratify BaaS providers according to variables outlined by regulators. In September, Acting Comptroller of the Currency Michael Hsu announced a new set of regulatory intentions targeting BaaS. The OCC will organize bank-fintech partnerships according to the risk profiles and other risk-related characteristics they share, and focus oversight accordingly, Hsu suggested.
While this may help regulators home in on risky BaaS providers efficiently and help those struggling institutions become more compliant, it can also help more compliance-focused providers differentiate themselves on the market and use regulatory approval as a vehicle for growth.
Partnership rights
As the number of BaaS-focused partnerships between banks and fintechs grows, so too does the need for clear partnership guardrails. Some of these partnerships have already encountered hurdles—both in the US and abroad. As Signzy Co-Founder Ankit Ratan told The Financial Revolutionist, some India-based banks have been burned by noncompliant partner fintechs that failed data-collection audits.
“There have been a lot of hiccups in India in past partnerships between banks and fintechs in terms of compliance,” Ratan said. “So banks are now creating identity infrastructure first, and then offering services as a BaaS.”
This concern for compliance has compelled banks to think more carefully about the kinds of partnerships they enter before launching BaaS offerings. This places compliance-focused Infrastructure-as-a-Service startups at an advantage—but also gives incumbent banks the upper hand. In the US, for instance, banks may emphasize their right to audit fintech partners in order to ensure AML and data-storage compliance.
That motivation comes in part from the content of Acting Comptroller Hsu’s comments in September.
“Who is responsible for what when things break?” he said. “How do banks and their third parties view and treat customers in bank-fintech arrangements? When do customers go from being the client to becoming the product, and how are consumer protections maintained?”
Finding the right size
BaaS providers and fintechs will remain cautious about their size. While BaaS providers see their modern solutions as a path for considerable growth, many smaller providers are also interested in remaining below the $10B in assets that exempt banks from the Durbin Amendment, which limits the size of interchange fees. While interchange-fee ploys are increasingly considered unoriginal and ultimately unsustainable in the face of competition, they remain a core part of many smaller banks’ and fintechs’ revenue strategies.
But at the same time, smaller BaaS players already face growing regulatory pressure, especially from the Consumer Financial Protection Bureau, which stated in April 2022 that it would examine nonbanks that pose a risk to consumers. This leaves many of these challengers in the lurch.
“Either these companies should be regulated like banks and belong in the banking system or they shouldn’t be and they’re properly outside of it,” said Konrad Alt, Partner at Klaros Group, in an interview with The Financial Brand. “I think, to some degree, the message to the fintech sector has been mixed so far. ‘You should be regulated like banks, but we don’t want you to be banks.’ It’s clear that that’s not a tenable long-term position for official Washington to maintain.”
While the BaaS space isn’t fully static, remaining in a holding pattern until regulators establish unambiguous mechanisms, clarity from regulators would help BaaS find its footing and expand sustainably.
