The fintech industry has experienced a rapid boom in recent years, with Banking-as-a-Service (BaaS) emerging as one of the hottest segments.

BaaS providers have been able to attract significant funding from venture capitalists (VCs) thanks to the growing demand for their services. However, as we enter the year 2023, the Banking-as-a-Service landscape is facing several challenges that are putting the sector under pressure.

One of the primary difficulties facing BaaS providers is the lack of a clear definition of what the term means. Regulatory and operational structures differ between Europe and the United States, resulting in varying interpretations of BaaS depending on the location. As a result, some companies use the term “BaaS” to describe their products and services merely to attract funding and media attention–even when their offering has little to do with the term.

In the United States, BaaS refers to the provision of core banking services to third parties by companies holding full banking licenses, such as Cross River Bank, The Bancorp, and Sutton Bank. These banks act as back-end service providers to customer-facing fintechs, such as Stripe, Revolut, and Chime, and handle critical operations such as loan agreements and holding customer deposits. By doing so, they offer customer protection in the form of federal insurance in the given country.

Program managers are a subset of companies that handle the operational side of the relationship between BaaS providers and customer-facing fintechs. Galileo, Nymbus, and Treasury Prime are among the most well-known program managers.

They manage the network of providers sitting behind the customer-facing brand, which includes the core banking supplier but is not always exclusive to them. Program managers also bill themselves as “BaaS,” but they fulfill different roles than full license holders.

According to a recent BDO report, the market of BaaS is predicted to reach an impressive $74.5 billion by 2030, consequently blurring the boundaries between traditional banking and fintech institutions.

This shift has not gone unnoticed; BaaS providers in the United States face significant challenges from regulators presently. The Office of the Comptroller of the Currency (OCC) has taken a renewed interest in the fintech industry as a whole, with fintech-bank partnerships coming under particular scrutiny.

Blue Ridge Bank, which expanded its deposit base rapidly in 2020 and 2021 by offering its services to more customer-facing fintechs, faced action from the OCC for failing to maintain proper governance, for example.

As a result of this increased regulatory oversight, BaaS providers need to be more cautious in their growth strategies and choice of partners, and fintechs need to conduct extensive due diligence when choosing a license holder to work with.

This is especially true given the stark decline of 46% in fintech funding since 2022 when compared to the year prior. In the US, BaaS venture capital funding totaled $3.9 billion within the final quarter of the – more than any other region but still far beneath 2021’s total figure.

Another significant challenge for Banking-as-a-Service providers is increased competition, leading to overcrowding in the marketplace. The result has been larger providers acquiring smaller, specialized organizations, creating more trendy and valuable propositions to make themselves more attractive to customers.

This trend is likely to continue, leading to fewer banks entering the BaaS space, while program managers will become larger, offering customers fewer options in terms of providers.

Despite these challenges, the need for Banking-as-a-Service is not going away. The embedded finance that these companies enable has taken hold, with consumers seeking access to financial services whenever they need them.

The companies that will come out on top are those that will focus on complying with the regulatory environment and those that have already started on the path to acquisitions to bolster their core offerings.

The evolution of Banking-as-a-Service providers is a positive sign for the fintech industry as a whole. By becoming more robust and better equipped to provide the services that consumers and fintechs require, BaaS providers are contributing to the overall growth and maturity of the industry.

However, the sector still faces many uncertainties, such as the changing regulatory environment, increased competition, drop in venture capital investment, an uncertain economic climate, and a lack of clarity around what BaaS actually means.

For all of these reasons, BaaS providers must adopt an approach that prioritizes compliance with regulations while maintaining a focus on customer needs. With increasing competition, it is more important than ever for BaaS providers to focus on delivering value and staying ahead of the curve.


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